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20140506 Canada GST Cases - 4

GST/HST 201 - Intermediate GST/HST


Canada's federal value-added taxing system is called the Goods and Services Tax (the GST), and is provided for in Part IX of the Excise Tax Act (the ETA).  The GST is a 5% tax applied federally.  Since 1997, several Canadian provinces (like Ontario, Nova Scotia, New Brunswick and Newfoundland) have abandoned their traditional "retail sales tax" systems, in favour of harmonizing their rules with the federal GST, and charging a "Harmonized Sales Tax" (HST) in their particular provinces, over and above the 5% federal rate.

We refer to the combined taxes as GST/HST, and they can vary depending on the particular province of the supply.

How the GST/HST Applies

While commonly considered a single tax, the federal GST/HST is actually imposed under three separate taxing divisions. Each taxing Division is aimed at a distinctly different type of transaction. Together, the three taxing Divisions create a comprehensive web of taxation, whose basic design is to tax virtually every domestic supply of goods, services, and intangibles,[1] as well as most goods,[2] services, and intangibles imported to Canada.

Under Division II of the ETA, for example, GST and HST is imposed on domestic supplies, which are referred to as taxable supplies made in Canada.[3] 

In turn, Division III imposes GST on most goods imported on a commercial basis, and also imposes the GST and the HST on goods imported on a casual (non-commercial) basis,[4] while Division IV imposes GST and HST on a number of imported taxable supplies which are defined to include certain services and intangibles acquired outside of Canada , but consumed, used or enjoyed in Canada.[5]

(Throughout, we will refer to GST/HST as the combined GST and HST applies in any given situation.  Where we refer to GST alone, we mean to refer to only the 5% component of the federal GST.  Where we refer to HST, we mean to refer to the varying provincial harmonized tax that applies at varying rates depending on the particular Canadian proviocne of the supply.)

Quite apart from the three "taxing" divisions in the ETA, there are also a number of provisions aimed at relieving GST/HST in certain situations.   These "exemptions" and "zero-rating" provisions may be found in Schedules V and VI of the ETA respectively.[6]   These special provisions are discussed further below.

What this all means is that persons engaged in even the simplest of commercial or cross-border transactions often find themselves facing a number of very complex GST/HST issues, sometimes resulting in the imposition of GST or GST and HST under one or more of Divisions II, III or IV, and sometimes, with proper structuring, resulting in the imposition of no GST or HST whatsoever.

Division II & Taxable Supplies Made in Canada

When people speak of the GST or HST, they are most often referring to the GST/HST that is imposed by sections 165 of the ETA, which is a Division II tax, and which applies to every recipient.[7] of a taxable supply made in Canada. While imposing a tax only on domestic supplies (i.e., taxable supplies made in Canada), Division II affects a large number of cross-border transactions, including supplies made in Canada by registered.[8] non-residents,[9] unregistered non-residents who carry on business in Canada, and supplies which are drop-shipped in Canada on behalf of unregistered non-residents. Division II can also affect certain goods, services and intangibles seemingly exported from Canada.

There are a number of general rules governing when Division II tax will apply, and when a non-resident supplier will be required to register for the GST, and enter into the GST system, some of which are discussed below.

What is a Taxable Supply under Division II ?

Before attempting to determine whether a supply is made in Canada or outside Canada (and therefore inside or outside the scope of the Division II tax imposed by section 165), an appropriate first step would be determining whether the particular supply is "taxable", or whether it is exempt or zero-rated.[10]

A "taxable supply" is defined in subsection 123(1) of the ETA to be a supply that is made in the course of a "commercial activity". Since commercial activity is defined quite broadly, a taxable supply would generally include most supplies made in the course of a business, or in an adventure or concern in the nature of trade. Significantly, however, a taxable supply specifically excludes the making of exempt supplies that are enumerated in Schedule V of the ETA.[11]

Supplies Made in Canada

If a supply is taxable, one can then proceed to determine whether that supply is made in Canada or outside Canada.[12] Section 142 of the ETA contains a number of general rules for determining when a supply is made in Canada, usually referred to as the place of supply rules. Under these place of supply rules, one is theoretically able to determine how any supply connected to Canada will be treated for GST/HST purposes.  For example, if the transaction involves a sale of goods, the supply would be considered to have been made in Canada if the goods are delivered or made available to the purchaser in Canada.  Other rules apply for other types of supplies (e.g., supplies of leased goods, services, intangibles or real property).

Once a supply is found to be "made in Canada", the GST will apply.  Other HST Place of Supply rules then need to be considered to determine whether any HST will apply, and if JST applies, what particular HST provinces rate applies.  Note that where a particular supply is found to have been made "outside of Canada" under the GST rules in section 142, it will also be deemed to have been made outside of any HST province, meaning that no HST will apply either.

Special Non-Residents Rule

The place of supply rules found in section 142 must always be read in conjunction with a number of other rules which affect the determination of whether a particular supply is made in Canada for purposes of the Division II tax.  For non-residents, the most important of these rules is found in section 143 of the ETA, which we will refer to as the special non-residents rule.

The special non-residents rule deems all supplies of property and services made in Canada by non-residents to be made outside Canada, unless (a) the supply is made in the course of a business carried on by the non-resident in Canada, or (b) the non-resident was registered for the GST?HST at the time the supply was made. The effect of this rule is to make the ETAs general place of supply rules inapplicable if the transaction involves a supply made by unregistered non-residents, not carrying on business in Canada.  When the special non-residents rule applies, it operates to deem any supplies made by the non-resident to be completely outside the GST system.  That means that the non-resident would remain completely exempt from any requirements to register for the GST, or to charge and collect the GST/HST on its supplies made to Canadians.[13]

The potential significance of this rule makes the meaning of terms like non-resident, registered, and carrying on business in Canada quite important.

Residents & Non-Residents

While a complete discussion is outside the scope of this discussion, the ETA does have rules regarding the meaning of "resident" and the meaning or "non-resident".  For example, section 132 of the ETA provides that a corporation will be considered a resident of Canada if it has been incorporated or continued in Canada , and not continued elsewhere.  A corporation will also be considered a resident if it satisfies the common law tests for residency namely, if the corporations central management and control is located in Canada.

While this might suggest that only corporations incorporated or continued outside of Canada or with central management and control in Canada will qualify as non-residents, the ETAs permanent establishment rules can also affect that determination as well.

Permanent Establishments

Subsection 132(2) of the ETA deals with permanent establishments for non-residents, and provides that where a non-resident person has a permanent establishment in Canada , the non-resident shall be deemed to be resident in Canada in respect of, but only in respect of, activities that are carried on through that permanent establishment. The effect of this rule is to exclude the now-deemed-resident from the application of the special non-residents rule in section 143 although that exclusion would only relate to supplies carried on through the permanent establishment.[14] This means that a non-resident with a Canadian permanent establishment might (unhappily) find that some of its Canadian business activities have succeeded in drawing it into the GST/HST system, and requiring it to take positive steps to register for the GST/HST, and to begin charging, collecting, and remitting the GST/HST to the Canada Revenue Agency (the CRA).  Furthermore, and to the extent the non-resident becomes GST/HST registered, the special non-residents rule would no longer be available to any of the non-residents activities.

In many respects, the significance of having a permanent establishment for GST/HST purposes is not unlike the significance of having one for purposes of the Income Tax Act as read in context of many of Canada s international treaties.

Carrying on Business in Canada

As previously indicated, the other main requirement for use of the non-residents rule in section 143 is that the non-resident must not be carrying on business in Canada . The concept of carrying on business is not defined in the ETA, and falls to be determined by the facts of the situation. A number of legal tests have also been developed, largely from jurisprudence under the Income Tax Act.  That jurisprudence suggests that to determine whether a person is carrying on business in Canada requires a factual-based analysis, focused on a couple of primary factors, and an inexhaustive set of secondary factors.[15] Based on these two factors, the mere advertising of products for sale in Canada (invitations to treat and not formal offers for sale) has not generally been regarded as sufficient activities to result in the carrying on business in Canada.

More recently, however, the CRA has begin to detract from its focus on two primary factors referred to above, in favour of a more general place of operations approach, first set out in a July 2002 Technical Information Bulletin B-090: GST/HST and Electronic Commerce.  (Please click here for a link to the CRA Website and the most up-to-date version of this TIB).

The upshot of this new approach is that the CRA has effectively done away with "the place the contract was made" criteria, relegating it to just one of a number of criteria that are relevant to determining the place of operations and thereby increasing the uncertainty of non-residents attempting to understand whether they are required to register for the GST.[16]

It is also apparent that these changes were developed by the CRA because of some concerns that electronic commerce-type businesses might be gaining an unfair advantage in Canada (i.e., relative to their brick and mortar competitors, it was much easier to avoid registration for the GST/HST).

GST/HST Registration Rules

GST/HST registration can either be required or voluntary.

Registration is generally required where a person is engaged in "commercial activities" in Canada (making "taxable supplies"), and after the persons surpasses the so-called "small supplier" trhreshold - currectly $30,000 in any preceding 4 quarter period (e.g., A business starts up October 1, 1997, and makes the following taxable supplies in Canada:   $18,000 in 1997-Q4, and $16,000 in 1998-Q1.  The business is a small supplier in 1997-Q4 and 1998-Q1, but not thereafter.  The business is required to be GST/HST registered for 1998-Q3).[17]

Once that small supplier threshold has been passed, the busienss is required to register for the GST/HST and begin charging and collected GST/HST in respect of its taxable supplies made in Canada.

Once a person is registered for the "GST", they are automatically registered for the HST.

Quite apart from "required registration" there are special rules in subsection 240(3) of the ETA that permit persons engaged in a commercial activity in Canada to voluntarily register.  These voluntary registration rules were broadened in 1996 and extend voluntary registration to non-residents who regularly solicit orders for the supply of goods to Canada, as well as non-residents who supply services to be performed in Canada, and intangibles that are to be used in Canada or otherwise related to Canada.

Accordingly, even if a non-resident successfully ensures that its business activities are not carried on in Canada, there may be advantages to registering for the GST/HST system, such as the eligibility to recover the GST/HST that they themselves pay on their inputs through claiming input tax credits (ITCs) under section 169 of the ETA (which allows registered persons to claim ITCs, to the extent they were engaged in commercial activities.[18]  For example, for non-residents who are required to pay GST/HST in order to carry on their activities (e.g., a non-resident selling goods into Canada on a delivered basis, who would be required to pay the GST at the border, under Division III: see infra), GST registration may provide an opportunity to fully recover that GST resulting from these activities.  While there are other ways of unlocking the GST (e.g., ITCs under section 180, application of the Drop-Shipment Rules in section 179 of the ETA), many times, simply registering for the GST is the easiest process to recover the GST.

That all said, with GST registration comes the administrative headaches of properly complying with one's GST obligations, which include regularly filing GST/HST returns, ensuring that the GST/HST is properly charged, collected and remitted, and a whole host of other obligations and considerations.

Division III & Imported Goods

Division III is entitled Tax on Importation of Goods, and imposes tax on every person who is liable under the Customs Act to pay duty on imported goods, or who would be so liable if the goods were subject to duty. [19]  Accordingly, the Division III tax applies to most goods imported into Canada.

Somewhat like the situation under Division II, the non-resident supplier of the imported goods is under no obligation to charge or collect tax.  On the other hand, since the importer of record is generally the one paying the Division III tax when clearing the imported goods at the border, a non-resident might well find itself on the paying end of the equation depending on the delivery terms of the particular goods.  Thus, even if an unregistered non-resident has successfully shielded itself from any Division II tax obligations perhaps because of the special non-residents rule in section 143, Division III tax can still apply to the goods being imported to Canada.  Furthermore, and because there is no provision in the ETA creating a mutual exclusivity between Division II and Division III taxes, there is a real potential for double-taxation to exist in these types of cross-border transactions, with both Division II and Division III tax being payable in some instances.

(In our experience, confusing the application of Division III GST, with the collection obligations in Division II, is the single most common audit problem for non-residents new to the Canadian GST/HST system).

De facto Importer

Section 178.8 of the ETA is a complex provision aimed at addressing the de facto importer issue, and which imposes certain GST/HST obligations on what CRA determines to be a constructive importer to Canada.

In simple terms, this issue occurs when goods are supplied outside Canada and subsequently imported into Canada with the supplier, rather than the recipient of the supply, acting as importer of record, and thus paying the Division III tax (and applicable duties) and claiming an ITC.  The CRA historically took the position that since the supplier is not the user or consumer of the goods in Canada nor importing the goods for the purpose of supplying them in the course of their commercial activities which are prerequisites to ITC entitlement pursuant to paragraph 169(1)(c) they are not entitled to claim an ITC.  Whether the CRAs position was ultimately correct was rendered moot with the enactment of the rules in section 178.8.   These provisions now legislatively ensure that only the recipient of the supply made outside Canada (i.e., the de facto importer) is entited to claim an ITC for those goods when imported to Canada. - consistent with the CRAs theory that only that recipient would be the user or the consumer of the goods in Canada.[20]

Division IV & Imported Taxable Supplies

The third taxing division under which GST might be payable is Division IV, which is entitled Tax on Imported Taxable Supplies Other than Goods, and which imposes tax on every recipient of an imported taxable supply.

Since an imported taxable supply is defined quite broadly, Division IV captures most transactions not otherwise taxable under Divisions II or III and, as indicated above, can catch a number of international transactions involving services or intangibles. The rules defining imported taxable supplies are remarkably complex, and to the extent taxpayers are again involved in somewhat less than exclusive commercial activities, special attention should be paid to these rules. They will create a self-assessment tax in respect of amounts paid abroad for the use of intellectual property, and other intangibles or services, to the extent the services or intangibles that are being acquired for use otherwise than exclusively for commercial activities. In other words, if a Canadian resident is involved in some exempt activities, there may well be a Division IV self-assessment obligation imposed on it each time services or intangibles are acquired abroad.

For domestic supplies, the principal exceptions are goods, services, or intangibles enumerated in Schedules V or VI of the ETA, which provide for certain exempt and zero-rated supplies, respectively. 
Schedule VII of the ETA enumerates certain goods that, when imported to Canada , may be imported on a non-taxable basis. 
See subsection 165 of the ETA, which provides as follows:

165.(1) Imposition of goods and services tax - Subject to this Part, every recipient of a taxable supply made in Canada shall pay to Her Majesty in right of Canada tax in respect of the supply calculated at the rate of 7% on the value of the consideration for the supply. 

See section 212 of the ETA, which provides as follows:

212. Imposition of goods and services tax - Subject to this Part, every person who is liable under the Customs Act to pay duty on imported goods, or who would be so liable if the goods were subject to duty, shall pay to Her Majesty in right of Canada tax on the goods calculated at the rate of 7% on the value of the goods.

Section 212 must be read in the context of various definitions and rules in the Customs Act and Customs Tariff, as well as Schedule VII of the ETA: see again note 3, supra. 

See section 218 of the ETA, which provides as follows:  218. Imposition of goods and services tax - Subject to this Part, every recipient of an imported taxable supply shall pay to Her Majesty in right of Canada tax calculated at the rate of 7% on the value of the consideration for the imported taxable supply.Section 218 must be read in the context of a complex definition of imported taxable supply, found in section 217. 
One of the more important zero-rating provisions is found in Part V of Schedule VI of the ETA, and zero-rates most goods, services, and intangibles exported from Canada.  These provisions are consistent with the other aim of the ETA, which is to remove the GST from any Canadian goods, services or intangibles competing in the international markets. 
A recipient is defined in subsection 123(1) of the ETA to be the person liable to pay for the supply under a written or oral agreement, or as a matter of law. Special rules apply where no consideration is payable for the particular supply. 
Registered is used to refer to persons who are registered for the GST in accordance with the applicable requirements in the ETA (found in subdivision d of Division V). Note that the term registered is used in contra-distinction to the term registrant. While registered refers to a person who is actually registered for the GST, the term registrant refers to a person who is registered, or who is required to be registered: see subsection 123(1) of the ETA. 
like under the Income Tax Act, the term non-resident is, for GST purposes, used in contra-distinction to the defined term resident: see section 123(1). For the ETAs rules on residency, see section 132. 
This is because the Division II tax only applies to taxable supplies made in Canada. 
A taxable supply will also include the sorts of zero-rated supplies that are enumerated in Schedule VI of the ETA, since the concept of a taxable supply includes zero-rated supplies: see the definitions of commercial activity, exempt supply, and taxable supply, all found in subsection 123(1) of the ETA. The difference between the two is simply that a taxable supply is taxed at a GST rate of 7%, while a zero-rated supply is taxed at a GST rate of 0% effectively removing the GST from the zero-rated supply altogether. 
In reviewing the general and specific rules discussed infra, and in determining whether a particular taxable supply is made in Canada or outside Canada, remember the significance of these rules: (1) Where a taxable supply is made inside Canada it will be taxable under Division II, and not generally taxable under any other provision in the ETA (although there are some exceptional situations where double-tax can occur); (2) If, on the other hand, the taxable supply is made outside Canada, it will be outside the purview of Division II tax, and would only be subject to GST, if at all, under Division III (imported goods) or Division IV (imported services and other intangibles). 
Note the distinction between charging, collecting and remitting the Division II tax on supplies made by the non-resident in Canada, and the non-residents obligation to pay GST at the border on goods imported to Canada under Division III (discussed infra). 
A logical conclusion, however, might be that since a permanent establishment exists, for at least one purpose, the non-resident is actually carrying on business in Canada, which would deprive the non-resident from use of the section 143 rule in its own right. 
In the GST context, the CRA has indicated that other factors would include: (a) the place where the goods were delivered, (b) the place where the payment was made, (c) the place where the goods in question were manufactured, (d) the place where the orders were solicited, (e) the place where the inventory of the goods is maintained, (f) the place where the company maintains a branch or office, (g) the place where agents or employees, who are authorized to transact business on behalf of the non-resident person, are located, (h) the place where bank accounts are kept, (i) the place where back-up services are provided under the contract, and (j) the place in which the non-resident person is listed in a directory: see GST Memoranda GST 200-1-1, Chapter 2, Section 2.5 (May 1999). The two primary factors being:

(a) the place where the contract for the supply was made; and

(b) the place where the operations producing profits in substance take place.

In terms of the place where a contract is made, the jurisprudence generally accepts that the important elements of the contract are its offer, and its subsequent acceptance, and that the place the contract is accepted is the place where the contract for the supply is made.

Significantly, the CRA in its GST Memoranda Series 2.5 (Non-Resident Registration, June 1995) initially confirmed that the concept of carrying on business ought to focus on the two primary factors above, with the place where a contract is concluded being the place where the offer is accepted.{ref}For further reference to the meaning of carrying on business, see: W. Jack Millar and Dennis A. Wyslobicky, Cross-Border Transactions: Retail Sales Tax and Non-Resident Vendors (September 1986) A paper presented at the 1986 CICA Annual Symposium (Toronto: CICA, 1986), at pages 8 through 30. 

Previously it was fairly easy to provide a non-resident with the opinion that the non-resident was not carrying on business in Canada: Step 1: Ensure that all contracts are accepted outside of Canada, and that there are no agents with the authority to accept them in Canada; Step 2: Ensure that most of the other factors listed by the CRA (and referred to above) were minimized. Now the situation is much less clear, and that makes is much more difficult to advise a non-resident that it is not carrying on business in Canada, and therefore relieved from registering for the GST. 
See section 240 of the ETA. Note that the most important exception to this general registration requirement is for small suppliers, who would be exempted from registration provided their world-wide taxable supplies (including supplies by certain related persons) remained below $30,000 annually. For the precise rules regarding small suppliers, see subsection 123(1), and sections148 and 148.1 of the ETA. 
See section 169 of the ETA, which provides in part as follows:

169.(1) General rule for credits - [W]here a person acquires or imports property or a service and, during a reporting period of the person during which the person is a registrant, tax in respect of the supply, importation becomes payable by the person or is paid by the person without having become payable, the amount determined by the following formula is an input tax credit of the person in respect of the property or service for the period .

The formula referred to generally pro-rates the GST recoverable based on the extent to which the person was engaged in commercial activities. If engaged completely in commercial activities, the person would be entitled to a full ITC. On the other hand, persons engaged completely in exempt activities would be precluded from claiming any ITCs, making the GST they pay unrecoverable, and a hard cost. 

Section 214 provides that Division III tax shall be paid and collected under the Customs Act as if the tax were a customs duty levied on the goods. In turn, the Customs Act provides that the person who reports the goods in accordance with that Act (i.e., the importer of record), is jointly and severally liable, along with the owner, for the duties levied on the imported goods. Accordingly, Division III tax is often applied to persons not actually owning imported goods, but merely reporting them for customs purposes. 
The CRAs theory breaks down in the case of lessors, who might well be importing goods for the purposes of supplying them, by way of lease, to recipients in Canada. In that instance, the lessors would in fact be supplying the goods in Canada. 

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