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Indirect Taxes (GST, HST, PST) – So Many Moving Parts

29/10/2012


My son asked me to help build a fire station with his Lego set. Lots of tiny pieces – 650 pieces to be exact. He was doing well on his own until he came to a point he needed my help. I played Lego as a kid and figured I was well qualified to help him out, but according to him, I should keep my day job. I found a piece I thought was what he needed. He used it but found out at the end we had a lot of re-work to get it correct.

Why the Lego story?

Let’s relate this to indirect taxes. There are a lot of moving parts and when a step is missed or an incorrect assumption is made, the results are not what was expected.

Indirect tax is one area that gets the least amount of attention in most businesses yet affects every transaction that takes place. There is often a lack of available resources, lack of knowledge; taxes are being overlooked, among many other reasons. In some cases, the business just did not know there were any indirect tax applications to even focus on.

Most small businesses cannot afford to dedicate full time resources to manage indirect taxes. They may not face complex issues and can manage with what they have available. The larger, more-sophisticated business has the ability to dedicate full-time resources to manage indirect taxes, yet many will not. In reality, a dedicated resource may be tasked with the responsibility but the person has limited training in the specific indirect taxes. The saying “you don’t know what you don’t know” hits home when an auditor shows up and picks out the low-hanging fruit. A costly mistake for most.

In reality, we see this as a calculated approach to managing risk. It’s not wrong, but costly when things go sideways. Most large organizations dealing with on-going complex indirect tax issues manage the risk better than others. They have to. They are likely to have dedicated indirect tax resources and leave few stones unturned. Otherwise, the tendency is to cover the basics and seek external guidance on an as-needed basis. Is there a need to better manage indirect taxes? The answer is yes.

The challenge we see, more today than we have ever seen, is that transactions are becoming more sophisticated and complex. The majority of the challenge (and risk) with indirect taxes is not being fully aware of the resulting consequences. How many employers with a pension plan actually know they have a GST/HST liability for the pension administration costs ‘supplied’ to the pension plan? Not many.

Due to the sheer volume of transactions and/or the dollar size of a significant transaction, the risk (and exposure) can be very high. Indirect tax legislation is complex and is only increasing in complexity as tax bases expand, rates keep changing, and provinces harmonize (...or de-harmonize), and new rules are introduced.

Indirect taxes are transactional, which can only mean they are widespread throughout the organization. They impact the accounting cycle, the information technology group, human resources, purchasing, sales, and so on. Risk usually increases when changes occur internally.

Here are common examples:

  • Changing accounting software or adding new modules;
  • Using different accounting software throughout parts of the organization;
  • Not centralizing the indirect tax decision-making process;
  • Employee turnover with the new employees not having any manual to follow;
  • Having to change the systems to collect tax at new/changed tax rates.

A common conclusion among those businesses that recover the full amount of GST/HST is that there is low risk with a ‘cash in and cash out’ concept. GST/HST is intended to be neutral among businesses that recover the full GST/HST as an input tax credit. What about retail sales taxes? What about other indirect taxes that do not provide a credit or refund mechanism? Each tax carries risk. Each transaction has indirect tax consequences. You may need to:

  1. Do nothing;
  2. Apply the tax, and/or
  3. Pay the tax.

Too many moving parts and no simple answer.

Is it a supply of property or service? Is it a service related to property? Is it supplied in Canada (or a province) or outside Canada? Can it be used in whole or in part in Canada (or a province)? Is it consumed in the business or supplied to another business? Is tax to be collected or self-assessed? Is the rate GST or HST? Should there be PST or no PST? Is the tax due now or later? Should the coffee be regular or decaf? But I digress...

Unfortunately, the indirect tax knowledge that must be built up in a business must also be integrated within the business operations so that the Information Technology group has been informed and has coded the systems to tie the transaction into the General Ledger. The ‘front-line’ may know what is to be taxed and what is exempt. The Accounts Payable and Purchasing groups may know what tax is payable as well as when it is not. If the IT group doesn’t have this knowledge, then the accounting systems won’t reflect the appropriate tax treatment.

In practice, we see businesses run into some major issues by entering into transactions and not looking into the indirect tax applications ahead of time and this will include cross-border issues outside of Canada.

Some examples include:

  • Is a non-resident entity doing business with Canada or within Canada? Carrying on business in Canada brings with it the host of indirect taxes to deal with. Are they exporting to one country but importing into another?
  • A business sells goods to a customer in another province. Does it make a difference if the customer picks up the goods and removes it from the province or if the supplier ships the goods to the customer? It does. The place of supply rules apply and can trigger not only HST but also PST on the same supply.
  • A Canadian business buys a vehicle in the US to sell in Canada to a Canadian customer. It hires another company to import the vehicle on their behalf. Who can claim the GST paid at the border? Is it the importer who does not actually own the vehicle? Maybe…maybe not. It all depends on the facts and how the legislation can be applied.
  • A business from Alberta does some construction work in Saskatchewan for a short period of time. They bring vehicles and equipment into Saskatchewan while performing their contract. Are they aware they owe PST on the equipment ‘imported’ into Saskatchewan for that short period of time? Many times they are not aware. The surprise comes when they receive an assessment notice in the mail or a request for information.
  • A business buys real property that is subject to GST/HST. They end up using it in an exempt activity and cannot recover the tax paid. Years later they sell the real property on a taxable basis. As a result, they have the ability to recover some or all of the GST/HST paid on the cost and any improvements. This is often overlooked resulting in an avoidable cost, albeit the tax recovery had to be deferred for a period of time.
  • Another Host of Issues Relates to Assessments

    A Notice of Assessment is a time sensitive document. A client recently received an assessment for outstanding ‘tax’. Once we reviewed the account, we determined amounts were being transposed on more than one occasion and the taxpayer owed more tax. The error also includes penalty and interest costs. These need to be reviewed and corrected within the timeline provided. Assessments of any kind need to be reviewed to determine the cost-benefit of challenging the assessment. This is also part of managing indirect taxes. Assessments carry with them hefty penalty and interest costs covering years of transactions and these can be significant. Preventative maintenance likely could have minimized those costs, but it is often too late once assessed.

    Indirect taxes present many facets that need to be understood. Be compliant with the tax. Pay your fair share, but no more. Overpaying indirect taxes by either paying tax in error or overlooking the ability to recover tax paid is a missed opportunity. Both compliance and recovery of taxes fall into the realm of managing indirect taxes.

    With so many moving parts in such a complex world, indirect taxes are just that much more complicated. Our advice? Focus more attention on indirect taxes, which should result in reduced business costs.