Revisions to draft GST legislation: do they affect you?
Canadian Indirect Tax News
September 2009 (09-8)
On September 23, 2009, the Department of Finance announced revisions to draft goods and services tax (GST)* legislation previously released in draft form back on January 26, 2007, as well as some newly drafted legislation for announcements made on that same day. Deloitte published a summary of the initial draft changes in February 2007. Although described by Finance as changes “affecting the financial services sector,” that’s not completely the case. Before you set aside this message, ask yourself if any of the following applies to you:
- Is your business a “financial institution”?
- Does your Canadian business transact with a non-resident branch?
- Does your business have an employee pension plan?
If you answered yes to any one of these questions, we recommend you read on.
Compared to the previous announcement (and our first summary), this announcement has some new rules and amends some others, but maintains the initial framework. The changes are generally favourable and come about from feedback the government received from the public since the earlier release. There are some new definitions, new elections, plus the introduction of expected new penalty provisions related to the Annual Information Return and extended filing deadlines for the annual GST return, all of which may be relevant to your compliance obligations. As we work to analyze the deeper impact of these changes, our objective here is to raise the most noteworthy points.
The initial draft legislation and announcements from January 26, 2007, proposed rules for certain financial institutions (qualifying taxpayers) with cross-border dealings requiring self-assessment on certain expenses incurred outside Canada, but related to Canadian activities.
The September 23, 2009 revised draft legislation amends the calculation of “qualifying consideration” (i.e., the base for GST self-assessment) by removing certain transactions relating to derivatives, and introduces some new definitions within the calculation. In order to relieve potential excess taxation on branch-to-branch transactions, the revised draft introduces an election for Canadian financial institutions that conduct business through foreign branches. The election permits a qualifying taxpayer to self-assess GST on the charges from the foreign branches similar to charges from foreign subsidiaries. Under the election, qualifying taxpayers will self-assess on inter-branch (internal) charges when treated as taxable income or profit in the foreign jurisdiction and as an income tax deduction in Canada. The election will be permitted to be made retroactively back to any specified year that ends after November 16, 2005.
Input tax credit allocation methods of financial institutions
The initial draft proposed rules for more precise input tax credit (ITC) determinations and support, subject to greater scrutiny and powers of control by the Canada Revenue Agency (CRA).
The revised draft contains several notable changes:
- Qualifying institutions (large banks, insurers or securities dealers) will be permitted to file an election to use their own ITC allocation method, under certain conditions, including when the CRA has not acted fairly and diligently in considering the qualifying institution’s method, does not meet notification parameters or the CRA proposes modifications to the method essentially rendering the method to be considered other than fair and reasonable.
- A new late filing election will permit more flexibility in the pre-approval process.
- The appeal process is revised to permit a financial institution to challenge the CRA in respect of directives imposed by the CRA on the financial institution’s ITC allocation method further to an assessment. This change allows the financial institution to appeal to the Tax Court of Canada where the CRA will bear the burden of proving in court that the CRA’s proposed method is fair and reasonable.
GST information return for financial institutions
The initial draft announced the introduction of a new GST annual information schedule for registered financial institutions with annual revenues over $1 million. This filing obligation became effective for fiscal years commencing after 2006.
The revised draft sets out the legislative framework for compliance and administration related to this filing and now refers to the document as a “return,” even though it does not relate to a monetary remittance requirement.
The new legislative framework sets out new rules, as follows:
- Specific penalties for failure to report or for misstatements of amounts required to be reported. Interestingly the penalties are calculated based on the reported figures (with a minimum of $1,000) even though there is no tax owing with the information “return.” There’s also ministerial discretion to waive or cancel these penalties and the ability for financial institutions to rely on a due diligence defence in getting these penalties waived.
- The fields on the information returns would be classified into “tax” amounts and “non-tax” amounts and it will be possible for the financial institutions to provide estimates for non-tax amounts for which the actual values are not reasonably ascertainable at the time of the filing of the return. Tax amounts are data that are use to provide an analysis of the more global amounts reported on the regular GST return, such as it relates to GST collected/collectible and adjustments, and total ITCs and adjustment amounts. Non tax amounts pertain to information that is not directly used in determining the tax liability, such as taxable sales, taxable purchases, and intra-group transactions.
- The Minister of National Revenue will have the authority to allow financial institutions to use estimates and exempt any financial institution or class of financial institutions from filing the information return.
Generally, these new rules came into force for years beginning after 2007, while the penalties would apply for fiscal years beginning after 2008.
Filing due date extension
Currently, unless they elect to file monthly or quarterly returns, “listed financial institutions” file GST returns annually. The GST34 return needs to be filed within three months after the end of the fiscal year. As for “selected listed financial institutions” (i.e., listed financial institutions that earn income in Canada, including the harmonized provinces), they are required to file a GST494 return in order to complete and report the special attribution method calculation. The GST494 must also be filed within three months after the end of the fiscal year.
Due to the added complexity of these filings, the revised draft proposes to extend the filing due date of GST returns (GST34 and GST494) for annual filers to six months after the end of the fiscal year. In other words, the filing due date would generally be the same as the one for income tax returns. Monthly and quarterly filers who also need to complete GST494 would also benefit from the extended filing due date. The proposed changes come into effect for reporting periods commencing after 2009.
Pension plan rebate and employer recovery claims
Finance has provided draft legislation that would give effect to its January 26, 2007 announcements, intended to impose Finance’s response to the case of The Queen v. General Motors of Canada Limited (FCA docket A-136-08, April 16, 2009) and to ensure that the GST recoverable on pension plan-related expenses will all be according to a rebate process applicable to all pension plans.
The proposed changes will be effective as of the September 23, 2009, date of the revised draft announcement, and generally are not proposed to be retroactive.
Nevertheless, there will be a degree of retroactive application, as outlined below, and some past GST recovery claims may be affected.
The following is a summary of the effects of the proposed recovery process:
- Participating employers that make supplies to a pension entity or otherwise expend resources on pension activities will be deemed to have collected GST from the pension entity and must report to the pension entity the amounts of that tax. The participating employer will be entitled to claim ITCs according to specific formulae.
- Pension entities will be entitled claim a rebate of 33% of the eligible amounts, which, generally are the expenses incurred by the pension entity or deemed supplied to it by a participating employer. No distinction is made between the so-called employer expenses and plan trust expenses as under CRA’s former policy.
- The rebate will be available to all pension entities, whether they cover employees of one or more employer, and whether the funds are held in a trust or by a separate funding corporation.
- Pension entities continue to be disqualified from claiming the rebate if 10% or more of the contributions are made by a listed financial institution. Finance has provided limited relief by allowing an election for a proportionate rebate to be claimed by other participating employees whose employees are covered by the plan. But the elections are only available where the participating employer is engaged exclusively in commercial activities (where it is a financial institution, including a de minimis financial institution) or all or substantially all in commercial activities (where it is not a financial institution).
- Elections will also be available to flow through rebate and ITC entitlements between participating employers and the pension entity, and between the participating employers. Again, however, these flow-through elections will generally not be available to participating employers that are engaged in a mix of commercial and exempt activities unless those exempt activities constitute less than 10% of its total activities.
- Detailed tracking rules apply on the deemed supply to the pension entity, or subsequent adjustments thereto, to ensure that no tax escapes.
- Participating employers will generally have to report at year-end to the pension entity on the deemed supplies to the pension entity. As a result, there will be some degree of retroactive effect of the new rules to expenditures incurred and costs incurred by a participating employer prior to the September 23, 2009 announcement.
- Special rules stream the expenses where an employer has more than one pension fund.
Summary of the effects of the proposed rules
- The amount of GST recovery available with respect to the administration of an employer’s pension plan will in many cases be reduced where the employer sponsor has been entitled to claim ITCs or rebates on investment management services (consistent with either General Motors or The Queen v. The Canadian Medical Protective Association, FCA docket A-243-08, April 16, 2009).
- In the case of pension plans that do not currently qualify as “multi-employer pension plans,” and the employer is not entitled to claim ITCs or rebates, GST recovery will now be available.
- The proposed amendments will impose an additional accounting burden on participating employers and plan administrators to track the deemed supplies by the employers to the plan entity.
- Furthermore, the accounting requirements to support the elections between participating employers and the pension entity or another participating employer may outweigh the benefit of the additional GST recovery afforded by the election, which would again reduce the total amount of GST recovery.
* All references to the GST include, where applicable, reference to the harmonized sales tax currently in force in the three Atlantic provinces, and proposed to be introduced in British Columbia and Ontario, effective July 1, 2010.