HST Tips and Traps for Lawyers - The Canadian Business ... Tips and Traps... · Other Commodity Tax regimes • Lawyers whose firms carry on business/serve clients situated outside

HST Tips and Traps for Lawyers

Carl Irvine

Ontario Bar Association’s Institute 2015

Current Issues in Taxation Law

February 4, 2015

2

Introduction

• Basics of the GST/HST Regime

• Key Concepts

• Other commodity taxes

• Common HST traps for lawyers

o Starting a business/ HST registration

o Addressing HST in commercial agreements

o Failing to provide/obtain “prescribed information”

o Failing to file a Section 167 Election in respect of the Sale

of a business

o Settling, modifying or terminating contracts

o Directions, Nominees and Agents in real property

transactions

3

Basics of GST/HST regime

• HST imposed in “participating provinces” - ON, NS, NB, NFLD

and PEI

o HST imposed at rate equal to 5% federal portion and

relevant provincial portion (i.e., 8% in Ontario)

• GST imposed at 5% rate in “non-participating provinces” - BC,

AB, SASK, MB, QC – and the three territories

• GST/HST is imposed on “taxable supplies”

• no GST/HST is imposed on “exempt supplies” or “zero-rated

supplies”

• Certain otherwise taxable supplies are not subject to GST/HST

o “Indians” and “Indian bands” – s.87 of the Indian Act

o Certain provincial and territorial governments – s.125 of the

Constitution Act, 1867

4

Basics of GST/HST regime

• Appropriate GST/HST rate is determined by “place of supply”

rules in ETA and related regulations

o “place of supply” depends on the nature of the supply

o significant changes to these rules in 2010, particularly for

services

o Draft GST/HST TIB-103, Harmonized Sales Tax – Place of

supply rules for determining whether a supply is made in a

province

5

Key Concepts

• “Taxable supplies” (other than “zero-rated” supplies) are

subject to HST

• “Zero-rated” supplies are taxable supplies, but at a 0% tax

rate (therefore, tax-free) includes:

o basic food and groceries, prescription drugs, certain

medical devices

o many supplies to non-residents of Canada (including,

importantly, many of our legal services)

• “Exempt supplies” are not subject to HST includes:

o most financial services, many health care services and

supplies of used residential real estate.

6

Key Concepts

• “supplier” is the person who makes supplies (i.e., the vendor)

• “recipient”, means:

o where consideration for the supply is payable under an

agreement for the supply, the person who is liable to pay

that consideration

o other rules where no agreement (not discussed here)

o “recipient” for GST/HST purposes is the person who is

liable to pay for the supply, not necessarily the person

who receives it

7

Key Concepts

• “Commercial activity” includes

o a business, or adventure or concern in the nature of trade,

except to the extent it relates to the making of “exempt

supplies”, and

o a taxable supply of real property, including anything done

in the course of or in connection with the making of the

supply

8

Key Concepts

• An HST registrant can generally claim an “input tax credit” (an

“ITC”) to recover HST that it incurs in respect of property or

services to the extent they are used, consumed or

(re)supplied by the registrant in the course of a “commercial

activity”

o if they make taxable supplies, generally can recover HST

on inputs

o if they make exempt supplies, generally can’t claim ITCs

to recover HST on inputs

o an allocation of inputs between exempt and taxable

supplies may be required

• Key distinction between zero-rated and exempt supplies is

that a supplier making zero-rated supplies can generally

claim ITCs

9

Other Commodity Tax regimes

• Lawyers whose firms carry on business/serve clients situated

outside of Ontario need to think about other commodity tax

regimes

• QST is generally similar to HST and is imposed at rate of 9.975%

(combined with GST, 14.975%)

o (almost) fully harmonized with HST

• BC, SASK, and MB also impose PST on sales of goods and

certain services

o legal services are potentially taxable

o collection of PST is a difficult issue for lawyers working at

national firms

o not at all harmonized with HST

Common HST issues/traps for Lawyers

• Starting a business/HST registration

• Addressing the HST in commercial agreements

• Failing to provide/obtain “prescribed information”

• Failing to file a Section 167 Election in respect of the Sale of

a business

• Settling, modifying or terminating contracts

• Who is the recipient of the supply? Directions, Nominees and

Agents in real property transactions

10

Starting a Business – HST Registration

• One of the key questions for clients establishing a new

business will be about GST/HST registration

• Generally, if you’re making a taxable supply in Canada in the

course of a commercial activity, you need to register for

GST/HST purposes

• Three important exceptions:

o “Small supplier”

o Supply of real property outside of course of a business

o Non-resident who does not carry on business in Canada

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• Question of whether a non-resident is “carrying on business

in Canada” for GST/HST is a mixed factual and legal

question and can be complicated.

• Generally, CRA requires that a non-resident have a regular

and continuous presence in Canada,

o Not merely transitory or temporary – See CRA Policy

Statement P-051 “Carrying on Business in Canada”

o Long list of factors that CRA will consider in determining

whether a non-resident is carrying on business in Canada

o Some of these factors diverge from the common law legal

principles

• The analysis is complicated (and be careful, the analysis is

different for income tax)

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• In many instances, if there is uncertainty about whether or not

a client has to register, the easiest solution is to register

o Allows client to claim ITCs

o Can usually be done over the phone (but not for non-

residents)

o Not a particularly onerous obligation (not always

understood by foreign clients)

• In some cases a person not required to register may choose

to voluntarily register for GST/HST purposes

13

Trap: Failing to Register for HST

• Two main risks around failing to register for GST/HST

• First, liability for uncollected GST/HST

• A person making taxable supplies is required to collect

GST/HST if they are required to register, regardless of

whether they do or no

• Can be assessed for failure to remit GST/HST and

interest

• If assessed, it can be difficult to collect HST from clients

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• Second, unregistered supplier can’t claim ITCs on GST/HST

on own inputs

• In the context of a new business, the supplier is often

incurring significant expenses prior to making taxable

supplies

• If registered, it should generally be entitled to claim ITCs

to recover such expenses

• If not registered, it may not be able to claim ITCs

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• Example

o Bob is opening a new restaurant

o Hires you to review his lease agreement

o He enters into a lease for premises

o Hires a contractor to renovate the premises

o Buys equipment, inventory, etc.

o Registers for HST and opens for business

• What’s the problem?

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• Example

o Bob retains you to assist it in buying a new business

o You incorporate a new company to buy the business

(“Newco”)

o Newco retains professional service providers to assist in

the purchase of the business (including you)

o Immediately prior to closing, you register Newco for

GST/HST purposes

o What’s the problem?

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Avoiding/Fixing the Trap

• Ideally, you should have clients register as early as practical

o In some cases, this may also require

incorporating/forming the operating business vehicle early

in the process (i.e., not the day before closing)

• CRA will register a taxpayer with retroactive effect up to 30

days prior to the application at the request of the taxpayer

o For newly incorporated/formed entities, be sure to indicate

that the effective date is the date of

incorporation/formation, not the date of application

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• Because a person is a “registrant” when they are required to

register (i.e., generally when they make their first taxable

supply in Canada), regardless of whether they have actually

registered, the CRA will agree to backdate registration to the

date of that supply

o Typically such a request must be made in writing and

must be supported by proof that the registrant was making

taxable supplies

o However, this approach has limitations for new

businesses

19

Commercial Agreements

• HST should be considered in all commercial agreements

o Purchase and sale agreements

o Supply agreements

o Independent contractor agreements

o Manufacturing agreements

o Management agreements

o License and royalty agreements

o Leases

o Service contracts

o Retainer agreements

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• Important considerations include:

o Are supplies taxable or exempt? If taxable, zero-rated?

o If not zero-rated, does GST or HST apply?

o What HST rate applies?

o Is the provincial portion of the HST relieved (e.g., books)?

o Is GST/HST included in price, or is price tax-exclusive?

o Does the agreement provide that the recipient will pay any

applicable GST/HST (or other taxes)?

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• Key point is if the supplier is registered for (or required to

register for) HST, it is generally required to charge and collect

HST on taxable supplies (other than zero-rated supplies)

made in Canada

o Although a tax on the recipient, the supplier is required to

remit it to the CRA periodically (subject to any permitted

deductions, such as ITC claims)

o Supplier is generally required to remit tax regardless of

whether it is actually collected

o If you are acting for the supplier, you want to be certain

that it can collect all applicable HST

22

Trap: Failing to Address Tax

• Silence on liability for taxes creates commercial uncertainty

between the parties as to who bears the cost of HST and

other taxes

o Is purchase price tax inclusive or exclusive?

o Who bears liability if exempt/zero-rated supply turns out to

be taxable?

o Who bears liability if applicable GST/HST rate is higher

than expected?

o What right does the supplier have to collect HST from the

recipient?

• In the absence of tax language, how do you know if the

parties have actually agreed on these points?

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• In the absence of some tax language, the supplier and

recipient may disagree on who is liable for HST

• Generally, if an agreement is silent on HST, the courts have

interpreted the agreement as being tax-exclusive

o But… this is not universally true, and depends on the

interpretation of the particular agreement and the

reasonable understanding of the parties

o Do not assume that agreement is tax-exclusive!

• If the agreement is interpreted as being tax-inclusive, the

supplier bears the economic cost of the HST

24


• Under ETA, supplier has a right to sue the recipient of a

supply to collect HST payable

o But… can only sue to recover HST under the ETA after it

has been remitted to CRA

o Arguably better to have a contractual right

• If there’s uncertainty as to the characterization of HST, the

supplier bears the risk

o interest and possibly penalties for late/non-remittance of

HST are imposed on the supplier, not the recipient (or, at

least, not usually)

• As a practical matter, it may be harder to collect HST from the

recipient unless the commercial agreement expressly

provides that they will pay HST

25

Avoiding the Trap

• Agreements should clearly address responsibility for taxes

(including, but not limited to, HST)

• When acting for a supplier, commercial agreements should

have some tax language:

o Basic Example: “X. In consideration for the sale of

goods hereunder, the purchaser shall pay to the vendor

and amount equal to [the contract price] and any

applicable taxes.

• Even if it is expected that the supply will not be subject to

HST (or other taxes), its better to address the issue of taxes

ahead of time in case the law changes or the CRA challenges

the characterization of the supply

26

Avoiding the Trap

• In some case, the recipient may want to shift the

incidence/risk of HST to the supplier, in which case you might

consider a tax-inclusive price provision such as:

o X. In consideration for the sale of goods hereunder, the

purchaser shall pay to the vendor an amount equal to the

[Purchase Price], which amount shall be inclusive of any

applicable taxes.

• This language often arises in context where parties believe

that supply should be zero-rated or exempt, but want to shift

the risk arising from recharacterization or change in law to

the supplier

27

Prescribed Information

• In order to claim ITCs, an HST registrant must obtain

“prescribed information” supporting their ITC claim prior to

filing their HST return for the reporting period in which the

claim is made.

• Contents of the “prescribed Information” is set out in the Input

Tax Credit Information (GST/HST) Regulations

28

Prescribed Information

• Prescribed information includes:

o the supplier’s name or trading name

o the date of invoice or sufficient information to identify

when HST was paid or became payable;

o the total consideration paid or payable for the supply;

o the supplier’s HST registration number;

o the total amount of HST charged on the supply, or, if the

price is tax-inclusive basis, a statement to this effect;

o the recipient’s name, trading name, or the name of his or

her duly authorized agent or representative;

o sufficient information to ascertain the terms of sale (e.g.,

cash, credit); and

o a description sufficient to identify the supply.

29

Trap: Failing to Obtain Prescribed

Information

• If the supplier fails to provide the “prescribed information”,

however, the recipient’s ITC claim may be disallowed

o As a practical matter, the recipient may not realize it’s an

issue until after they’re audited by the CRA

• This problem typically does not arise when dealing with

established suppliers

• But can be a problem for newly established or

unsophisticated suppliers

o Often fail to provide an HST registration number (perhaps

because they’re not registered), while still charging HST

30


• This is a problem which can generally be readily avoided or, if

it is caught in time, fixed

• When dealing with unsophisticated suppliers, you might

include language in the supply agreement similar to the

following:

o X. The vendor shall invoice the client on a monthly basis,

provided however, that no amount shall be payable by the

client unless such invoices contain the prescribed

information in accordance with the Input Tax Credit

Information (GST/HST) Regulations.

• In some cases, it may be possible to embed “prescribed

information” into the agreement itself

31


• If an ITC claim is disallowed due to lack of information, the

claimant re-claim ITC in a subsequent reporting period once

information is obtained

• Need to be alert to relevant limitation period (2 or 4 years,

depending on the circumstances of the supplier ) which may

preclude an ITC claim

32

Section 167 Election

• Generally a sale of a business will engage HST (and other

commodity tax) considerations, as it often involves a supply

of at least some taxable goods and services

• Even when HST is fully recoverable by the purchaser through

ITC claims, having to pay HST on a purchase of a business

can create a significant cash-flow concern for the purchaser

• Usual practice, when selling all of a business, or an

identifiable part of a business (i.e., a division or branch), is for

the parties to make a joint election under section 167 of the

ETA (the “167 Election”) to relieve the sale from HST

33


• 167 Election is available when the following conditions are

satisfied:

o The supplier is making a supply of a business or part of a

business (which can include a division or branch)

o The business was established or carried on by the

supplier or another person

o Under the agreement for the supply, the recipient is

acquiring ownership, possession or use of all or

substantially all (i.e., according to the CRA, 90% or more)

of the property that can reasonably be regarded as being

necessary for the recipient to be capable of carrying on

the business or part as a business

34


• If the 167 Election is unavailable, consider whether other

HST elections/mechanisms might be available to mitigate

cash-flow costs

• Election form must be executed and, in most instances, filed

with the CRA

• Election form should be filed on or before due date of the

HST return of the purchaser

35

Trap: Failure to file a Section 167 Election

• Unfortunately, this is an election that is often overlooked and

not filed in a timely fashion (if at all)

• Such a failure arises for a number of reasons, including:

o Forgetting to complete the election form

o Uncertainty as to who has carriage for filing the election

form (lawyers vs. accountant, recipient vs. supplier,

responsibility within the recipient)

o Lack of oversight (common in corporate reorganizations)

• Could result in the supplier being accessed for uncollected

HST if assessed by the CRA, having to collect HST from

recipient

36


• Obviously, the best approach is to ensure that 167 Election

form is completed and ready to file at closing

• Fortunately, the CRA has a discretion to accept a late-filed

election on an application by the taxpayer where:

o extenuating circumstances prevented the parties from

filing the election by the required date;

o the parties met the criteria for making the election at the

time of the purchase and sale;

o both parties conducted themselves at all times as if the

election had been made;

o there is no revenue loss to the government.

37


• Since the 167 Election is principally for the benefit of the

recipient, a common practice is for the recipient to indemnify

the vendor for any tax, interest, penalties or costs that may

arise if the 167 Election is disallowed by the CRA

o This also protects the supplier where the 167 Election is

not available.

• This is particularly relevant given that the filing of the election

for is the responsibility of the recipient, even though the costs

of non-filing are borne by the supplier.

38

Settlement, modification or termination of contracts

• GST/HST issues often arise – unexpectedly – in the context

of the termination/modification of a contract or the settlement

of a commercial dispute

• Examples include:

o Lease termination payment

o Payment for agreeing to modify an agreement

o Payment to settle a lawsuit for breach of contract

• Often gives rise to an unexpected trap for the unwary

39

• Subsection 182(1) of the ETA is a deeming rule that, in effect,

deems payment to be inclusive of applicable GST/HST

where:

o An amount is paid or forfeited to a registrant (or a debt or

other obligation is extinguished without payment) (a

“Payment”)

o The Payment arises as a consequence of a breach,

modification or termination of an agreement for the

making of a taxable supply (other than a zero-rated

supply) in Canada by the registrant

• Note that this section only applies to Payments made to the

supplier, not payments made by the supplier to the recipient

• Doesn’t apply to consideration for the supply

40

Settlement, modification or termination of contracts

• Where subsection 182(1) applies, the recipient is deemed to

have paid and the supplier is deemed to have collected an

amount equal to (13/113)*(the Payment) (in Ontario)

o i.e., if termination Payment = 100, that amount is deemed

to include ~$11.50 of HST (100*13/113), which must be

remitted to the CRA by the supplier

o In other words, on a $100 Payment, the supplier nets

$88.50 and the recipient (i.e., the payor) may, if

registered, may be entitled to claim an ITC of $11.50

• If subsection 182(1) isn’t accounted for, supplier may end up

with less than it bargained for

41

Trap: Failing to Take Into Account Section 182

• If you are representing the supplier, you want to make sure

that any Payment is grossed up to reflect that HST liability, so

that the supplier nets what it bargained for

• If you are representing the recipient (i.e., the payor) you want

to make sure that they know they may be able to claim an

ITC for the deemed HST

42


• When drafting agreements, pay particularly close attention to

termination clauses or liquidated damages clauses, since

payment under such clause may be deemed to be inclusive

of HST

• Consider adding specific language to gross-up such

payments :

• X. To the extent that the [Termination Payment] paid to

the [supplier] hereunder is deemed by subsection 182(1)

of the Excise Tax Act (Canada) to include HST, an

amount shall be added to the [Termination Payment]

equal to applicable HST rate multiplied by the

[Termination Payment].

43


Directions, Nominees and Agents in Real

Property Transactions

• Many sales of real property are taxable

• Special rules for dealing with charging and collecting

GST/HST in respect of taxable sale of real property

44

Directions, Nominees and Agents in Real

Property Transactions

• The vendor is not required to collect GST/HST if, inter alia:

o the recipient is registered for GST/HST, unless the

recipient is an individual and the property is a residential

complex or cemetery plot (or similar place of burial, etc.),

collect GST/HST on taxable supplies of real property

• Otherwise, the vendor has to charge and collect GST/HST on

taxable supplies of real property

• Where the supplier is not required to collect GST/HST, the

recipient has to self-assess for its GST/HST tax liability

45

Trap: Who is the “recipient”?

• Where lawyers and there clients get into trouble is in

situations where the “recipient” of the property is confused

with the person acquiring actually property

• Recall that the “recipient” is the person liable to pay the

consideration, not necessarily the person who acquires

the property

• Where title is registered with a person other than the

“recipient” by way of a direction at closing

• Where the “purchaser” is a nominee or agent for the true

“recipient”

46


• Example 1: Lois enters into agreement to buy property, prior

to closing, she directs that title be registered with XYZ Co.,

which is registered for HST. Lois is not. Vendor does not

collect HST

Problem

• XYZ Co. isn’t the “recipient”, Lois is

• Lois isn’t registered for HST, XYZ Co. is

• vendor could be assessed for HST (and interest)

• neither Lois nor XYZ Co. may be entitled to claim ITCs to

recover that that tax

47


• Example 2: Nominee Co. enters into agreement to buy

property as agent/nominee for John. Nominee Co is

registered for HST, John is not. Vendor does not collect HST

Problem

• Nominee Co. isn’t the “recipient”, John is

• John isn’t registered for HST, Nominee Co. is

• vendor could be assessed for HST (and interest)

• neither John nor Nominee Co. may be entitled to claim ITCs

to recover that that tax

48

Avoiding the Trap

• If acting for the vendor, you must confirm:

o the identity of the “recipient”

o that the purchaser is not a nominee or agent for the true

“recipient”

o registration of recipient with CRA (using CRA website)

o typically you’ll obtain a statutory declaration or certification

along with an indemnity from the “recipient”

• If acting for the recipient, you should:

o confirm that the “recipient” is registered for GST/HST

o remind recipient of its self-assessment obligations

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Questions?

50

51

Cautionary Note

The foregoing commentary is summary in nature and does not address

all of the issues and considerations that may be relevant under any

particular set of circumstances.

The statements and material presented herein do not represent legal or

tax advice.

No transactions should be executed on the basis of the foregoing

statements and commentary.

Formal legal, tax, and accounting advice should be obtained prior to

making any investment or executing any transaction.

HST Tips and Traps for Lawyers

Carl Irvine, Principal

[email protected]

d 416.865.7266 | f 416.865.7048

McMillan LLP

181 Bay Street, Suite 4400

Toronto, ON M5J 2T3

Documents

HST Tips and Traps for Lawyers - The Canadian Business ... Tips and Traps... · Other Commodity Tax regimes • Lawyers whose firms carry on business/serve clients situated outside