Pending excise tax issues: December 4, 2001. (Canada Customs and Revenue Agency).

On December 4, 2001, Tax Executives Institute held its annual liaison meeting with the Canada Customs and Revenue Agency on pending commodity and excise tax issues. The written agenda for the meeting, prepared under the aegis of TEI's Canadian Commodity Tax Committee, whose chair is Martina Krummen of Air Canada is reprinted below. Alan Wheable, the Institute's Vice President-Region I, coordinated preparations for the liaison meeting. The answers to the questions are posted on TEI's website.

Tax Executives Institute, Inc. welcomes the opportunity to present the following comments and questions on pending commodity and excise tax issues, which will be discussed with representatives of the Canada Customs and Revenue Agency (CCRA) during TEI's December 4, 2001, liaison meeting. If you have any questions in advance of that meeting, please do not hesitate to call either Alan Wheable, TEI's Vice President for Canadian Affairs, at 416.982.8003, or Martina Krummen, chair of the Institute's Canadian Commodity Tax Committee, at 514.856.6675.

Customs Issues

1. Under the Administrative Monetary Penalty System (AMPS) which will soon be adopted by CCRA's Customs branch when an error is made in respect of an import valuation, the penalty is calculated on the entire amount of the line item on the customs document, rather than just the amount of the error. In certain circumstances, items such as casing and packing or freight may be prorated over an entire shipment. Consequently, if an error is made in the valuation of these items, it will affect all items in the shipment.

Where the penalty is disproportionately high in relation to the dollar value of the error, the Customs officer may waive the penalty and issue a warning for the first offense. The language of the waiver provision, however, is not mandatory, resulting in inconsistent applications for similar offenses. Moreover, the waiver is available only for the first error.

TEI believes that calculating the penalty on the entire amount of the line entry conflicts with CCRA's penalty system under both the Income and Excise Tax Acts. Under these Acts, penalties are generally calculated solely on the amount of the error or omission. Calculating the penalty on the entire value is excessive and fails to reflect the materiality of, or potential harm caused by, the error. In addition, the restrictive nature of the waiver provision limits the relief available to taxpayers.

Would CCRA consider calculating the penalty on the value of the error made (i.e., the difference between the value declared and the value that should have been declared), rather than the entire value of the line item in question? Such an approach would ensure that the penalty levied is proportionate to the error made and be consistent with the methodology for calculating penalties under the other statutes administered by the CCRA.

2. AMPS imposes a graduated series of penalties, based on whether the error in valuation is the importer's first, second, or third infraction. The legislative changes are due to be implemented in the 2001-2002 fiscal year. An issue arises concerning the treatment of prior infractions under the new penalty system. Will a prior notice from Customs (through National Customs Rulings, detailed adjustment statements, seizures, or audit results) be regarded as "being advised" in respect of AMPS? Or will taxpayers and the government start with a clean slate and only infractions after the legislation is passed be taken into account for AMPS purposes?

3. During TEI's December 6, 2000, meeting with CCRA, an issue arose concerning the imposition of interest on the Goods and Services Tax when goods are imported into Canada, and the importer subsequently realizes that additional GST is payable. CCRA suggested that we raise this issue with the Director of the Trade Incentives Program, which the Institute did in a letter dated February 14, 2001. During this year's meeting, TEI requests a status report concerning this issue.

Goods and Services Tax (GST) Issues

4. A registered freight-shipping corporation (ABC Freight) provides freight transportation services in Canada to various parties. ABC Freight makes zero-rated, 7-percent taxable, and 15-percent taxable supplies, generally contracting directly with the owner of the goods. ABC Freight has acquired insurance arising with respect to the movement of the goods. The company offers this insurance coverage to its customers. If the customer chooses the insurance coverage, ABC Freight's invoice provides one line item for the transportation of the goods and another line item for the insurance. Is ABC Freight making a single supply of a freight transportation service or two supplies one for the freight transportation service and another for the insurance coverage?

5. For several years, TEI has raised concerns about documentation issues and claims for input tax credits (ITCs) in respect of procurement card purchases. We understand that CCRA has made progress in this area and will soon issue guidance. Please provide an update on the procurement card issue. If a draft is available, the Institute would be pleased to review it prior to our December meeting and discuss it during the meeting.

6. The GST Regulations prescribe the information that a registrant must obtain before filing a return in which an ITC is claimed. Is it sufficient for a registered recipient of a taxable supply to prepare the documentation of the information pertaining to the supply or must the information be physically provided by the supplier? For example, a contractor may document the prescribed information for payment for a taxable supply provided by a subcontractor. If permitted to prepare the documentation, must the contractor physically send that documentation to the subcontractor for its records? What documentation, if any, must the contractor obtain from the subcontractor, e.g., a letter on the subcontractor's letterhead stating its GST registration number?

7. Assume that there is a written agreement between a registered recipient and a registered provider of a taxable supply that calls for more information than required by the GST Regulations. Does this contract have any bearing on the registered recipient's ability to claim an ITC under section 169 of the Excise Tax Act (ETA) if all the information prescribed by the Regulations is available but the additional information is not (assuming there is no effect on the timing or amount of GST paid or payable)?

8. Please provide an update on the Export Distribution Centre Program, including the number of taxpayers using the program, the types of activities that they are carrying out in Canada, and the dollar value of imports entering Canada under this program. Are most program applicants approved by CCRA? Are there any plans to broaden the program?

9. Please provide an update on CCRA's study of electronic commerce. Is more work being considered in this field?

10. Consider the following:

   A financial institution uses a broker to import a computer into Canada. The
   computer costs $10,000 and is supplied by a nonresident, non-GST-registered
   vendor. The broker pays $700 in Division III tax on importation of the
   computer and is reimbursed by the financial institution. The financial
   institution plans to use the computer entirely in its noncommercial
   activity and thus is not able to recover the Division III paid on
   importation as an ITC.

   In installing the computer, the institution discovers that the computer is
   damaged and inoperable. It ships the computer back to the original supplier
   located outside Canada for a full credit.

Please answer the following questions:

(i) May the financial institution adjust its GST liability and recover the Division III tax of $700?

(ii) If a GST-registered supplier in Canada invoiced the financial institution for this computer plus the Division II tax ($10,000 plus $700) and the computer were then found to be inoperable and returned, would the GST-registered supplier in Canada provide a credit for the full amount?

(iii) If the financial institution may not adjust its GST liability and recover the Division III tax, is there another procedure that would provide for the recovery? Would section 215.1(2) or 215.1(3) (relating to rebates for returned goods) or any other provision provide relief?

11. Assume the same facts as in question 10, but assume that the foreign owner provides the computer to the financial institution on a "temporary-loan" basis for three months and retains title to the computer. The foreign owner has determined that the useful life of the computer is three years. During the three months, the financial institution will use the computer in its non-commercial activity. Normally, the financial institution would not be able to recover any of the Division III tax paid on importation as an ITC. After three months, the financial institution returns the computer to the foreign owner. Please answer the following questions:

(i) Because the computer was used for only three months in Canada, may the financial institution adjust its GST liability downward by $641.66, which represents 91.667 percent (i.e., 33 out of 36 months) of the GST that the financial institution paid on importation?

(ii) If not, is there any procedure for the financial institution to recover any portion of the $700 GST paid on importation?

(iii) Would the answer to (i) be different (other than the mathematics) if the value of the computer were $100,000 and $7,000 of Division III tax had been paid on importation?

(iv) Instead of a non-resident, non-GST-registrant owner lending the computer to a financial institution, assume the lender was a Canadian resident, GST-registered party. The lender normally would not issue a physical invoice to the financial institution since there is no consideration (except possibly a no-charge invoice for shipping purposes). Please confirm that Division II tax is not applicable under this assumption since no consideration is being paid. Also confirm that Division IV tax does not apply since the supply is not an imported taxable supply.

12. (i) The Input Tax Credit Information (GST/HST) Regulations outline the conditions for GST registrants to claim an ITC on a supplier's invoice. Under section 3.(c)(ii), one condition for claiming an ITC is that supporting sales documentation set forth "the recipient's name, the name under which the recipient does business or the name of the recipient's duly authorized agent or representative."

In our 1997 liaison meeting, CCRA indicated that tradenames registered with a provincial government under the recipient's "legal entity" name would qualify as the name of the recipient for the purposes of the above section. CCRA indicated, however, that--

   There is no requirement that the name under which the recipient does
   business be registered with a particular province, the province in which
   the recipient resides or the province in which the supply is made in order
   to meet the ITC documentary requirements.

Consider the following example:

   ABC Investments & Securities Inc. (the legal entity name) conducts business
   under the business names ABC Investments and ABC Securities but neither
   name is a provincially registered tradename. If the supplier's invoice were
   addressed to either "ABC Investments" or "ABC Securities," these names
   would satisfy the requirement under section 3.(c)(ii) and ABC Investments &
   Securities Inc. could claim an ITC even though neither name is a
   provincially registered tradename.

Please confirm that--

(a) the recipient's provincially registered tradenames qualify as business names under the Regulation, and

(b) CCRA will accept non-provincially registered business names as long as the recipient is known by that business name, e.g., ABC Investments and ABC Securities.

(ii) Section 3.(c)(ii) of the Regulation also refers to "the name of the recipient's duly authorized agent or representative." What determines that the agent is a "duly authorized" agent acting on behalf of the recipient? Is a formal written agreement required between the two parties? If there is no written agreement, will a verbal expression in conjunction with the ongoing presumption of both parties be sufficient to qualify?

(iii) The Regulations require under section 3.(a)(i) that "[t]he name of the supplier or the intermediary in respect of the supply, or the name under which the supplier or the intermediary does business" be included in the documentation. It is reasonable to assume that supplier's tradenames registered with any provincial government under the supplier's "legal entity" name would similarly qualify as the name of the supplier for the purposes of the Regulation. It is also reasonable to assume that there is no legal requirement that the "name under which the supplier or the intermediary does business" be a provincially registered tradename.

Following our earlier example, assume ABC Investments & Securities Inc. (the legal entity name) conducts business under the business names ABC Investments and ABC Securities but neither name is a provincially-registered tradename. Please confirm that these provincially registered supplier's tradenames qualify under section 3.(a)(i).

In addition, please confirm that CCRA will accept non-provincially registered business names as "the name under which the supplier or the intermediary does business" as long as the supplier's business is referred to by that business name. In other words, invoices issued in the names of ABC Investments and ABC Securities to customers will satisfy the documentation requirements under section 3.(a)(i) and 100-percent commercial activity customers will be permitted to claim an ITC for these invoices.

13. On July 25, 2001, a GST-registered entity (assume 100-percent commercial activity) has its broker process paperwork to import a production machine into Canada on the entity's behalf. The production machine costs $100,000 and is supplied by a non-resident, non-GST-registered vendor. The broker pays $7,000 in Division III tax, which is reimbursed by the entity and claimed as an ITC. (Assume no duty is payable.)

Within 90 days, on October 15, 2001, the same broker inadvertently processes the paperwork again for the same production machine and pays the Division III tax. The error is discovered when the broker invoices the entity. The broker acknowledges its error, but claims it cannot recover the "second" Division III GST payment from the federal government as an ITC or apply for a refund of the tax, even assuming the standard documentation requirements for the second ITC for the Division III importation are met. It suggests that the customer (i.e., the GST-registered entity) claim the Division III tax a second time. Please answer the following questions:

(i) Assuming it paid the broker's second invoice, may the entity recover the Division III tax related to this payment?

(ii) May the broker recover the Division III GST from the federal government as an ITC or by other means (i.e., by filing a rebate claim)?

(iii)Would it make a difference if the date of the second invoice were August 15 (i.e., within 30 days of the first invoice)? In other words, is there a time period (e.g., within 30 or 60 days) during which another option is available?

14. A GST-registered entity (CANCO) sells an item to a Canadian customer (Company X). The terms of delivery are FCA (free carrier) Company X's site in Ottawa. CANCO purchases the good from its U.S. parent in Boston, Massachusetts, which has itself acquired the good from a third-party U.S. supplier that delivered it to the parent's warehouse in Boston. The good is shipped from Boston to Company X's site in Canada. CANCO invoices Company X $100 for the good, $20 for a "handling and administrative fee," and $15 for the actual freight charge. All three amounts show as separate line items on CANCO's invoice to Company X.

The $20 "handling and administrative fee" is a fee paid by CANCO to its U.S. parent for receiving, warehousing, and locating the transportation company; the $15 freight charge is for the actual transportation cost from Boston to Ottawa. U.S. parent pays the transportation cost to the transportation company and then invoices CANCO. CANCO then invoices both charges to its Canadian customer.

(i) Based on former Policy Statement P-078R, the above supply is made available in Canada because the FCA site is in Canada. Therefore, Division II GST tax applies on the invoice value of $100 from CANCO to Company X. Please confirm this statement.

(ii) In respect of the "handling and administrative fee" of $20, does GST apply? This separate charge could be considered a supply/resupply of a service made outside Canada. Since the supply is made outside Canada, GST is not applicable under section 165 of the ETA. On the other hand, if the charge is considered part of the consideration for the supply of a GST-taxable good, GST would apply.

(iii) Would the answer to (ii) change if the "handling and administrative fee" were modified to reflect a higher or lower value than the actual fee charged to CANCO (e.g., $25 or $17.50)?

(iv) In respect of the actual freight charge of $15 in this example, does GST apply? This separate charge could be considered a reimbursement of a "freight transportation service." As such, this "freight transportation service" may qualify as a zero-rated supply under Schedule VI, Part VII, section 8. On the other hand, if the charge is considered part of the consideration for the supply of a GST taxable good, GST would apply.

(v) Would the answer to (iv) change if the freight charge were modified to reflect a higher or lower value than the actual freight charge (e.g., $20 or $10)?

15. (i) A GST-registered entity (CANCO) wishes to have a U.S. nonresident, non-GST-registered vendor supply parts to be incorporated into CANCO's manufactured product. To confirm whether the part meets CANCO's quality specifications, the U.S. vendor ships sample parts to CANCO at no charge. CANCO tests the individual sample parts, inserts them into its production line, and then tests the manufactured product. For Customs purposes, assume the sample parts have a value of $1,000 each. CANCO (via its broker) imports the parts and pays $70 in Division III tax for each part. The U.S. vendor does not invoice CANCO for the samples. Can CANCO recover the $70 Division III tax for each part, assuming standard documentation requirements are met?

(ii) The same U.S. non-resident, non-GST-registered vendor wants to supply additional parts to CANCO and sends the company promotional literature consisting of various product brochures outlining the products' benefits and contact information for placing orders or additional information. CANCO is not invoiced for this information and there is no obligation to purchase any item contained in the promotional literature. The package sent to CANCO has a declared value of $100 and $7 in Division III GST tax is paid. Can CANCO recover the $7 Division III tax for the package related to promotional literature, assuming standard documentation requirements are met?

16. Consider the following example:

   A GST-registered U.S. company (Company R) rents a machine to a Canadian
   entity (Company C) and invoices Division II tax. Company C pays Company R's
   invoice and recovers the tax since it uses the machine 100 percent in its
   commercial activity. Company R rents only one machine in Canada and 50,000
   machines worldwide.

   Another non-GST registered U.S. Company (BUYCO) buys the assets of Company
   R on July 1, 2000, including the machine that is rented in Canada. BUYCO is
   unfamiliar with the Canadian commodity tax and does not register for GST
   purposes at the time of the acquisition of the machine.

   For six months, BUYCO uses Company R's billing system to invoice Company C.
   BUYCO's name replaces Company R's name on the invoice to the customer and
   GST continues to be invoiced to the customer although Company R's GST
   number is removed from the invoice. BUYCO does not remit the GST. BUYCO
   discovers the GST billing problem on December 31, 2000, and registers for
   GST on January 2, 2001.

   During January 2001, BUYCO makes a voluntary disclosure to CCRA with
   accompanying details and a cheque for the full GST payable. The amount
   payable is the GST payable on the rental invoices to the customer for the
   six-month period. BUYCO also asks for retroactive registration to the date
   of acquisition because the rental amount is over $30,000 per month.

   By voluntarily disclosing the error, BUYCO believes it will not be assessed
   penalty and interest because Company R is using the machine in a
   100-percent commercial activity and there is thus no revenue loss to CCRA.
   BUYCO subsequently receives notice that its voluntary disclosure is not
   accepted because none of the transactions contained and disclosed in the
   voluntary disclosure is over a year old.

(i) Paragraph 6.(d) of Information Circular 00-1 (June 12, 2000) provides that information being disclosed must include information that is at least one year past due. In BUYCO's case, it has been only six months. The one-year requirement acts as a deterrent to taxpayers to correct errors on a timely basis and is contrary to the intent of CCRA's voluntary disclosure program. Please answer the following questions:

(a) Is CCRA reviewing the voluntary disclosure program to permit voluntary disclosures for GST purposes for errors occurring within the first year? If so, will its effective date be made retroactive?

(b) If BUYCO is assessed interest and penalties, what options exist for a waiver? Will the wash transaction provision apply if BUYCO can provide documentation to show its customers were entitled to full ITCs?

(ii) The information circular also states that "the disclosing client is expected to provide full and accurate reporting of all previously inaccurate, incomplete, or unreported information." This full disclosure along all program lines (presumably the income tax, GST, payroll, and customs area) creates difficulties for large corporations that employ specialists who are often unaware of the tax issues relating to other areas.

TEI suggests that the voluntary disclosure policy be adapted to reflect these corporate realities and invites CCRA's comments on this issue. In addition, please confirm that the voluntary disclosure program is entity specific. In other words, significant problems in a related legal entity will not affect the ability of the entity making the voluntary disclosure to obtain relief.

17. A Canadian GST-registered party (CANCO) has a facility located in Ottawa and performs some services for a foreign company (FORCO) located in Jamaica. FORCO has no Canadian operations, no presence in Canada, and is not a GST registrant. FORCO orders goods from several smaller Canadian suppliers and asks that these suppliers deliver the goods to CANCO's location in Ottawa. CANCO provides an accounts payable service to FORCO. FORCO's Canadian suppliers provide invoices to FORCO addressed to CANCO's Ottawa location.

Several of FORCO's suppliers are not regular exporters and therefore do not want to be involved in shipping the goods off shore. There are also significant transportation sayings gained through consolidated transportation shipments. CANCO consolidates these FORCO goods for shipment, determines the best mode of transportation and price, and arranges for FORCO's goods to be exported to Jamaica. CANCO is not a transportation carrier.

FORCO's suppliers issue invoices to FORCO including GST. From the suppliers' standpoint, this appears correct since they have no documentation to show that the goods will be exported without being used in Canada. The shipment of the goods from Ottawa to Jamaica may be made several months after the delivery of FORCO's goods to CANCO by the suppliers. Thus, FORCO or CANCO cannot supply export documentation to FORCO's suppliers until well after the goods are shipped to CANCO and FORCO is invoiced for GST.

CANCO believes that section 179(3) of the ETA applies in this case. Section 179(3)(c)(ii)(E) requires, however, that the registrant (FORCO's Canadian supplier) maintain "evidence satisfactory to the Minister of the exportation of the property." This section does not stipulate a timing requirement. Please answer the following questions:

(i) Must the actual export documentation be in the hands of the registrant at the time of invoicing? Such documentation is virtually impossible to acquire when the registrant invoices an unregistered non-resident.

(ii) Would CCRA accept as "evidence satisfactory to the Minister of the exportation of the property" a letter from FORCO to its Canadian suppliers on FORCO's letterhead signed by both FORCO (and CANCO if necessary) asserting that all shipments of FORCO's purchases to CANCO's Ottawa location are being exported to FORCO without being used in Canada? The letter would also state the standard export documentation would be available at time of audit.

(iii) If the letter in (ii) is insufficient, what other alternatives are available to FORCO (besides having FORCO's suppliers wait for the full export documentation from CANCO before the suppliers invoice FORCO without GST)?

(iv) It is our understanding that section 252.(1) of the ETA (i.e., the non-resident rebate in respect of exported goods provision) cannot apply in this case. Is this correct?

(v) CANCO originally contracts and pays the freight company to ship FORCO's goods to Jamaica. These freight charges are normally zero-rated because the goods are directly exported. CANCO then seeks reimbursement from FORCO for these freight charges. Please confirm CANCO's reimbursement invoices for these freight charges are not subject to GST.

(vi) CANCO also invoices FORCO a separate fee for each of the following:

(a) arranging for the transportation carriers,

(b) handling FORCO's goods in CANCO's warehouse, and

(c) processing and paying the transportation company's invoices to CANCO for subsequent reimbursement from FORCO per (v) above.

Please confirm these three services are zero-rated.

(vii) Please confirm that

(a) the fee for the accounts payable processing and payment service for the supplier invoices to FORCO is zero-rated.

(b)the funds to reimburse CANCO for the cash expended to pay FORCO's suppliers is not subject to GST.

18. Anon-resident, non-GST-registered person (Company R) leases machinery entirely to non-residents of Canada. Company R (a U.S. entity) has no activity, personnel, or equipment in Canada. Company R wishes to lease some equipment to a Canadian GST-registered party (Company X). Company X (a 100-percent commercial activity entity) will import the rental goods into Canada and thus pay Division III tax. Company R accepts the order outside Canada. The value of the leased machine is $2,000,000, the rental term is for one year, and the monthly rental payments are $100,000. The rental period starts as soon as the equipment leaves Company R's site in the United States. At the end of the lease, Company X must return the leased good to Company R's site in the United States.

Under the rental agreement, Company X accepts the risk of loss of the goods. In other words, if the rental equipment is damaged, destroyed, lost, etc., from the time it leaves Company R's location in the United States, it is Company X's responsibility to fix or replace the equipment. This rental is Company R's only activity in Canada.

(i) Under Policy Statement P-051R, one of the key criteria to be considered in determining taxability is "the place where the operations from which profits arise take place." Is Company R carrying on business in Canada for GST purposes because it has a leased piece of equipment in the country for the year?

(ii) Does CCRA view "the place where the operations from which profits arise take place" as the place

(a) where the goods to be leased are physically located at the time of the acceptance of the lease,

(b) where the leased goods are physically located at the start of the lease,

(c) where the leased goods are located geographically primarily during the term of the lease, or

(d) a combination of the three?

(iii) If Company R is required to register for GST purposes, must Company R invoice Division II tax on the monthly rentals payments of $100,000?

(iv) If the fact pattern were changed to have the rental period start at the customer's site in Canada, the lessor responsible for the risk of loss until the unit reaches the site, and Company R registered for GST, must Division II tax be charged?

19. A non-resident, non-GST-registered person (U.S. parent) bids on a Canadian contract to supply and install a large piece of industrial production machinery to a customer (Company R) located in Toronto. At the time of the bid, the U.S. parent has no activity, personnel, or equipment in Canada. The bid is $2,000,000, with $1,500,000 related to the supply of the equipment and $500,000 related to the installation. The bidding documents state that Company R will be the importer of record of the goods and thus will pay Division III tax. The bidding documents contain the following clause:

If the bidder's tender is accepted, bidder has the right to assign all or part of the contract to any of its affiliates. The bidder guarantees the work of the assigned affiliates.

U.S. parent's bid is accepted. The parent has a Canadian subsidiary (SUBCO) that is a resident of Canada and a GST-registered party. U.S. parent assigns the installation portion of the contract to SUBCO.

An assignment is treated differently from a supplier vendor (or contractor subcontractor) relationship between U.S. parent and SUBCO. Under a supplier vendor relationship, SUBCO would invoice U.S. parent, which would then invoice Company R. In contrast, under an assignment, SUBCO invoices Company R directly and does not invoice U.S. parent. Thus, U.S. parent directly invoices Company R for the $1,500,000 value of the goods and SUBCO invoices the installation charge of $500,000. Please confirm that:

(i) SUBCO is required to invoice, remit, and collect GST on the $500,000 supply to Company R and, assuming standard documentation requirements are met, Company R may recover the GST.

(ii) U.S. parent's assignment under the contract will not require it to register for GST purposes.

(iii) Based on its 100-percent commercial activity, Company R is eligible to recover the Division III tax it paid on importation for the supply of the equipment.

If the assignment were executed in Canada, would that make a difference?

20. A Canadian GST-registered hospital generally providing tax-exempt medical services receives funding for advance medical research. Non-GST-registered U.S. and GST-registered Canadian firms supply the research funds with no "strings" attached. The hospital develops working prototypes of new machines to be used in surgery. In addition, the hospital researches and develops new drugs to combat disease. As a result of this research, the hospital discovers (i) an innovative treatment for a disease requiring the manufacture of hospital equipment, and (ii) a new drug that slows the growth of the disease. A U.S. firm wants the rights to manufacture the machine and to produce the new drug. The hospital is paid a fee for the rights to produce and market the machine (which was once the prototype). A separate fee is paid for the rights to produce the new drug. Please answer the following questions:

(i) Is the hospital required to pay GST on the initial research funds received from the non-GST-registered U.S. firms?

(ii) Is the hospital required to pay GST on the initial research funds received from the Canadian GST-registered firms? If the hospital is required to remit GST, are the firms providing the funds eligible to claim ITCs, assuming standard documentation requirements are met?

(iii) When the non-GST registered U.S. firm pays the hospital a fee for the rights to manufacture the machine based on the prototype ($1,000,000) and for the right to produce the new drug ($5,000,000), is GST due on these amounts?

(iv) What is the result if the party paying a fee for the rights to manufacture the machine and produce the new drug is a GST-registered firm? Is GST due on the value of the payments received? If the hospital must remit the GST, is the Canadian GST-registered firm eligible to claim ITCs, assuming standard documentation requirements are met?

21. A GST-registered entity (Company P) engages Company A (another GST-registered entity) to be its agent (not an auctioneer) in all functions (including importing goods into Canada) related to selling imported widgets to the Canadian market. Company P (principal) and Company A (agent) sign a legally binding agency agreement. Company A issues invoices to Canadian customers for the widgets and invoices GST. Company A's GST number is shown on these invoices. Company P and Company A have also signed an election under section 177(1.1) of the ETA that permits the agent (Company A) to remit the GST in relation to these sales. Company P records all sales of the widgets. Company A records only the commission income. Please answer the following questions:

(i) In relation to the Division III tax paid on importation by Company A (acting on Company P's behalf), may Company A claim an ITC for Division III tax paid at the border for the widgets Company A will sell as an agent for Company P? In other words, does the section 177(1.1) election permit the agent to claim ITCs in relation to goods bought by the principal and sold by the agent on behalf of the principal?

(ii) If Company A cannot claim the ITC, may it pass the Division III tax onto Company P which would then be eligible to claim an ITC, assuming the documentation requirements are met? Does the fact Company A is the importer of record bar Company P from claiming an ITC?

(iii)Assuming the customer is using the widgets 100 percent in a commercial activity, and Company A is invoicing the customer on Company A's letterhead and providing Company A's GST number, please confirm that the customer may claim an ITC even though Company P is the party recording the sale of the widgets.

22. Section 167.(1) of the ETA provides:

Where a supplier makes a supply of a business or part of a business that was established or carried on by the supplier or that was established or carried on by another person and acquired by the supplier, and under the agreement for the supply, the recipient is acquiring ownership, possession, or use of all or substantially all of the property that can be reasonably regarded as being necessary for the recipient to be capable of carrying on the business or part of the business,

(a) for the purposes of this Part, the supplier shall be deemed to have made a separate supply of each property and service that is supplied under the agreement for consideration equal to that part of the consideration for the supply of the business or part that can reasonably be attributed to that property or service; and

(b) except where the supplier is a registrant and the recipient is not a registrant, the supplier and the recipient may make a joint election in prescribed form containing prescribed information to have subsection (1.1) apply to those supplies.

If the joint election is made, no tax is due in respect of a supply of any property or service made under the agreement (with certain exceptions). Policy Statements P-179, P181, and P-188 provide some guidance concerning CCRA's interpretation of the use of section 167, which has provided significant administrative benefits where the two parties involved are fully commercial entities.

Sales of businesses are becoming more complex, in some cases involving multiple purchasers (usually within related legal entities) and then subsequent transactions to facilitate the desired corporate structure. There may be only one main agreement that refers to several side agreements.

From an audit perspective, has CCRA denied the use of a section 167 certificate (especially between 100 percent commercial activity entities) and if so, what are the most commons reasons for such a denial?

23. A GST-registered company in Canada (Company S) is developing source code from scratch for a new order/ship/bill system. Company S's only customer is a non-resident, non-GST-registered party (Company USA). Using a standard programming language, personnel from Company S create a set of command instructions to create the source code. Company S has two ways to send the final source code to Company USA: (i) by an electronic means, or (ii) by putting the source code on a disc and physically delivering the disc. Company S will sell the source code outright to Company USA.

(i) If the final source code is sent electronically to the U.S. customer, is it considered tangible personal property, intangible personal property, or a service for purposes of the ETA?

(ii) Based on the answer to (i) above, is the final source code zero-rated?

(iii) If the final source code is delivered on a disc to the U.S. customer, is it considered tangible personal property, intangible personal property, or a service for purposes of the ETA?

(iv) Based on the answer to (iii) above, is the final source code zero-rated?

(v) Would the answers to (i)-(iv) differ if personnel from Company S did not create the final source code from scratch using standard programming language, but rather used some canned programs and then modified the programs to create the final source code, which would then be sent to Company USA?

(vi) Instead of selling the source code outright, assume Company S licenses the source code only to Company USA. Do the answers in (i) through (v) change?

24. During last year's liaison meeting with the Department of Finance, TEI asked:

A non-resident, GST-registered seller makes a sale FOB outside Canada, collecting no GST on the sale. The seller utilizes his business expertise to arrange transportation and importation of the goods into Canada on behalf of the customer. The seller incurs GST at the time the goods clear Customs. Is the seller entitled to an ITC?

The Department responded:

At the present time, the seller is not eligible to take an ITC ... Finance would like to arrange a further meeting with some TEI members to discuss this issue before they reach any conclusions.

The Department subsequently met with some TEI members (as well as representatives of other associations) concerning this issue.

(i) Where a GST-registered seller makes a sale FOB outside Canada and invoices no Division II tax but acts as the importer of record and pays Division III tax is the seller entitled to recover the Division III tax as an ITC?

(ii) If the answer is no, please provide the statutory basis for that opinion and cite any published memorandum, technical information bulletin, or policy paper supporting the position.

(iii)How is CCRA handling this issue in audits?

25. Parentco owns 100 percent of the outstanding share capital of Subco A, which owns 100 percent of the outstanding share capital of Subco B. Parentco also owns 70 percent of the share capital of Subco C. Both Subco A and Subco B each own 15 percent of the remaining share capital of Subco C.

Section 156(2) of the ETA provides a joint election for a qualifying group to treat transfers of taxable supplies (subject to certain exceptions) as being made for no consideration.

(i) Are Parentco and Sub B entitled to make an election under section 156(2) of the ETA?

(ii) Are Parentco and Sub C entitled to make the election?

(iii) Are Sub A and Sub C entitled to make the election?

26. Property Co. and Company A are both GST-registered. Property Co. has granted Company A the right to explore and exploit a mineral deposit on a property for a period of 10 years. Under the terms of the agreement, Company A will pay Property Co. a royalty of $5 per unit extracted from the property. The agreement also requires Company A to pay Property Co. a minimum royalty of $1,000,000 due on execution of the agreement.

Under section 162(2) of the ETA, certain mineral rights are "deemed not to be a supply and any consideration paid or due, or any fee or royalty charged or reserved, in respect of the right shall be deemed not to be consideration for the right."

(i) Are Property Co. and Company A entitled to use this provision?

(ii) If subsection 162(2) is not applicable, is Company A entitled to claim ITCs when the initial $1,000,000 minimum royalty is paid?

27. Company A purchases all or substantially all the assets of Company B. Company A and B do not make a section 167 election. Company B refuses to calculate the amount of GST/HST due on the transaction. Instead, it instructs Company A to calculate the tax and provide it with a copy of the calculation when remitting the tax. Assuming that company A uses its best effort to make the calculation, what exposure exists for both companies if there is an error in the calculation?

28. A non-resident, non-registered leasing company (A) has a lease with a registered Canadian lessee engaged in commercial activity. The leased property is made available outside Canada. Company B (a leasing company), a registered resident for GST purposes, purchases the property and is assigned the lease from Company A. The registered Canadian lessee is notified of the transaction and directed to make future lease payments to Company B. Company B registers a security lien against the property. For GST purposes, has there been novation? Do the lease payments remain exempt from GST on the basis that the property was originally made available outside Canada?

29. Company A is in the leasing business, outsources all of its functions, and has no employees except for a president and a vice president-finance. The outsourcing contract may be cancelled on 30 days' notice. Company B, a competing leasing company, offers to purchase all of company A's business. Company B will acquire all assets, leases, and customer lists. Additionally, Company B will acquire goodwill and a "no compete" agreement from Company A. Company B has excess capacity and will service the portfolio itself. Can a section 167 election be used for the transactions?

30. With the deregulation of electricity, consumers will be able to purchase electricity from various retailers and pay a separate charge for delivery and any ancillary services by the local distribution companies (LDC). Under the OEB's Retail Settlement Code, the LDCs are required to provide consolidated billing to the consumers and administer retail settlements among various stakeholders. In accounting for GST, there are three options:

Option 1-Establishing supplier accounts for GST;

Option 2-Filing a joint election under section 177(1.1); or

Option 3-Treating the transaction as an LDC buy/sell.

Under a CCRA ruling, only option 1 is available to the LDCs. Under this option, the LDCs may not be able to recover the GST on any bad debts. Please answer the following questions:

(i) If the retailers provide consolidated billing to consumers, is option 1 the only option available?

(ii) Can the retailers recover GST on bad debts?

(iii) For retailers that obtain an "Avoided Cost Credit" from the LDCs to provide consolidated billings, how is GST calculated?

31. A GST-registered resident and a non-GST-registered non-resident enter into an agreement to share the costs of operating two real properties, one in Canada and the other in the United States. The resident owns the real property located in Canada and the non-resident owns the real property located in United States. Non-resident is responsible for the operation costs of the U.S. property and the resident for the operation costs of the Canadian property. Costs are shared equally by the resident and the non-resident on the two properties. At the end of each month, if one party incurs more expenses than the other, they will invoice the other to recover for its share of the excess costs.

The resident incurs more costs on the work performed on the Canadian property and bills the non-resident for the excess costs. How is GST accounted for on the invoice sent by the resident?

32. (i) In Example No. 6 of the Draft Policy Statement on the Meaning of the Term "Arranging for" in paragraph (1) of the definition of "Financial Service," a supply of merger and acquisition (M&A) services is ruled to be exempt if the supplier is actively engaged in soliciting and negotiating with the potential buyers of the shares of the subsidiary of XYZ Company.

(a) What is the tax status of the supply if the attempt to sell the subsidiary fails?

(b) What is the status of the supply if the M&A service provider is assisting the acquirer in an hostile takeover? Would the M&A provider meet the requirement for soliciting and negotiating?

(c) Would the tax status change if the hostile takeover fails?

(d) What is the status of the supply if the M&A service provider is assisting a "white knight" in a hostile takeover?

(e) Would the tax status change if the "white knight" fails?

(f) Would the above answers change if the subsidiary has mainly financial assets?

(ii) While the Draft Policy Statement is meant to simplify the application of, or exemption from, the GST, certain practical considerations must be addressed. Does the tax status of M&A advice given by investment dealers depend upon the outcome of the advice? For example, it appears that if the M&A activities result in a share transaction, GST would not apply; in contrast, if a non-share transaction results, GST applies. Inasmuch as invoicing occurs throughout the planning and execution of a transaction, basing the tax status on the outcome would be problematic.

Where an investment dealer receives a payment for advisory services for advice concerning whether there should be a sale of shares or assets or the valuation thereof, the investment dealer is unable to determine whether GST applies to those fees at the time of invoicing (because the form of the transaction is not known). If the investment dealer does not charge GST on advice that ultimately results in the acquisition of assets, will CCRA waive any penalty or interest for failure to collect GST? Would these answers apply to the same services supplied by a consulting firm such as a public accounting or consulting firm?

33. A manufacturer operating a cafeteria collects GST on supplies of prepared meals to employees, but not on "free issue" meals. The latter such as overtime meals, catering for training courses, and departmental "charge" sales represents a cost allocation to a department profit centre and not a sale, despite being rung through a cash register. To the extent that only 50 percent of the taxable inputs are claimed on these meals (for the GST paid on sodas and pre-packaged cookies, for example), there appears to be minimal tax leakage on free issue prepared meals.

Does the situation change if the manufacturer engages in a services contract where an outside provider operates the cafeteria on the manufacturer's premises? In such circumstances, the outside provider is responsible for the collection and remittance of any GST due. Presumably, the charges for the "free issue" meals become taxable supplies. Please confirm that the outside provider can claim full ITCs for all foodstuffs used in the preparation of the meals. Where the outside provider invoices the manufacturer for such meals, please confirm that the manufacturer is only eligible to claim back 50 percent of the GST that the outside provider has invoiced.

34. A Canadian GST-registered entity (the parent) owns a Canadian, GST-registered subsidiary, which owns the assets of a production facility that it leases to the parent. The subsidiary's assets include the land, building, and manufacturing equipment at a specific location. The parent has several subsidiaries, each owning a specific manufacturing facility. The parent owns the inventories, goodwill, and other non-manufacturing equipment required for the operation of the each facility. The employees who work in the manufacturing facility are employees of the parent.

A buyer (Company B) wants to acquire the production facility at one location and continue operating it. Company B wants to purchase the land, the building, and manufacturing equipment from the subsidiary, as well as the inventories, goodwill, and other non-manufacturing equipment owned by the parent. In addition, all employees formerly with the parent will now become employees of Company B. The purchase and sale agreement will identify one buyer (Company B) and two sellers (i.e., the parent and subsidiary).

(i) Will CCRA accept two section 167(1) elections in relation to the one purchase and sale agreement (i.e., one election between the buyer and the parent, and the second between the buyer and subsidiary)?

(ii) If the answer to (i) is no, will CCRA accept one section 167 certificate and if so, which section 167 election will be permitted?

(iii)If the answer to (ii) is no, please provide the rationale.

(iv) What would be the answer if there were two separate purchase and sale agreements, one between Company B and the parent and the second between Company B and the subsidiary?

(v) Would the answers to (i) and (ii), change if there were two non-related parties (Company X and Company Y) selling to Company B?

(vi) If, within the one purchase and sale agreement, the subsidiary were required to sell the operating assets of the specific manufacturing facility to the parent which in turn would sell the business to Company B would CCRA accept a section 167 election between Company B and the parent?

35. Sales are made to four divisions of a GST-registered, non-resident company. GST is charged on the sales of goods shipped to Canadian divisions; GST is zero-rated on sales to divisions where the goods are exported from Canada. At the end of the fiscal year, the seller issues a volume rebate through a credit note, based on total sales to the customer, i.e., both taxable and zero-rated supplies. GST is added to the total value of the rebate. (The company's policy is to credit the GST on customer volume rebates; it has not elected with the customer to forego the credit of GST for consistency reasons. The company also sends the credit note to the customer.)

Will CCRA bar the GST debit adjustment in the seller's books for the proportion of the activity that relates to zero-rated sales? Must GST be tracked back to the original transactions to render the proper GST allocation of the credit? Do the answers change if the GST-registered customer is a resident of Canada as opposed to a non-resident?

36. An electricity forward or swap contract that contemplates only a cash settlement is considered a "financial instrument" under subsection 123(1) of the ETA. The terms of the contract are similar to those in the IMO energy forward market. In this regard, one party agrees to supply and the other agrees to purchase electricity at a fixed price at some future date. In turn, the other party agrees to sell and the first party agrees to purchase electricity at the floating market rate on the same future date. Instead of each party receiving the electricity and paying the other for the supply, however, the party whose "sale" price exceeds its "purchase price" receives a cash settlement for the difference from the other party.

Because the parties never actually pay or receive amounts other than the cash settlement, it appears that the transaction flow is limited to those settlement amounts. In this regard, the only amount payable or receivable is the cash settlement amount. When calculating the revenues of the parties for purposes of determining their status under subsection 149(1) of the ETA, should the revenues from these swap transactions be limited to the amount of the cash settlement? If not, a significant number of companies in many industries may be considered de minimis financial institutions because of the potential size and volume of these hedging transactions.

37. Section 185 of the ETA permits non-financial institutions that in the course of their commercial activities provide incidental financial services to claim ITCs in respect of those services. Corporations in commodity industries often engage in swap or hedging transactions to protect profit margins as a result of fixed price contracts with customers that must be fulfilled by purchasing the commodity at the prevailing market rate at a future date. The hedging activities are thus a necessary part of their commercial business because it allows them to enter into agreements with customers while protecting themselves against unforeseen events.

As a result of their hedging activities, the corporations may earn some financial service revenue in the course of their commercial activities. Please confirm that a corporation in the electricity retailing (or other commodity-based) business using hedging transactions in the course of its taxable retailing business may claim ITCs in respect of expenses relating to those transactions under section 185 of the ETA.

38. Schedule VI, Part V, paragraph 12(b) zero rates a supply of tangible personal property if the supplier transfers possession of the property to a common carrier or consignee that the "supplier has retained, on behalf of the recipient" to ship the property to a destination outside Canada. Similar phraseology appears in Schedule IX, Part II, section 3, dealing with the place of supply rules for the harmonized sales tax (HST).

In its response to GST/HST Questions & Answers #185, dated March 18, 1997, dealing with the HST, CCRA provided the following guidance on its interpretation of the phrase "supplier has retained on behalf of the recipient":

   It means that the supplier has made arrangements with a carrier or
   consignee at the request of the recipient. The manner in which the shipping
   charges is billed will generally not be relevant. It could be billed by the
   supplier or by the carrier to the recipient.

Please answer the following questions:

(i) Is this interpretation still valid and if so, can it be applied to paragraph 12(b) of the zero-rating provision?

(ii) A strict reading of the statute implies that the supplier must retain the carrier as agent for the recipient (possibly necessitating that a formal written agency agreement be entered into between supplier and recipient for this purpose). This is in sharp contrast to the much broader meaning applied by the CCRA in its response to question #185. Which interpretation is correct?

In addition, TEI requests guidance on zero-rating for the following scenarios:

(iii) The terms of sale are FOB the supplier's premises at several locations in Canada. The GST-registered supplier contracts with a carrier to deliver the goods to its customer in a foreign country, i.e., a written contract is entered into between the Canadian supplier and the carrier and the supplier pays the carrier. A freight charge appears as a separate line item on the supplier's invoice or alternatively a separate freight only invoice is prepared.

(iv) Same facts as in (iii), but the invoice is marked "Freight Prepaid."

(v) The terms of sale are FOB the supplier's premises in Canada. The supplier contracts with a carrier to deliver the goods to its customer in a foreign country, i.e., a written contract is entered into between the Canadian supplier and the carrier. Under the contract, however, the foreign customer is made liable for the freight and is required to pay it directly to the carrier (freight collect). There may or may not be a written agreement between the Canadian supplier and its foreign customer to this effect, but the payments are made without incident or dispute.

(vi) The terms of sale are FOB the supplier's premises in Canada (there are several locations). The foreign customer contracts with a carrier to deliver the goods in its home country. The carrier invoices the foreign customer for the freight and the customer pays it directly. The Canadian supplier is required, however, to notify the carrier (by facsimile, electronic data interchange, telephone, etc.) when and where the goods are available for pickup in Canada and provide export documentation.

(vii) The foreign customer requests that the Canadian supplier allow the foreign customer's customers (U.S. distributors) to come to Canada and pick up the goods. They will transport the goods directly out of Canada and into their U.S. warehouses. The Canadian supplier is required to arrange with the U.S. distributors when and where the goods are available for pick-up in Canada and provide export documentation. The U.S. distributors appear to qualify as "consignees" as required by the zero-rating provision.

39. X Co. engages in energy management contracts with its commercial customers (i.e., all are engaged exclusively in commercial activities). Under the contract, X Co. will retrofit the customer's premises with energy efficient equipment and apparatus and manage the customer's energy needs. The customer will pay X Co. monthly, based on an estimate of what the customer's utility bill would have been without the retrofit. Under the contract, the customer pays a fixed amount each month to X Co. that covers its utility costs. To the customer, the contract represents its utility costs.

X Co. intends that the retrofit and management will reduce its customer's energy consumption and that the difference between what the customer pays and what X Co. pays for the energy will pay for the project costs and produce a profit. Upon receiving the fixed monthly amount from its customer, X Co. breaks down each bill internally into separate components: payment of its customer's actual utility bill; repayment of principal for the supply and installation of equipment and apparatus; interest payable thereon; monthly energy performance services charges; and the balance, if any, as profit margin. In some months, the customer payment will be less than the above components.

X Co. collects GST in respect of the supply and installation of the equipment and apparatus in the month after the customer acquires ownership and possession. In addition, X Co. collects GST on the portion of each monthly payment attributable to its ongoing maintenance and monitoring services; it does not collect GST on the monthly charge in respect of the payment of principal or interest. X Co. also does not collect GST in respect of the interest paid by the customer. The monthly invoice to the customer states "monthly payment for Energy Performance Contract" with an amount indicated for GST on the monthly payment in respect of the energy performance services. X Co. treats the supply of electricity as a re-supply and charges GST.

X Co. pays its customer's utility bills directly to the utility. In the agreement with its customer, X Co. agrees to pay the actual utility bills incurred by the customer at the particular premises during the period of the energy management contract. The customer sends a letter to the utility requesting that it bill X Co. Accordingly, the utility sends the invoice to X Co.'s customer c/o X Co. X Co. pays the bills and is the only party that receives correspondence in respect of the monthly bill from the utility. As such, X Co. is the only person able to obtain documentation supporting an input tax credit claim.

X Co. has a proprietary interest in ensuring that its customer does not know the amount charged by the utility because it would allow the customer to ascertain X Co.'s profit margin. X Co. will not release the information to its customer. If X Co. cannot claim the ITC, nobody will. In these circumstances, the government would be unjustly enriched because neither party would be able to recover the GST on the utility bill.

It is our understanding that CCRA interprets the ITC documentation and entitlement requirements to ensure that only one person can claim ITCs in respect of a particular expense. In this regard, if the person who paid for the supply and the person who received the supply were both able to satisfy the requirements for claiming ITCs, it would result in significant revenue loss. In the example, however, only one person (X Co.) has the necessary documentation to claim the ITC. Moreover, the energy management contract makes it clear who is responsible for paying the utility bills. Accordingly, the CCRA's revenues are protected because X Co. is the only person with documentation for claiming the ITC. Please confirm that X Co. is entitled to claim an ITC to recover the GST paid on utility bills issued directly to X Co. by the utility.

Conclusion

Tax Executives Institute appreciates this opportunity to provide its comments and questions on various commodity and excise tax issues. We look forward to discussing our views with you during our December 4, 2001, liaison meeting.