Proposed improvements to GST Technical Bill: October 1, 1996.

Background

TEI is an international organization of approximately 5,000 professionals who are responsible - in an executive, administrative, or managerial capacity - for the tax affairs of the corporations and the other businesses by which they are employed. TEI's members represent more than 2,700 of the leading corporations in Canada and the United States.

Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together make up one of our nine geographic regions. In addition, a substantial number of our U.S. members work for companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this submission reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

TEI has historically been concerned with issues of tax policy and administration and is dedicated to working with government agencies in Ottawa (and Washington), as well as in the provinces (and the states), to reduce the costs and burdens of tax compliance and administration to our common benefit. We are convinced that the administration of the tax laws in accordance with the highest standards of professional competence and integrity, as well as in an atmosphere of mutual trust and confidence between business and government, will promote the efficient and equitable operation of the tax system. In furtherance of this principle, TEI supports efforts to improve the tax laws and their administration at all levels of government.

General

TEI is pleased that the Technical Bill will clarify the application of the GST in a number of areas including:

* The expanded list of items eligible for zero-rating;

* The broadened scope of the de minimis rules, which will limit the application of the deemed financial institution provisions;

* The modifications to the taxable benefit to employees arising from employer-provided automobiles;

* The elimination of the requirement to file GST Form 60 for most business real estate transactions.

Other provisions of the Technical Bill, however, raise issues that warrant careful consideration and reevaluation.

Two-year Limit for

Claiming Input Tax Credits

1. Differing Statutes for Assessments, Input Tax Credit Claims, and Refunds. Under current rules, a registrant may claim input tax credits in respect of qualifying purchases for up to four years following a taxable supply. The Bill will shorten the period for claiming input tax credits from four years to two for "large taxpayers." TEI believes that imposing a special limitation period on large taxpayers is both unwarranted and unfair. The discriminatory treatment of large taxpayers unjustifiably restricts the benefit of input tax credits in contravention of the economic rationale for adopting a multi-stage sales tax, namely, the pass through of the incidence of GST to the ultimate consumer. Moreover, there is no corresponding and equitable change to the limitation period within which Revenue Canada may assess additional GST on, or deny input tax credits claimed by, large taxpayers. We recommend that the two-year limitation rule for large taxpayer to claim input tax credits be withdrawn.

2. Illustration. The detrimental effect of the shortened period for claiming input credits is easily illustrated. One exception to the four- (or two-) year limitation period permits a taxpayer-supplier to claim an input credit beyond the normal limitation period where the purchaser is under audit. Consider the application of the revised rule under the following common circumstances. In connection with an audit of four years of GST returns, Company A is assessed for uncollected GST on supplies made to Company B. Following an assessment, Company A will generally attempt to collect the GST from its customer. Company B will generally be willing to pay the uncollected tax to A as long as (1) the supplier can demonstrate that tax is due and unpaid on the purchase and (2) Company B is able to claim an input credit for the tax payable to A. Under the proposed amendment, however, Company B would be entitled to claim an input tax credit for payments of uncollected tax only in respect of the two most recent years. Input tax credits for purchases made three or four years prior appear to be available to Company B only in the unlikely event that B is simultaneously under audit in respect of the same periods as Company A. A taxpayer with an unclaimed input tax credit in years 3 and 4 (a circumstance in which Company B likely would be) would never benefit financially from opening a prior audit or requesting reassessment since the taxpayer would be required to identify an unpaid liability against which to offset the additional credit. Hence, Company B will likely always refuse to pay A. If the two-year rule for claiming input credits is retained, and the statute of limitations for Revenue Canada to assess is not similarly shortened, a special rule should be implemented to permit a net credit position (or refund) to registrants on reassessments.

3. Discretion to Permit Input Credit. As revised by the Bill, section 296(2) will state that:

The Minister may take the allowable credit into account in assessing the net tax for the particular reporting period as if the person had claimed the allowable credit in a return filed for the period.

The use of permissive language - may - is troubling. By implication, the Minister's representative, the auditor, may also deny a properly documented tax payment as a credit. We believe this provision grants auditors far too much discretionary authority in respect of input tax credits. The use of the term "allowable" modifying word "credit" signifies that taxpayers retain the burden of proving by documentary evidence the amount of input tax credit to which they are entitled. Permitting the Minister to deny arbitrarily an otherwise "allowable" credit is unacceptable. Hence, we recommend that section 296(2) be revised to state that "the Minister shall take the allowable credit...."

Section 301:

Notice of Objection

The Technical Bill will add section 301 to the Act. The provision sets forth rules that will increase the formal requirements to raise a Notice of Objection respect of the assessment of GST or denial of input tax credits. Regrettably, the Notice of Objection provisions incorporated in the Technical Bill are as flawed as similar provisions recently added to the Income Tax Act. The principal effect of the provisions will be to undermine taxpayer confidence in the informal dispute resolution process that the Appeals Division was established to serve. More important, the elaborate procedures set forth in the Notice of Objection rules will likely cause taxpayers to involve outside legal counsel in the earlier stages of the audit and appeal process. Taxpayers may be reluctant to prosecute first-level appeals without counsel in the belief that such assistance is essential to preserve legal issues or state disputed facts with the precision more typical of formal court proceedings. The increased use of outside legal counsel either during the audit or Notice of Objection phase, in turn, can only serve to diminish the utility of the appeals process and increase the likelihood of litigation since taxpayers and Revenue Canada alike will be encouraged to develop entrenched legal positions rather than resolve factual matters or legal issues in an informal and open dialogue.

In addition, the scope of businesses to which the new procedural rules will apply is, in TEI's view, far too inclusive. Specifically, the $6 million business revenue threshold is too low. Many smaller and medium-size companies will be compelled to bear substantial costs in order to file a first-level administrative appeal of a GST assessment. Should the first stage of a tax appeal become - or, more important, be perceived as - cost prohibitive, confidence in the fairness (or the perception of fairness) of the Canadian tax system will be eroded and, hence, voluntary compliance may diminish.

Extend Rebate of GST to

Non Residents for Other

Expenses

The government's April 23, 1996, announcement will permit non-resident businesses to file a single, combined Form GST 176E in order to consolidate multiple claims for the rebate of the GST on hotel accommodations. Thus, where there are multiple visits by an individual over a period of time or where multiple individuals travel to Canada on behalf of the claimant, the non-resident business will be permitted to cumulate the GST from the various individuals' visits and present a combined rebate claim. TEI applauds this administrative simplification of the GST rebate process.

In addition, we recommend that the government consider aligning its foreign-traveler rebate provisions with those found in European value-added tax systems. By extending the GST rebate to encompass other non-resident business travel costs, including meals, car rentals, gasoline or diesel fuel, and other in-country transportation expense, for example, the government will provide an additional incentive to promote international business travel and investment.

Effective Date of Technical

Changes and Section 177

TEI recommends that the government reconsider its general policy of making technical changes to the GST effective from their announcement date. The current general policy imposes substantial burdens on registrants because it is impossible to implement immediately the changes set forth in complex technical legislation. Registrants must have time to study the new rules, understand their nuances, change their business processes and, most important, make changes to their accounting and information systems in order to comply with the revised requirements. To its credit, where the Department of Finance anticipates the confusion spawned by new legislation (or a specific provision within the legislation) or is apprised of the administrative and compliance burdens engendered by the transition to new rules, it often announces specific ad hoc transition periods to ease registrant's implementation burdens. That ad hoc relief, though, is often limited to narrow provisions or specific bills. Moreover, despite the technical expertise and diligence of its personnel, the Department will generally be unable to anticipate all the collateral effects of technical or policy legislation.

As a result, in respect of a transaction-based tax such as the GST, TEI believes that limited, ad hoc transition periods are an inadequate remedy for eliminating the technical, and possibly widespread, non-compliance that results from an "effective on announcement date" policy. TEI recommends that the government adopt a general policy that the effective date for all changes to the GST shall be the date of Royal Assent. Such a policy will afford registrants time to understand the legislation and, more important, implement the changes necessary to collect the proper amount of GST from their customers (or, in some cases, to self-assess GST). As an alternative, the government could adopt a minimum standard transition period of say, 6 months from date of announcement as the effective date for all GST changes. A minimum standard transition period, if reasonable in length, will afford taxpayers time to understand the rules, identify the administrative and compliance issues, and either implement necessary changes or bring the substantial administrative and compliance issues to the attention of Finance for technical changes or additional relief.

The confusion engendered and burdens imposed on taxpayers by the failure to anticipate transitional issues may be illustrated by the proposed changes to section 177. The revised legislation clarifies that, where an agent and its principal are both registrants and a taxable supply is made in the course of commercial activity, an agent need only collect and remit the GST applicable to the agent's service fee. Under prior rules, an agent would collect and remit tax based on the gross amount of charges to its principal's customer and simultaneously claim an ITC on the deemed supply to the principal, thereby resulting in a net tax remittance equivalent to a tax on the agent's service. The effective date of the proposed changes is the announcement date. TEI believes that some transition rule relief is necessary and appropriate because in nearly all cases, neither the principal nor the agent obtained notice of the proposed changes in time to make the systemic changes needed to comply. Moreover, the government's revenue interest will not be harmed by permitting transition rule relief because in nearly every case there will be equal and offsetting errors in the GST returns of the principal and agent. Hence, we urge the Department of Finance to issue an appropriate transition rule in respect of section 177.

National Retailers

In order to implement the provincial sales tax harmonization provisions contained in the Technical Bill, national retailers will incur substantial administrative costs. Those costs, which arise from the Bill's requirement that goods sold in the maritime provinces after March 31, 1997, be priced on a tax-included basis, constitute an unnecessary burden on retailers. As it did in 1991 when GST was implemented nationally, the government should permit retailers to decide whether to price goods on a tax-included or -excluded basis. Outside of the maritime provinces, goods sold after the effective date will continue to be priced, as now, on a non-tax-included basis. As a result, the government's decision to compel tax-inclusive retail pricing imposes additional administrative and marketing costs including the one-time cost of re-pricing existing inventory at the effective date and the ongoing costs to produce, package, promote, and price identical products on a non-uniform basis.

Examples of the ongoing costs arising from maintaining separate inventories on a tax-included or tax-excluded basis include the following:

* In respect of pre-priced goods (i.e., those priced by the manufacturer or distributor prior to delivery to the retail outlet), separate product packaging will likely be required for the maritime provinces, thereby necessitating the use of separate Stock Keeping Unit (SKU) codes and increasing product packaging costs correspondingly.

* The loss of the fungibility of product inventories for distribution in the maritime provinces and the rest of Canada will increase inventory carrying costs since separate inventory stocks must be maintained in order to fill orders in the maritime provinces and the rest of the country.(1)

* As a result of the higher, tax-included prices for the maritime provinces, separate catalogues and advertising flyers will be required increasing the cost of producing those materials.

* Separate consumer coupons will also likely be required in the maritime provinces. Current practice in the rest of Canada is to issue "GST-included" coupons. In the maritime provinces, the coupons will likely be issued on a combined GST and maritime tax-included basis.

* All computer information systems, including point-of-sale (POS) terminals, must be revised in order to charge customers the proper tax and permit registrants to capture the information from supplier invoices to claim the proper amount of input tax credits. Such system changes, particularly those involving a wholesaler's or retailer's accounts payable systems, may require up to 12 months for proper development, testing, and implementation. Drafts of detailed rules implementing tax-included pricing, however, have not yet been issued. As a result, retailers may already be unable to comply with the April 1, 1997, effective date.

* In a harmonized system, the "place of supply" rules must be carefully reviewed to prevent multiple taxation (i.e. " GST, QST, and maritime tax) on the same supply. For example, under current rules where a taxable supply is made, and portions of the supply are attributable to amounts arising inside and outside Quebec, Quebec requires that the QST be included upon the entire amount of the supply notwithstanding that some portion of the supply arises outside Quebec. In the case of, for example, supplier rebates or advertising allowances (both of which are tax-included), the application of GST, QST, and the maritime provincial tax would result in cascading taxes and be extremely complex to administer. We recommend that, in a case where a single country-wide billing is rendered for which a portion of the invoice is attributable to the harmonized provinces, only to the amount "reasonably attributable" to the maritime provinces should be subject to, and tax included for, such amount. We urge the government to reject a rule similar to that imposed by Quebec. TEI is willing to work with the Department to develop an administrable alternative.

There may not be obvious solutions to some of these issues, and our comments are intended principally to focus attention on the urgent need for further discussions. One possible solution the government should consider, however, is to defer the implementation of tax-included pricing in the harmonizing provinces until December 1997.

Conclusion

TEI is pleased to have the opportunity to present its comments in respect of the April 23, 1996, Technical Bill. TEI's comments were prepared under the aegis of its Canadian Commodity Tax Committee, whose chair is Pierre M. Bocti of Hewlett-Packard (Canada) Ltd. Should you have any questions concerning the Institute's comments, please do not hesitate to call either Mr. Bocti at [phone], or J.A. (Drew) Glennie, TEI's Vice President for Canadian Affairs, at [phone].

(1) The effect of the requirement to maintain separate inventories for harmonized and non-harmonized jurisdictions may be illustrated by example. Though the issue is not confined to sales to Prince Edward Island (P.E.I.), retail outlets there typically are served by regional distribution centres based in Halifax or St. John. Since P.E.I. is not participating in the harmonization, prepriced goods sold there will be stated without the tax, whereas the balance of goods in the distribution centre intended for delivery in Nova Scotia or Newfoundland will be prepriced on a tax-included basis. With harmonization, it will be necessary either to carry separate inventory in the regional distribution centre or to supply P.E.I. from outside the maritime provinces. Either course will increase costs to the retailer and