On July 12, 2010, the federal Canadian government enacted new goods and services tax/harmonized sales tax ("GST/HST") self-assessment rules (the "Rules") for financial institutions ("FIs") relating to the acquisition of certain goods and services outside Canada. The Rules have caused significant confusion in the financial services industry, and have created a number of problems for FIs in determining exactly what amounts will now be subject to GST/HST. While the Rules were enacted in 2010, they were originally announced in 2005, and therefore were made applicable to amounts that were paid or became due after November 16, 2005.
Under the GST/HST regime, Canadian residents are required to self-assess for GST/HST on consideration payable for taxable services supplied outside Canada to the extent such services are not acquired for use in a commercial activity. As financial services are exempt from GST, Canadian residents are generally not required to self-assess for GST/HST on financial services acquired outside Canada from non-residents. However, under the Rules, "qualifying taxpayers" (i.e. FIs which are resident in Canada, have a permanent establishment in Canada, or, in certain circumstances, carry on an activity in Canada) are required to self-assess GST/HST on part of the payments they make for financial services to non-residents who do not deal at arm's length with the qualifying taxpayer, even though such amounts would be exempt if paid to a Canadian resident or an arm's length non-resident. Specifically, qualifying taxpayers must self-assess on the "Loading" aspect of these payments (essentially amounts for profit and administrative costs, as described in more detail below). In addition, every qualifying taxpayer that is resident in a province where HST applies will generally be required to self-assess the provincial component of the HST on qualifying consideration for goods or services which are used by it in carrying on a business or activity in that province.
While the Department of Finance (the "Department") has provided a definition of "Loading", it has not provided any guidance on how to calculate which portion of the consideration for a financial service constitutes Loading. We understand that in practice it is difficult, if not impossible, for taxpayers (or CRA auditors for that matter) to determine what portion of the consideration for a financial service constitutes "Loading" and is thus taxable. As such, many taxpayers are having significant difficulties in determining the amount of GST/HST they must self-assess.
We understand that various industry groups have raised these concerns with the Department, and that the Department is in the process of establishing a group (including industry members, the CRA and members of the Department) to review the Rules. It is hoped that the Department will introduce new rules or propose a formula which can be used by taxpayers to help them comply with the Rules and calculate the amount of "Loading" which will be subject to tax.
Self-Assessment on "Qualifying Consideration"
Under the Rules, unless a particular election is made, qualifying taxpayers must self-assess GST/HST on all "qualifying consideration". Qualifying consideration for a taxation year is essentially the total (less certain "permitted deductions") of the amount of any outlay or expense for a supply made outside Canada where: (a) the outlay or expense is or would be allowed as a deduction, allowance or an allocation for a reserve under the Income Tax Act ("ITA") in computing the qualifying taxpayer's income for the taxation year and (b) the outlay or expense may reasonably be regarded as being applicable to a Canadian activity of the qualifying taxpayer. This definition of "qualifying consideration" is very broad and includes most payments (subject to permitted deductions) made to a parent corporation or head office to the extent that the payments are deductible for Canadian tax purposes, even in situations where they would not have been subject to GST if they were made in Canada.
"Permitted deductions" are amounts that would otherwise be included in qualifying consideration, including:
- amounts upon which GST was otherwise payable (so that these amounts are not taxed twice);
- consideration for most arm's length supplies of property or services as long as no part of the activity was carried on or engaged in by a party which does not deal at arm's length with the qualifying taxpayer;
- salary, wages and other compensation for employees where their duties are performed primarily in Canada;
- consideration for supplies of financial services where all participants deal at arm's length with the qualifying taxpayer;
- consideration for supplies by an agent, salesperson or broker of arranging for the issuance, renewal, variation, or transfer of ownership of a financial instrument (which includes an insurance or reinsurance policy) not owned by the agent, salesperson or broker;
- consideration for supplies of financial services that include the issuance, renewal, variation, or transfer of ownership of a financial instrument where any of the participants do not deal at arm's length with the qualifying taxpayer. However, "Loading" (as described below) is excluded from this deduction; and
- consideration for certain specified derivative supplies.
As noted above, if a qualifying taxpayer makes a payment to a Canadian resident, or to an arm's length non-resident, for an exempt financial service, they will generally not be required to self-assess any GST/HST. However, based on the Rules, as described above if a qualifying taxpayer makes the same payment for a financial service to a non-resident with which the taxpayer does not deal at arm's length, it will generally be required to self-assess GST/HST on the "Loading" portion of the charge.
Loading is defined to include any part of the consideration for a financial service that is attributable to administrative expenses, an error or profit margin, business handling costs, most commissions, communications expenses, claims handling costs, employee compensation or benefits, execution or clearing costs, management fees, marketing or advertising costs, occupancy or equipment expenses, operating expenses, acquisition costs, premium collection costs, processing costs, and "any other costs or expenses of a person who makes the supply". However, "Loading" is specifically defined not to include: (a) the part of the consideration that is equal to the estimate of the net premium of an insurance policy (with respect to the issuance, renewal, variation or transfer of ownership of an insurance policy); and (b) the estimate of the default risk premium associated with the qualifying instrument (with respect to the issuance, renewal, variation or transfer of ownership of a qualifying instrument other than an insurance policy).
For example, consider a qualifying taxpayer that has a parent in the US. The CRA has stated that where the FI acquires insurance from a company outside Canada which does not deal at arm's length with the FI, and the FI deducts the premium under the ITA, the insurance premium would be included in calculating qualifying consideration. Since the insurance premium is paid to a party which does not deal at arm's length with the taxpayer, any portion of the insurance premium which represents Loading (i.e. certain of the non-arm's length party's expenses of doing business and its profit margins), will be included in the calculation of qualifying consideration and the FI will be required to self-assess GST/HST on these amounts. However, the portion of the insurance premium representing future claims under the insurance policy should generally not be Loading, and therefore should not be subject to GST/HST. For instance, assume that the above qualifying taxpayer pays its US parent $100 for reinsurance. If the average cost of claims covered multiplied by the probability that the event covered occurs is $90, then the qualifying taxpayer will have to determine which portion of the remaining $10 is Loading, and will only have to self-assess GST/HST on the Loading amount.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.