Besides providing a major cash flow boost to the government of Canada, one of the most significant accomplishments of the goods and services tax and harmonized sales tax (GST/HST) was that the law imposed, on almost all businesses, a higher standard for record keeping. The operation of the GST/HST requires businesses to impose the tax and allows input credits throughout the production and distribution chain of a supply (goods or service). For this to work, suppliers of goods and services need to keep good records. The Excise Tax Act, the law behind the GST/HST, specifically requires that sufficient books and records be maintained to properly support the imposition of the tax and the allowance of credits. The requirements apply equally to other types of organizations besides commercial businesses, such as not for profit organizations and charities. There are no restrictions placed on the type of records that must be kept by an organization. They just have to be sufficient to report the collection of the tax and support the claim for input credits and rebates of any type. So accounting records may be computerized or manual.
One of the main reasons for difficulties encountered in GST/HST audits by the Canada Revenue Agency (CRA) year after year is insufficient records and incomplete or insufficient source documents. The CRA has the right to examine any records of the organization that are pertinent to determining its tax obligations. It is in the best interest of any business to maintain good accounting records with audit trails that allow a person to easily trace entries to source documents. While it may seem obvious that good records are important this is an area of difficulty that arises frequently in CRA's audits.
Paper based, manual records often do not clearly show the GST/HST applied to invoices for supplies and how the tax was accumulated to support the tax returns subject to audit. When this happens it is up to the business operator to satisfy the CRA auditor that all the tax that should have been collected and remitted, in fact was. Without reliable records this can be difficult. The risk is that the CRA will determine an amount of tax payable that is higher than was remitted by the business and assess that tax to the business.
Similarly, in manual bookkeeping systems, the accumulation of GST/HST paid and recoverable may not readily support the returns that were filed during the audit period. The result is often the denial of input credits if the business cannot prove the validity of the claims.
Most computerized systems are designed t aid in charging the tax and accumulating information from the invoices. Popular systems have been written to be user friendly to the extent of making it possible for a novice to keep a credible set of accounts. But if the system is not used properly the same results can occur as with manual bookkeeping records. The breadth of potential users and abilities is wide. Consequently the use of these products varies significantly among users causing inconsistent results. Some training on use of these 'off the shelf' products can go a long way to ensuring good bookkeeping records. Regardless of how the bookkeeping is maintained it is important for the business operator to ensure its records track the tax collected, remitted and paid accurately.
Accounting records must be kept in a readable and recoverable form that can be accessed by a CRA auditor. Paper based records can become damaged by exposure to water, fire, chemical agents and other environmental hazards. Computerized records can become inaccessible through damage to the computers themselves and failure of back-up systems. An old flash drive stuffed in a desk drawer may not be as reliable a system of data backup as desired.
A growing problem is the failure to retain the software systems required to retrieve past accounting records. Businesses often change accounting systems from one author to another. Also software versions are frequently updated with support for older versions terminated after a time. The CRA can apply its own data extraction technology to data files and obtain audit data they desire. However if the business does not have the ability to retrieve its data it may not be able to prove that it has complied with the law in the event the CRA auditor raises an unfavorable assessment.
Use of 'cloud' based software and backup systems is becoming more popular. The cloud offers the convenience of data backed up regularly and automatically. Data is readily available from just about anywhere there is access to the internet. Also, the software is generally upgraded automatically. A business, however, may wish to stop using a cloud based resource. Then it will have to ensure it can obtain a useable backup and software that it can use to retrieve its data.
Supporting documents also need to be kept available in a readily accessible manner. Source documents are absolutely necessary to support the entries made to the accounting system. Without them it is nearly impossible to prove the entries made prove tax was correctly imposed on supplies and support claims for input credits and rebates.
The system of input credits throughout the supply chain is a key component making the GST/HST system function efficiently as a consumption tax. In order to claim an input credit there are documentation standards that apply to invoices and contracts for supplies. Incomplete documentation can cause the loss of a claim for an input credit. Required information is as follows:
- The party making the supply must be a registrant under the GST. So the invoice or contract should clearly show the GST/HST registration number of the supplier.
- The document should show who was the recipient of the supply and that they had a legal obligation to pay for the supply. Only the recipient of the supply may claim the input credit.
- The GST/HST charged must be payable to the registrant making the supply.
- The GST/HST should be clearly identified or show a statement that the total amount due includes the tax.
- The terms of payment.
- A description of each supply sufficient to identify it.
Some of this information is not available on a point of sale till receipt. However, most of the information is available and is accepted on audit as valid support for an input credit claim.
A common problem occurs where the registrant attempts to make a claim for input credits based on a credit card statement. The credit card statement, as detailed as it may be, would not report all the information required to support a claim for the input credits. Consequently the underlying invoices and point of sale receipts should be retained to support the claim.
Another common problem is the recipient not being the party named on the invoice. In many cases this results in the input tax credit being denied. This generally occurs when more than one company exists in a related group.
How long should accounting records be kept? Bookkeeping records and source documents should be retained for a period of six years past the year to which they apply. If after the six years there is still an unresolved matter such as a notice of objection or appeal then the records should be kept until after the conclusion of the matter. A notable exception to this is with respect to fixed or capital assets. Records supporting the acquisition of fixed or capital assets should be kept for six years past the year the assets are disposed of.
As we have seen, maintaining a good bookkeeping system and keeping source documents readily available for scrutiny, are vital to preparing accurate GST/HST returns and satisfying the CRA audit process. If the registrant cannot show that tax was imposed properly and fully as required it can be imposed on the registrant. If source documents are insufficient or unavailable to support claims for the input credits they will simply be denied. The consequences in both cases can be costly to a business.
If a business owner or director has any uncertainty that their accounting system sufficiently captures the information to properly support their GST/HST returns then they should review the system carefully and if necessary improve it.
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.