Canada: Proposed GST/HST Amendments Relating To Drop Shipments

The drop shipment rules found in section 179 of the Excise Tax Act (the Act) essentially allow an unregistered non-resident person to acquire goods in Canada, or commercial services in respect of goods, on a tax-free basis, provided the goods are ultimately exported or are retained in Canada by a registrant. The Department of Finance has also stated that the drop shipment rules are intended to apply only where a registrant agrees to accept a potential liability for tax in respect of a subsequent transfer or non-commercial use of the goods.  In addition, the Department of Finance has stated that the rules are intended to help "ensure that GST1 applies to goods located in Canada that are supplied by an unregistered non-resident person for final consumption in Canada in the same way as tax would apply to the goods if they were acquired by an unregistered non-resident person outside of Canada and imported for final consumption in Canada" 2.

Absent the drop shipment rules, an unregistered non-resident buying goods for resale in Canada would have to pay GST on the purchase of the goods, but would not be able to claim an input tax credit for the GST they paid. This would be the case even where the goods were ultimately sold to a registrant who would be entitled to claim a full input tax credit for any GST paid. In these circumstances, without the drop shipment rules, the unregistered non-resident would effectively be forced to register for GST in order to claim input tax credits for the taxes they had to pay. 

Unfortunately, over the years the Canada Revenue Agency (CRA) has taken a rather restrictive view as to when the drop shipment rules apply. In order to clarify and fill some perceived gaps in the existing rules, on July 22, 2016 (the Announcement Date), the Department of Finance released proposed legislative amendments to the drop shipment rules. These amended provisions (the New Rules) are intended to ensure that the policy objectives of the drop shipment rules are being met. 

While the New Rules are fairly lengthy and are extremely technical (as are the existing rules), the New Rules appear to resolve, in a consistent and logical manner, many of the issues that had arisen based on the CRA's interpretation of the existing rules3.

The following is a high-level summary of some of the major changes found in the New Rules. All statutory references below are to provisions of the Act:

Creation of a new "Owner's Certificate"

Under the New Rules, only a consignee that purchases supplies directly from an unregistered non-resident can issue a drop shipment certificate. However, the New Rules also create the concept of an Owner's Certificate, which essentially works in the same way as a drop shipment certificate, but allows for greater flexibility and relief relative to the CRA's rather restrictive interpretation of the existing drop shipment rules (an Owner's Certificate). If a GST registrant (the Registrant) supplies goods, a service of manufacturing or producing goods or a commercial service in respect of most goods, to an unregistered non-resident, the Registrant causes the transfer of physical possession of those goods at a place in Canada to another GST registrant (the Consignee), and the Consignee is not entitled to issue a drop shipment certificate, then an Owner's Certificate can be issued if either: (a) immediately after physical possession of the goods are transferred, the goods are goods of a third person that is registered for GST (the Registered Third Party), or (b) the Consignee acquires physical possession of the goods as the recipient of a taxable supply by way of sale of the goods from a Registered Third Party, before physical possession of the goods is transferred.  In these circumstances, either the Registered Third Party (in both cases (a) and (b) above) or the Consignee (in case (b) above) can issue an Owner's Certificate which should have essentially the same effect as a drop shipment certificate (i.e., the supply to the unregistered non-resident will be deemed to be made outside of Canada, so no GST is payable, and the effects of subsection 179(1) will be nullified).

For example, the Owner's Certificate should apply where a Registrant sells goods to an unregistered non-resident person, who then on-sells to a GST-registered wholesaler who ultimately sells the goods to a GST-registered distributor, and the goods are then physically delivered direct from the Registrant to the distributor.  In this scenario, the CRA had taken the position under the existing rules that a drop shipment certificate could not be issued by the wholesaler because it did not receive physical possession of the goods, and the distributor could not issue a drop shipment certificate because it was not liable under Division IV of the Act. Under the New Rules, either the wholesaler or the distributor in this example should be able to issue an Owner's Certificate, such that the supply to the unregistered non-resident person should be deemed to be made outside of Canada.

Creating new liability for Consignees and owners who issue certificates

As mentioned above, the CRA's position was that only someone who was liable to self-assess tax as a recipient of an imported taxable supply of the goods could issue a drop shipment certificate, notwithstanding there was nothing in the old rules which deemed this to be the case. The New Rules contain a number of provisions which would create a potential liability to self-assess tax on anyone who issues a drop shipment certificate or an owner's certificate. 

New rules dealing with inputs used in the manufacturing process

The existing drop shipment rules only worked for goods that were physically delivered in the same form in which they were sold. The rules did not technically apply to goods that were used as inputs or were consumed in the manufacture of other goods. Sub-paragraphs 179(2)(c)(ii) and (iv) of the New Rules now allow a Consignee to issue a drop shipment certificate for goods which are incorporated or transformed into, or consumed or expended in the manufacture or production of, other goods.

New rules dealing with leases

Concerns were raised with respect to the existing rules that there were some gaps in cases where an unregistered non-resident leases goods in Canada. For example, if an unregistered non-resident imported goods into Canada and then leased them in Canada, the lessee could potentially claim input tax credits under section 180 for GST paid on the import of the goods into Canada. At the end of the lease, the non-resident would own the property in Canada and could supply it to a Canadian consumer under section 143 such that the supply would be deemed to be made outside Canada and no GST would be exigible. While the non-resident might be required to register for GST, this would depend on whether the non-resident was carrying on business in Canada, which might not always be the case. New subsections 179(8) to (12) set out how the drop shipment rules will apply with respect to leases.  Generally speaking, the New Rules create a potential liability on a previous lessee (under subsection 179(1)) unless the new lessee issues a drop-shipment certificate or Owner's Certificate.  As there are a number of special rules, and exceptions to these rules, and as the rules are fairly complex, any non-residents dealing with leases in Canada should review the drop shipment leasing rules to determine if the New Rules apply to their particular facts.

Clarification of the retention of possession rules in subsection 179(4)

A number of changes are proposed to the retention of possession rules in existing subsection 179(4) to deal with some timing issues, and to clarify how the rules will work in other situations. 

After royal assent, the new retention of possession rules will be set out in subparagraphs 179(5)(b)(i) to (v).  It should be noted that subparagraph 179(5)(b)(v) explicitly deals with a "buy-back" situation where a Registrant sells goods to an unregistered non-resident, and then repurchases the same goods from the non-resident for resale in Canada.  While a strong argument could be made that the existing rules would have applied in these circumstances such that no GST should have been payable by the unregistered non-resident, the New Rules should clarify the application of section 179 in such cases.

Coming into force provisions

We note that there are two sets of new drop shipment rules: first a set that applies from the Announcement Date forward (with some limited retroactivity as discussed below), and a second set which will apply from royal assent.  Notwithstanding the two sets of rules, both sets generally function in the same way. 

One concern we have with the New Rules is the coming into force provisions. In particular, most, if not all of the changes that are relieving in nature are only effective for supplies made after the Announcement Date. However, a few of the provisions, which generally do not have a relieving effect, can apply retroactively if taxes were paid. Considering the Department of Finance regularly uses retroactive legislation when it believes that taxpayers are not complying with the intent of the Act, we would have thought that the Department of Finance should allow the relieving rules to also apply retroactively since, in this case, it was the CRA's assessments which were not complying with the intent of the Act. This is especially the case as it took so long for the New Rules to be released.

Finally, we note that the Department of Finance has invited interested parties to submit comments on the proposed amendments before the end of August. If you wish to make a submission, but do not believe that you can meet that deadline, we recommend that you advise the Department of your intention and of the date by which you will make your submission.

Footnotes

1 References herein to GST include a reference to both the goods and services tax and the harmonized sales tax.

2 As set out in the Explanatory Notes to the legislative amendments to the Act announced on July 22, 2016.

3 One exception to this is that the amended rules do not address issues with commingled goods such as continuous transmission commodities that are transported by pipeline or wire (CTCs which include oil, gas, etc.). Our understanding is that this was purposeful, as the Department of Finance believes that the rules relating to drop shipments of CTCs should be dealt with separately under a future review of the provisions of the Act specific to CTCs. 

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.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
 
In association with
Related Topics
 
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions