Introduction – Export Businesses and Canada’s GST/HST System
Export-oriented businesses in Canada play a vital role in facilitating Canada’s international economic presence and economic growth. An export business engaged in repackaging and distribution of goods abroad, rather than on manufacturing or production, may be able to benefit from beneficial sales tax treatment under Canada’s Export Distribution Centre Program (the “EDCP”). Enacted in 2000, the Export Distribution Centre Program was designed to benefit export business models strictly focused on redistribution services. What export business models may qualify for authorization under the Export Distribution Centre Program, and what activities may threaten that authorization once obtained, can involve complicated tax rules and principles. It is vital that any registrant seeking authorization speak to an expert Canadian tax lawyer on eligibility for authorization and how best to structure a business to benefit from favourable sales tax treatment under the Export Distribution Centre Program.
Canadian GST/HST Rules for Businesses
In Canada, GST/HST is generally charged on taxable supplies purchased in or imported into the country. GST/HST will be payable on a supply purchased domestically by a Canadian business at time of purchase, while for imports GST/HST will generally be payable at the time of import itself with limited exceptions under Part IX, Division III of the Excise Tax Act. To prevent the inevitable increase in costs that would result were every supplier along a supply chain required to pay GST/HST, an off-setting input tax credit (ITC) is offered to registrants on non-exempt supplies. That input tax credit will be equal to the GST/HST that the registrant paid on supplies used as part of the registrant’s commercial activities. The input tax credit system is designed to prevent cascading taxation in the hands of businesses, and to shift the GST/HST charged on a supply onto the final consumer.
This sales tax system, as it applies to export-oriented businesses, is far from ideal. Generally speaking, the value-added to a supply or to inventory by an export business focused on redistribution is minimal. That same export business will nevertheless be responsible for paying GST/HST on any goods for export purchased domestically and internationally. Export-oriented businesses may be entitled to claim and receive input tax credits on GST/HST paid on supplies, but the delay in time between payment of GST/HST and receipt of the credit often creates cash-flow issues. The Export Distribution Centre Program was principally enacted in order to provide some relief from cash-flow issues among appropriate export-oriented businesses.
Benefits of the Export Distribution Centre Program
Subsection 273.1 of the Excise Tax Act, defining the scope of the Export Distribution Centre Program, authorizes the Minister of National Revenue (the “Minister”) to grant qualifying applicants authorization under the Export Distribution Centre Program. An applicant granted authorization by the Minister through the Canada Revenue Agency (the “CRA”) is entitled to issue Export Distribution Centre Program certificates when purchasing supplies or inventory domestically on a zero-rated basis (so long as the total consideration for property purchased with the certificate is at least $1,000), and internationally on a non-taxable basis. A zero-rated supply is effectively taxed at a rate of 0%, meaning that the authorized purchasing business will not be subject to GST/HST payable on the value of purchases made in Canada or from abroad. In the context of the export industry, the Export Distribution Centre Program is a substantial boon and helps to avoid significant cash-flows from becoming trapped as a consequence of Canada’s GST/HST remittance system.
An applicant who successfully applies for authorization with CRA will be entitled to issue Export Distribution Centre Program certificates for a period of up to 3 years from the effective date of authorization of the applicant. Certification under the Export Distribution Centre Program is therefore not a permanent designation, and thus an authorized business must continue to qualify for the program by re-applying for each 3-year period under the Program.
Qualifying for the Export Distribution Centre Program
In order for an applicant to qualify for the Export Distribution Centre Program under the Excise Tax Act, that applicant must satisfy a number of specific conditions. First and foremost, the applicant must be a registrant for the purposes of collecting GST/HST and must be both actively and exclusively engaged in commercial activity. A registrant meeting these criteria must also be reasonably expected to satisfy three additional conditions pertaining to the nature of its commercial activities:
- The registrant must not engage in “substantial alteration of property”;
- The registrant must refrain from contributing excess value to consumers’ goods through processing activities; and,
- The registrant’s percentage of revenue from export activity must be reasonably expected to be at least 90%.
“Substantial Alteration of Property”
First, the registrant must not engage in “substantial alteration of property” in a given tax year. “Substantial alteration of property” in this context has several complicated definitions under the Excise Tax Act, and includes:
- Any manufacturing or producing activities, or an engagement with another person to manufacture and produce, property in a tax year;
- Any processing (including adjustments, alterations, assembly and any similar ‘basic service’ to a supply) undertaken by the registrant in a tax year which results in finished inventory of the registrant, if:
- The percentage value-added attributable to non-basic services with respect to that inventory exceeds 10%; and
- The percentage total value-added with respect to that inventory exceeds 20%.
In essence, a registrant is prohibited from contributing too much value through its services to finished inventory designated for export. A registrant can surpass one percentage limit on value-added attributable to services, but not both, and only if those activities do not qualify as either manufacturing or producing. Thus, a registrant can contribute more than 10% to the value of the supply through non-basic services, so long as the total value-added with respect to inventory does not exceed 20%. On these grounds, it is plainly clear that only export businesses focused on redistribution will be able to qualify for tax benefits under the Export Distribution Centre Program.
Contributing Excess Value through Processing Activities
Second, in order to qualify under the Export Distribution Centre Program, it must be reasonably expected of the registrant that either:
- The registrant’s percentage value-added attributable to non-basic services concerning customers’ goods will not exceed 10%; or
- The registrant’s percentage total value-added with respect to customers’ goods will not exceed 20%.
That is to say, a registrant involved in processing goods for consumers must refrain from surpassing both of the above percentage value-added limits. Just as with the “substantial alteration of property” condition, a registrant is permitted to surpass one percentage limit under the Export Distribution Centre Program.
Percentage of Revenue from Export Activities
Third, the registrant’s revenue from export activities must be at least 90% of the registrant’s total revenue generated by commercial activity in Canada for the registrant’s tax year. The Excise Tax Act enumerates what qualifies as “export revenue” for the purposes of evaluating a registrant’s percentage of revenue. The Excise Tax Act includes in the definition of “export revenue” any consideration resulting from sale of domestic inventory outside of Canada, any sale of “added property” (which includes, among others, packing materials and components for inventory to be sold to consumers) used by the registrant in order to process Canadian property for export, and any processing, storing and distribution services for exports of property offered to other persons.
Pro Tax Tip – Revocation of Certification under the Export Distribution Centre Program
Once a registrant’s top Canadian GST lawyer has obtained authorization from CRA under the Export Distribution Centre Program, it is expected that the registrant will remain a qualifying entity over the 3 years that the authorization remains valid. Under subsection 273.1 of the Excise Tax Act, CRA is entitled to revoke a registrant’s authorization where the registrant fails to comply with any conditions that may have been attached to the registrant’s authorization under the Export Distribution Centre Program, or the registrant fails to comply with any GST/HST provisions of the Excise Tax Act. CRA may also revoke the registrant’s authorization where CRA reasonably expects that:
- The registrant will engage in substantial alteration of property in that tax year;
- The registrant will surpass the prescribed limits to percentage value-added attributable to customers’ goods in that tax year;
- The registrant’s export revenue percentage will be lower than 80% for that tax year.
Alternatively, the registrant may instead suffer an automatic deemed revocation to take effect at year-end where any of the three above conditions are breached by the registrant. A deemed revocation of a registrant’s authorization will disbar that registrant from re-applying for authorization under the Export Distribution Centre Program for at least one fiscal year. Where CRA has revoked the registrant’s authorization for breach of authorization conditions or any GST/HST provisions, the registrant will be disbarred from re-applying under the Export Distribution Centre Program for two years. It is therefore vital for an export business to actively monitor the nature of operations in order to ensure that the business will not risk running awry of these rules. If you are a registrant considering making an application under the Export Distribution Centre Program, or are an existing authorized registrant seeking to learn how better to structure your operations to avoid a potential revocation, then you should consult with one of our expert Canadian tax lawyers.