Canadian GST/HST Tax Trap: ITC Record-Keeping Requirements for Canadian Businesses – Canadian Tax Guidance from a Canadian Tax Lawyer

Introduction – The Canada Revenue Agency Targets Canadian Businesses that Keep Poor Records

The Canada Revenue Agency isn’t shy about pursuing a tax audit. But the CRA invokes its most aggressive tactics when auditing groups that the CRA’s tax auditors perceive as most likely to retain poor records. Indeed, Canada’s Excise Tax Act, which governs GST/HST, precludes a GST/HST registrant from claiming input tax credits (ITCs) unless “before filing the return for which the credit is claimed, the registrant has obtained sufficient evidence in such form containing such information as will enable the amount of the input tax credit to be determined.” In other words, not only must the registrant obtain evidence supporting the ITC, but the registrant must also obtain those records before attempting to claim the ITC.

Thus, when auditing a taxpayer’s ITC claims, the CRA’s GST/HST auditors will check both whether the taxpayer possesses supporting documents and when the taxpayer actually received those supporting documents. Taxpayers who fail to meet the Excise Tax Act’s record-keeping requirements will lose all impugned input tax credits. As a result, Canadian businesses that routinely keep poor records find themselves facing a large GST/HST bill when the CRA’s tax auditors are through.

This article examines the ITC record-keeping requirements for Canadian businesses. Before discussing the Excise Tax Act’s record-keeping requirements for input tax credits, this article first reviews Canada’s GST/HST system.  It then concludes by offering pro tax tips for Canadian businesses from our expert Canadian GST/HST tax lawyers.

Canada’s GST/HST Regime: An Overview

Section 165 of Canada’s Excise Tax Act imposes GST/HST on “every recipient of a taxable supply made in Canada.” A “taxable supply” essentially refers to any commercial activity, and it captures most business transactions—e.g., sale of goods or services; barter transactions; licensing or leasing arrangements; etc.

Yet while GST/HST is levied on the recipient of the property or service (the purchaser), the person who makes the supply (the vendor) bears the obligation of actually collecting the tax and remitting it to the Canada Revenue Agency. In particular, a Canadian business earning $30,000 or more in worldwide annual gross revenues must register for a GST/HST number and begin charging GST/HST on its goods and services. Failure to do so is subject to tax penalties plus interest and possible prosecution for tax evasion.

A Canadian business earning less than $30,000 in annual gross revenue qualifies as a “GST small supplier.”  And under paragraph 240(1)(a) of the Excise Tax Act, a small supplier need not register for—and thus need not collect—GST/HST. (This doesn’t apply to a taxi business. Regardless of how little it earns in gross annual revenue, a taxi business must register for GST/HST.)

Registered suppliers participating in the supply chain may recoup the GST/HST that they paid to their own business vendors by claiming those amounts as input tax credits (ITCs). The ultimate consumer, however, cannot claim input tax credits and hence cannot recover the GST/HST paid to retailers or other suppliers. Thus, in most cases, only the final consumer bears the GST/HST burden. Businesses collect GST/HST on sales, but since they receive a full input tax credit for GST/HST paid on their own purchases, businesses remit only the difference to the Canada Revenue Agency.

Input Tax Credits: Calculating ITCs & Qualifying for ITCs

A registered supplier who paid GST/HST to one or more of its own business vendors may claim those payments as input tax credits, thereby reducing the supplier’s net GST/HST payable to the Canada Revenue Agency.

In most cases, a registrant will calculate its input tax credits by tallying the GST/HST paid or payable on each business expense. When making a purchase upon which it may claim ITCs, the business doesn’t record the GST/HST as an expense (or as part of the cost of the item). Rather, it treats the GST/HST as a recoverable disbursement, recorded as an asset in the business’s books. The business records the GST/HST as an asset because the business will receive a full refund when it files its next GST/HST return.

But qualifying GST/HST registrants have the option of calculating their ITCs by using a simplified method, which allows the registrant to determine its ITCs by multiplying its qualifying expenses by a specified rate. This allows the registrant to avoid the burden of separately tracking GST/HST in its own records.

Under the regular method, the registrant must record the GST/HST paid or payable on each business expense. Under the simplified or quick method, however, the registrant adds up the total amount of expenses that qualify for ITCs—i.e., adds up the total amount of all business expenses for which the registrant paid GST/HST to another registrant. The registrant then calculates the available ITCs by multiplying its expenses by a proportion based on the rate of tax paid on the expense—for example, multiplying by 5/105 for purchases on which it paid 5% GST, by 12/112 for purchases on which it paid 12% HST, by 13/113 for purchases on which it paid 13% HST, etc. Total amount represents the registrant’s input tax credits for the particular reporting period.

A registrant cannot use the simplified method unless it meets all of the following conditions:

• During the registrant’s last fiscal year, the registrant’s annual worldwide revenue from taxable property and services (including those of its associates) did not exceed $1 million. (This limit doesn’t include goodwill, zero-rated financial services, or sales of capital real property.)
• For all preceding quarters of the current fiscal year, the registrant’s total revenue from taxable supplies (including those of its associates) does not exceed $1 million. (This limit doesn’t include goodwill, zero-rated financial services, or sales of capital real property.)
• During the registrant’s last fiscal year, the registrant’s taxable purchases in Canada did not exceed $4 million.

This is a very general description of the simplified method of calculating input tax credits. For more information on the simplified method, take a look at our article “Simplified Method for Claiming Input Tax Credits (ITCs).” If you have questions about the simplified method of calculating ITCs, please schedule a consultation with one of our expert Canadian tax lawyers.

Yet regardless of whether a GST/HST registrant uses the regular method or the simplified method, the registrant must meet certain criteria to qualify for the ITC claim itself. For instance, the registrant must have been a GST/HST registrant during the reporting period in which the GST/HST was paid or became payable. Moreover, a registrant cannot claim an input tax credit unless the GST/HST was payable on a business expense (as opposed to a personal expense). In addition, a business cannot claim ITCs unless that business makes “taxable supplies,” which includes zero-rated supplies (sales) but excludes exempt supplies. In other words, a business cannot claim ITCs if it makes only exempt supplies (e.g., financial services, health care, educational services, and long-term residential rent).

Furthermore, paragraph 169(4)(a) of Canada’s Excise Tax Act precludes a registrant from claiming an input tax credit “unless, before filing the return for which the credit is claimed, the registrant has obtained sufficient evidence in such form containing such information as will enable the amount of the input tax credit to be determined, including any such information as may be prescribed.” That is, “before filing” the GST/HST return claiming the ITC, the registrant must obtain documentary evidence substantiating the ITC.

The Input Tax Credit Information (GST/HST) Regulations detail the exact documentary evidence that a registrant must obtain to substantiate its input tax credits. In most cases, to support its ITCs, a registrant must obtain documents listing all of the following information:

• The name of the supplier who charged the GST/HST underlying the ITC;
• The total amount paid or payable to that supplier;
• The amount of GST/HST paid or payable to that supplier;
• The date on which the GST/HST was paid or became payable;
• The supplier’s GST/HST registration number;
• The terms of the payment; and
• A description sufficient to identify each supply.

In practice, invoices, receipts, and contracts will usually be the source of this information.

Credit-card statements, bank-account statements, and cancelled cheques by themselves will fail to provide the above-listed details. They might indicate that a payment was made, but they don’t establish whether the payment included GST/HST. So, the taxpayer must ultimately supplement the credit-card statements, bank-account statements, and cancelled cheques with invoices, receipts, and contracts.

Pro Tax Tips: Input Tax Credits & CRA Tax Audits: Verifying Your Suppliers to Protect Yourself from Tax Fraud and Defend Your ITCs from a Tax Auditor’s Scrutiny

The Canada Revenue Agency’s GST/HST auditors routinely deny ITCs because of insufficient supporting documents. A GST/HST registrant must obtain documentary evidence substantiating its input tax credits “before filing” the GST/HST return claiming the ITCs. Thus, when auditing a taxpayer’s ITC claims, the CRA’s GST/HST auditors will check not only whether the taxpayer possesses supporting documents but also when the taxpayer actually received those supporting documents. Taxpayers who fail to meet the Excise Tax Act’s record-keeping requirements will lose all impugned input tax credits.

In most cases, a GST/HST registrant must obtain documents listing all of the following information to support its ITCs:

• The name of the supplier who charged the GST/HST underlying the ITC;
• The total amount paid or payable to that supplier;
• The amount of GST/HST paid or payable to that supplier;
• The date on which the GST/HST was paid or became payable;
• The supplier’s GST/HST registration number;
• The terms of the payment; and
• A description sufficient to identify each supply.

In addition, the GST/HST registrant should also confirm that the supplier possesses a valid GST/HST registration number. The CRA’s tax auditors will deny your ITCs if you cannot produce a valid GST/HST registration number for your supplier—even if you can prove that you did in fact pay GST/HST to that supplier. This problem typically arises when a supplier’s invoice lists (i) a GST/HST number that doesn’t exist, (ii) a GST/HST number that is registered under another supplier’s name, or (iii) a GST/HST number that wasn’t registered on the date of the invoice (e.g., it was cancelled as of the date on the invoice or was registered after the date on the invoice).  Unfortunately, there is no equity in taxation, and neither the CRA nor the courts are very sympathetic to the fact that your supplier may have fraudulently charged you for GST/HST.

You should therefore confirm the validity of your supplier’s GST/HST registration number before paying the supplier any amount that you intend to claim as an input tax credit.

You can confirm a supplier’s GST/HST registration number by using the GST/HST registry search on the Government of Canada’s website (https://www.canada.ca/en/revenue-agency/services/e-services/e-services-businesses/confirming-a-gst-hst-account-number.html). You should also keep a record showing that you searched the CRA’s GST/HST registry (e.g., taking a screenshot capturing the search result and the date upon which you performed the search). You can also confirm a supplier’s GST/HST registration number by calling the Canada Revenue Agency’s business-enquiries line at 1-800-959-5525.

Our experienced Canadian tax lawyers can provide advice on protecting your business from GST/HST fraud and on ensring that your ITC claims withstand the scrutiny of the Canada Revenue Agency’s tax auditors.

FREQUENTLY ASKED QUESTIONS

Question: What is an input tax credit?

Answer: An input tax credit (or ITC) is a credit that a GST/HST-registered supplier may claim to reduce the supplier’s net GST/HST payable to the Canada Revenue Agency. The amount of the ITC essentially equals the GST/HST that the supplier incurred on its own inputs (i.e., on its own business expenses).

Question: My sole-proprietorship business is registered for GST/HST. What conditions must I satisfy to qualify for input tax credits on the GST/HST paid to my vendors?  

Answer: First, you must have been registered for GST/HST during the reporting period in which the GST/HST was paid or became payable. Second, you cannot claim an input tax credit unless the GST/HST was payable on a business expense (as opposed to a personal expense). Third, a business cannot claim ITCs unless that business makes “taxable supplies,” which includes zero-rated supplies but excludes exempt supplies. In other words, you cannot claim ITCs if your business makes only exempt supplies (e.g., financial services, health care, educational services, and long-term residential rent). Finally, you must obtain documentary evidence substantiating your input tax credits before filing the GST/HST return in which you claim those ITCs. In most cases, you must obtain documents listing all of the following information to support your ITCs:

• The name of the supplier who charged the GST/HST underlying the ITC;
• The total amount paid or payable to that supplier;
• The amount of GST/HST paid or payable to that supplier;
• The date on which the GST/HST was paid or became payable;
• The supplier’s GST/HST registration number;
• The terms of the payment; and
• A description sufficient to identify each supply.

Invoices, receipts, and contracts will usually be the source of this information. To confirm whether your business qualifies for input tax credits, contact one of our expert Canadian GST/HST lawyers today.

Question: I understand that, to qualify for input tax credits, I must obtain certain supporting documents. I typically pay my business vendors by credit card or cheque. Can I use my credit-card statements, bank-account statements, and cancelled cheques as supporting documents for my ITC claims?

Answer: To satisfy the supporting-document requirements, you must (at a minimum) produce evidence showing that your vendor charged you GST/HST. This information won’t appear on your credit-card statements, bank-account statements, and cancelled cheques. Although they might indicate that you made a payment, they don’t establish whether the payment included GST/HST. So, by themselves, credit-card statements, bank-account statements, and cancelled cheques won’t serve as evidence for your ITCs. You must ultimately supplement the credit-card statements, bank-account statements, and cancelled cheques with other documents, such as invoices, receipts, and contracts.

Question: I’ve heard that the Canada Revenue Agency won’t be very sympathetic if my business vendors fraudulently charged me for GST/HST. Is this true? What steps can I take to avoid GST/HST fraud?

Answer: Unfortunately, it’s true. The CRA’s tax auditors will deny your ITCs if your supplier doesn’t possess a valid GST/HST registration number—even if you are the victim of fraud and can prove that you did in fact pay GST/HST to that supplier. You should therefore confirm the validity of your supplier’s GST/HST registration number before paying the supplier any amount that you intend to claim as an input tax credit. You can confirm a supplier’s GST/HST registration number by using the GST/HST registry search on the Government of Canada’s website (https://www.canada.ca/en/revenue-agency/services/e-services/e-services-businesses/confirming-a-gst-hst-account-number.html). You should also keep a record showing that you searched the CRA’s GST/HST registry (e.g., taking a screenshot capturing the search result and the date upon which you performed the search). For further advice on protecting your business from GST/HST fraud and on ensuring that your ITC claims withstand the scrutiny of the Canada Revenue Agency’s tax auditors, consult one of our experienced Canadian tax lawyers today.