CRA Wrongly Denies ITCs for Businesses that use Agents

ITC Record-Keeping Requirements for Canadian Businesses that Use Agents

Agency is a legal relationship whereby one person (the agent) acts in accordance with the directions of another person (the principal). The employee-employer relationship is perhaps the most recognizable agency relationship. But Canadian businesses often rely on implied agency relationships to facilitate operations.

One crucial aspect about the agency relationship is that the agent’s dealings are attributed directly to the principal. For example, when an agent holds property on the principal’s behalf, the agent is ignored, and the property is treated as though it were held directly by the principal. Likewise, if an agent receives the principal’s funds, those funds are the principal’s income, not the agent’s.

Similarly, if an agent incurs an expense on the principal’s behalf, the principal generally reimburses the agent for the expense, and the principal, not the agent, may claim that expense for tax purposes. Often, an agent will enter contracts on the principal’s behalf, and the agent’s name will appear on invoices for services or goods that the agent acquired on behalf of its principal’s business operations. Although the agent’s name appears on these supporting documents, Canada’s Excise Tax Act, which governs GST/HST, still permits the principal to claim the corresponding input tax credits (ITCs). (This assumes, of course, that the principal has satisfied all the other legislative requirements for the ITC claim.)

The catch, however, is that the Canadian business must retain sufficient evidence of the agency relationship; otherwise, the Canada Revenue Agency will deny the ITCs on the (incorrect) assumption that another taxpayer incurred the expense. The Canada Revenue Agency employs its most aggressive tax-audit tactics when auditing taxpayers that the CRA’s tax auditors perceive as most likely to retain poor records. This is because Canada’s Excise Tax Act 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.” Taxpayers who fail to meet the Excise Tax Act’s strict record-keeping requirements will lose all impugned ITCs—especially the unsupported input tax credits relating to expenses that appear to have been incurred by an agent.

This article examines a Canadian registrant’s entitlement to claim ITCs for expenses incurred by an agent. We first review Canada’s GST/HST system. Afterwards, we discuss the notion of agency and then analyze the tax rules concerning the records that a Canadian registrant should retain to qualify for ITCs generally and to claim ITCs relating to purchases by an agent. The article concludes by offering pro tax tips for Canadian businesses from our expert Canadian GST/HST 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 “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.

The Legal Concept of Agency

As mentioned above, agency is a legal relationship whereby one person (the agent) acts in accordance with the directions of another person (the principal). A more comprehensive definition of agency is “a fiduciary relationship which exists between two persons, one of whom expressly or impliedly consents that the other should act on his behalf so as to affect his relations with third parties, and the other of whom similarly consents so to act or so acts.” (Kinguk Trawl Inc. v. Canada, 2003 FCA 85).

An agency relationship has three essential ingredients: (1) the consent of both the principal and the agent; (2) the agent’s authority to affect the principal’s legal position; and (3) the principal’s control over the agent’s actions. (Royal Securities Corp. Ltd. v. Montreal Trust Co. et. al, 1966 CanLII 173 (ONSC)).

Moreover, the parties can create an agency relationship in one of two ways. The first is by agreement between principal and agent. The agreement can be either an explicit written agreement or an implicit unwritten agreement, which is evidenced by the parties’ conduct. The second method of creating an agency relationship is by the principal’s subsequent ratification of acts done on the principal’s behalf. The second method gives rise to the agency relationship retrospectively (Fourney v. The Queen, 2011 TCC 520, at para 37).

If no written agency agreement exists, the parties’ conduct determines whether they intended to create an agency relationship. The key feature is the level of control that the alleged principal exerts over the alleged agent. The following indicia, for example, might suggest an agency relationship:

The purported agent derives no personal benefit from the alleged principal’s property or dealings (unless the principal permits it).
The purported principal receives all income that the alleged agent generated while acting on the principal’s behalf, and the purported principal pays all expenses that the alleged agent incurred while acting on the principal’s behalf.
If the purported agent commits a tort while acting in accordance with the principal’s instructions, the principal faces the liability—that is, the injured party may sue the principal for the agent’s malfeasance.
If the purported agent enters a contract on the alleged principal’s behalf and in accordance with the principal’s instructions, then the principal must perform those contractual obligations or face liability for breach of contract.
The alleged agent has no independent power, discretion, or responsibility beyond carrying out the purported principal’s instructions.
Without instructions from the purported principal, the purported agent doesn’t sell, transfer, donate, lease, or put up as collateral any property that is subject to the agency relationship.

The final point follows from the doctrine that, in an agency relationship, the principal retains beneficial ownership of any property subject to that relationship (e.g., see: Prévost Car Inc. v. The Queen, 2008 TCC 231 at para 100; aff’d 2009 FCA 57).

Input Tax Credits: Supporting-Document Requirements

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.

Yet the GST/HST registrant must meet certain criteria to qualify for the ITC claim. 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).

Our focus here, however, is the requirement to obtain documentation supporting the input tax credit. 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.

Input Tax Credits & Agents: Paragraph 3(c) of the ITC Regulations

Paragraph 3(c) of the ITC Regulations requires the registrant to obtain a supporting document that identifies “the recipient’s name, the name under which the recipient does business or the name of the recipient’s duly authorized agent.” The “recipient” refers to the GST/HST registrant, who incurred the business expense to which the ITC relates. To satisfy this requirement, a retailer, for example, should obtain the wholesaler’s invoice showing that the goods were purchased by the retailer itself or by the retailer’s agent.

Although paragraph 3(c) of the ITC Regulations explicitly contemplates that a vendor invoice may identify the registrant’s agent, the CRA’s GST/HST auditors routinely deny ITCs when vendor invoices don’t identify the registrant itself. The reason is that, in Canadian tax disputes, the taxpayer generally bears the initial burden of disproving the Canada Revenue Agency’s factual assumptions. Thus, if the vendor’s invoice identifies the registrant’s agent as the purchaser, the CRA tax auditor will simply assume—albeit incorrectly—that the agent was in fact the true recipient of the supply and thereby deny the registrant’s ITC claim. Moreover, if the registrant cannot produce sufficient evidence of the agency relationship, the tax auditor’s assumption will stand, and the taxpayer will lose all impugned input tax credits and must now pay the resulting net GST/HST.

Canadian businesses that make vendor purchases through agents must therefore retain sufficient evidence of the agency relationship. Ideally, the business and the agent should enter a properly drafted written agency agreement. In particular, the agency agreement should be drafted by an expert Canadian tax lawyer, who can ensure that the agreement doesn’t give rise to unwanted tax consequences. In addition, the registrant should retain evidence showing that, even though the vendor’s invoice names another party as the recipient, that vendor received payment for that invoice from the registrant.

Pro Tax Tips – Input Tax Credits & CRA Tax Audits: Defending Your ITCs from a Tax Auditor’s Scrutiny when Supporting Invoices Identify an Agent

The Canada Revenue Agency’s GST/HST auditors routinely deny ITCs because of insufficient supporting documents. This is especially a problem when an agent’s name appears as the recipient of invoices or other supporting documents. Although subparagraph 3(c) of the ITC Regulations explicitly contemplates that a vendor invoice may identify the registrant’s agent, the CRA’s GST/HST auditors routinely deny ITCs when vendor invoices don’t identify the registrant itself. If, for example, a vendor’s invoice identifies the registrant’s agent as the purchaser, the CRA tax auditor will assume that the agent was in fact the true recipient of the supply and thereby deny the registrant’s ITC claim. Moreover, if the taxpayer cannot produce sufficient evidence of the agency relationship, the tax auditor’s assumption will stand, and the taxpayer will lose all impugned input tax credits and must pay the resulting net GST/HST.

Canadian businesses that make vendor purchases through agents must therefore retain sufficient evidence of the agency relationship. Ideally, the business and the agent should enter a properly drafted written agency agreement. A properly drafted written agency agreement will protect the agent, too. In Anand v The Queen, 2019 TCC 199, for example, a taxpayer provided project-management services to a homeowner who sought to construct a custom-built home. In his capacity as a project manager, the taxpayer hired contractors and purchased materials as an agent on the homeowner’s behalf. But the taxpayer and the homeowner unfortunately papered their arrangement by using a template agreement (which they probably found online) that was meant for use by general contractors, not project managers. As a result, the CRA reassessed the taxpayer for almost $200,000 in GST/HST because the written contract purported that he had purchased all services and materials as a general contractor on his own account and then resupplied them to the homeowner. Although the Tax Court of Canada ultimately concluded that the taxpayer acted as a project manager who made purchases as the homeowner’s agent, the court noted that the parties “were careless in documenting their arrangement.” This case demonstrates the importance of having a knowledgeable Canadian tax lawyer draft—or at least review—your legal contracts to ensure that you avoid unwanted tax consequences.

If, on the other hand, you and your agent have not reduced your agency agreement to writing, and a CRA tax auditor intends to deny your ITCs on the basis that your agent was in fact the true recipient of the supply, your experienced Canadian tax lawyer must prepare extensive legal and factual arguments establishing that your conduct demonstrates an intention to create an agency relationship. This might, for instance, involve showing that, even though the invoice names another party as the recipient, the vendor received payment for the invoice from your business. In Lohas Farm Inc v The Queen, 2019 TCC 197, the taxpayer purchased and exported over 3,500 Apple iPhones. To do this, the taxpayer’s director asked friends to purchase the phones from the Apple Store on the taxpayer’s behalf, but the parties never entered any written agency agreements. The Apple Store issued receipts that identified the friends as the purchasers. As a result, the CRA’s tax auditor initially denied the taxpayer of over $250,000 in ITCs. The taxpayer’s Canadian tax-litigation lawyer convinced the Tax Court of Canada that, although the Apple Store receipts bore the friends’ names, they had acted as the taxpayer’s agents.

Fortunately, Canadian businesses who engage agents can typically avoid these problems through early engagement of an experienced Canadian GST/HST lawyer. Speak to our Certified Specialist in Taxation Canadian tax lawyer today. Our experienced Canadian tax lawyers thoroughly understand this area of law, and we can ensure that you deliver a forceful, thorough, and cogent response to the CRA’s tax auditor, objection to the Canada Revenue Agency Appeals Division, or appeal to the Tax Court of Canada.

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 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. But 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, you must ultimately supplement your credit-card statements, bank-account statements, and cancelled cheques with invoices, receipts, and contracts.

To confirm whether your business qualifies for input tax credits, contact one of our expert Canadian GST/HST tax lawyers today.

Question: My Canadian business is registered for GST/HST, and it typically makes vendor purchases through agents. The agent’s name often appears as the recipient on the vendors’ invoices. Will this undermine my ability to claim input tax credits? If so, how can I avoid any problems?

Answer: Although subparagraph 3(c) of the ITC Regulations explicitly contemplates that a vendor invoice may identify the registrant’s agent, the CRA’s GST/HST auditors routinely deny ITCs when vendor invoices don’t identify the registrant itself. This is because the CRA tax auditor assumes—albeit incorrectly—that the agent was in fact the true recipient of the supply and thereby deny the registrant’s ITC claim. Moreover, if the registrant cannot produce sufficient evidence of the agency relationship, the tax auditor’s assumption will stand, and the registrant will lose all impugned input tax credits and must pay the resulting net GST/HST.

Canadian businesses that make vendor purchases through agents must therefore retain sufficient evidence of the agency relationship. Ideally, you and your agent should enter a properly drafted written agency agreement. In addition, you should retain evidence showing that, even though the vendor’s invoice names your agent as the recipient, the vendor’s invoice was paid by your business. Our knowledgeable Canadian GST/HST lawyers can draft or review your agency agreements to ensure that you avoid unwanted tax consequences. Our experienced Canadian tax lawyers thoroughly understand this area of law, so if the Canada Revenue Agency’s GST/HST auditors threaten to deny your input tax credits because your vendor made the invoices out to your agents, our Canadian GST/HST tax-litigation lawyers can ensure that you deliver a forceful, thorough, and cogent response to the CRA’s tax auditor, objection to the Canada Revenue Agency Appeals Division, or appeal to the Tax Court of Canada.

DISCLAIMER:

This article provides only general information and contains no legal advice. This article is current only as of the publishing date. It will not be updated, so it may no longer be relevant on the day that you read it. This article is not a substitute for legal advice. Each tax circumstance is unique to its facts and may not qualify for any perceived remedy described in this article. You should contact a Canadian tax lawyer if you have specific legal inquiries.