When CRA Wrongly Denies Input Tax Credits (ITCs) For Businesses That Use Agents: A Canadian GST/HST Tax Trap

• Law Firm: Rotfleisch & Samulovitch P.C.
• Subject Matter: Finance and Banking, Tax, Financial Services, Income Tax, Sales Taxes: VAT, GST, Tax Authorities
• Author: Mr David Rotfleisch
• Published date: 10 March 2023

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...