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Debt collection services are taxable for purposes of the goods and services tax/harmonized sales tax (GST/HST), as they are administrative in nature and are not financial services. This tax treatment has been well understood by collection agents and their clients. Recently, however, questions have arisen as to whether these services fall within the existing definition "financial service" contained in subsection 123(1) of the Excise Tax Act (ETA). In order to clarify the tax status of these services and to reaffirm the longstanding policy intent, an amendment is proposed to the definition "financial service" to specifically state that debt collection services are excluded from this definition.
A debt collection service includes not only the actual collection of a debt but also all other activities incidental to debt collection, such as attempting to collect the debt (even if unsuccessful), arranging for the collection or attempted collection of a debt, negotiating the payment or forgiveness of all or part of a debt, and realizing on security provided in respect of a debt. This proposed amendment, however, does not affect bill payment services where a person, whose principal business is not the collection of debt, accepts payments of accounts on behalf of another person (for example, a bank that accepts payments on behalf of a utility company) but has no authority to take any other debt collection action, such as attempting to collect any part of the account or realizing or attempting to realize on security given for the account.
The proposed amendment applies to a debt collection service rendered under an agreement for a supply if any consideration for the supply became due or is paid after Announcement Date. It also applies if all the consideration for the supply became due, or was paid, on or before Announcement Date and tax was charged or collected on any supply made under the agreement for the supply. The accompanying legislative proposals and explanatory notes provide further details on the amendment.
Foreign Bank Branches
Under the foreign bank branching regime provided in the Bank Act, foreign banks, which previously could only operate in Canada through a Canadian subsidiary, were accorded the right to carry on the business of banking through a branch in Canada. As a result, many foreign banks have restructured or will restructure their Canadian businesses by converting their Canadian subsidiaries into Canadian branches and/or by moving assets from these subsidiaries to these branches. These reorganizations can give rise to GST/HST liabilities in the absence of any special rules.
In response to industry concerns, the proposed amendments to the ETA provide time-limited GST/HST relief for initial asset transfers from a foreign bank's Canadian subsidiary to its newly established Canadian branch. The proposed amendments permit, in certain circumstances, a tax-free rollover of certain property and services supplied in the course of the foreign bank reorganization if both parties to the transaction so elect in accordance with the new provisions. The proposed amendments also effectively provide retroactive relief through an adjustment to net tax to allow a foreign bank, which has previously reorganized under the branching regime and paid GST/HST on the transfer of assets from a Canadian subsidiary, to recover the GST/HST it would not have paid if it had made the joint election with the subsidiary under the proposed rules at the time of the supply.
The proposed amendments will have effect from June 28, 1999, the same date that the legislation establishing the foreign bank branching regime came into force. The accompanying legislative proposals and explanatory notes provide further details on the amendments.
Closely Related Groups
Special group relief rules exist under the GST/HST to allow closely related persons to make certain elections so that tax is not charged on certain intra-group supplies of goods and services. The election under section 156 of the ETA allows groups of persons making only taxable supplies to elect to treat certain supplies between them as being made for no consideration. The election under section 150 of the ETA allows members of a group of corporations that includes a financial institution to treat certain taxable supplies between them as GST/HST-exempt supplies of financial services. These elections are limited to closely related corporations and, in the case of the election under section 156, to closely related corporations or partnerships, which are resident in Canada and registered for the GST/HST.
Two amendments are proposed to broaden the scope of these rules and remove unintended impediments to the use of these relieving provisions. The first proposed amendment ensures that two Canadian-resident, closely related corporations, both of which are registered for the GST/HST, will not be disqualified from making those elections simply because they are connected to each other in the ownership chain by other corporations that are non-resident and/or non-registered for the GST/HST. The second proposed amendment facilitates corporate reorganizations where, in order to comply with the requirements of the Income Tax Act, a corporation transfers assets to a newly incorporated subsidiary in the first step of realizing an income-tax-free reorganization. The proposed amendment will allow the election under section 156 to be used in the case of these reorganizations so long as the transferred assets are used exclusively in commercial activities before and after the reorganization. Both proposed amendments will have effect as of Announcement Date. The accompanying legislative proposals, draft regulations and explanatory notes provide further details on the amendments.
As the GST/HST is a tax on consumption in Canada, it applies not only to domestic purchases but also to imports of goods and services. In the case of goods imported into Canada, GST/HST is collected at the border. With respect to imported services and imported intangible personal property, tax collection at the border would be impractical. As a result, specific rules under the ETA require certain recipients of these imports to pay tax on a self-assessment basis.
Since businesses that make exempt supplies (e.g., financial institutions that supply financial services) are not entitled to recover the GST/HST paid on inputs used to make their exempt supplies, there would be an incentive for these businesses to import services and intangibles to avoid paying the unrecoverable GST/HST. To prevent the non-taxation of inputs that are consumed or used in the course of making exempt supplies, special rules, which have been in place since the introduction of the GST, require these businesses to self-assess tax on their imports of services and intangibles.
Self-assessment is required where a Canadian resident receives a taxable supply of intangible personal property, or a service, made outside Canada for use in the exempt activities, of the resident, in Canada. In this situation, the intangible property or service is considered "imported" by the resident since after being acquired outside Canada it is used in Canada. For example, if a Canadian bank acquires the right to use a trademarked logo and information services from a company operating exclusively outside Canada that is not required to charge GST/HST, the Canadian bank must self-assess GST/HST on the value of the trademarked logo and the information services that are considered to have been "imported" for use in the exempt activities, of the Canadian bank, in Canada.
To maintain an equitable system, the self-assessment of tax is intended to apply whether a taxable import of a service or intangible property is obtained outside Canada from a branch or a separate person. A special rule therefore requires Canadian branches of international organizations to self-assess tax on property or services received by them from non-resident branches of the organization the same way they are required to self-assess tax if property or services are acquired outside Canada from a separate legal entity and imported for consumption, use or supply in Canada. In the absence of any self-assessment requirement, financial institutions that have operations both in and outside Canada would have a competitive advantage over financial institutions that operate solely in Canada.
Due to a Tax Court of Canada decision regarding the applicability of this rule to cross-border dealings between the foreign and Canadian branches of a non-resident insurance company, the compliance and administration of this rule has been called into question. Moreover, it appears that certain comments in this decision have been taken to mean that many taxable supplies (e.g., administrative services) could potentially be treated as exempt supplies (e.g., financial services) to avoid GST/HST. This interpretation would have an impact not only on dealings between branches (as in the case under decision) but also on supplies between separate persons.
While this interpretation is an issue for both supplies made in Canada and imported supplies, additional concerns arise in the case of imported supplies. Exempt financial services supplied in Canada are not entirely free of GST/HST, as suppliers in Canada incur unrecoverable GST/HST on the inputs to their supplies. However, exempt financial services imported into Canada could effectively be free of all GST/HST as there is no unrecoverable tax on inputs. Under the current rules, recipients of imported exempt financial services are not required to self-assess any GST/HST and suppliers outside Canada either do not pay any tax on their inputs or do not incur any unrecoverable value-added tax (VAT) since most VAT jurisdictions, including Canada, remove embedded taxes from exports of financial services. The differential treatment of exempt financial services imported into Canada vis-à-vis those supplied in Canada is inequitable.
From an international perspective, in 1998, the Organisation for Economic Co-operation and Development developed the "Ottawa framework" to provide guidelines on the application of consumption taxes in the context of electronic commerce. To address the concern regarding non-taxation of imported services and intangibles, the framework states that "where business and other organisations within a country acquire services and intangible property from suppliers outside the country, countries should examine the use of reverse charge, self-assessment or other equivalent mechanisms where this would give immediate protection of their revenue base and of the competitiveness of domestic suppliers".
New Rule for Financial Institutions Under Division IV of Part IX of the ETA
To ensure that competitive equity is preserved and to maintain the integrity of the tax system, effective Announcement Date, it is proposed that a new rule apply to financial institutions (FIs) only. The new rule will require an FI with a presence outside Canada (e.g., a branch or related person) to self-assess GST/HST on certain expenses incurred outside Canada, generally relating to all services and intangibles imported into Canada. Once this new rule takes effect, the rule found in section 220 of the ETA for supplies between branches (which is also proposed to be amended-see below) will no longer apply to FIs. All other existing rules in Division IV will continue to apply to FIs.
The new rule for FIs will generally apply to any FI resident in Canada and to any non-resident FI if that non-resident has a presence in Canada that falls within an expanded meaning of the term "permanent establishment" (as described in the accompanying document, entitled "Detailed Proposals on the GST/HST Treatment of Imported Supplies"). Under this proposed rule, these FIs will generally be required to self-assess tax on certain expenses incurred outside Canada that are in respect of Canadian activities to the extent that these expenses could be directly or indirectly deducted under the Income Tax Act in computing the FI's income, or could be deducted if the FI were subject to that Act and required to compute its income in accordance with that Act. In the case of capital expenditures, the general result would be that only annual allowances in respect of depreciation, obsolescence or depletion would have to be considered.
From these expenses, the FI will generally be allowed to deduct the portion that represents the following: amounts upon which tax under Part IX of the ETA (including Division IV, other than this new rule) was calculated and became payable, compensation paid to employees where their duties are performed primarily in Canada, and other exclusions. The other exclusions include items such as certain interest payments, dividends, consideration for a supply of a financial service supplied as part of a transaction or series of transactions in which all participants deal at arm's length with the FI and, in the case where any participant does not deal at arm's length with the FI, the portion of the consideration that represents the inherent financial element of the transaction or series (e.g., the pure risk premium).
The accompanying document, entitled "Detailed Proposals on the GST/HST Treatment of Imported Supplies", provides the details on the proposed new rule for FIs.
Clarifying Amendment to Section 220 of Division IV of Part IX of the ETA
In addition to the new rule for FIs, the existing provisions in section 220 are proposed to be amended, with effect from the day that section first came into force (i.e., December 17, 1990), to clarify that self-assessment of tax applies to taxable imports of services and intangibles between separate branches of the same person. It is proposed that the amended section 220 cease to apply to FIs for taxation years that include, or commence after, Announcement Date. The other provisions in Division IV will continue to apply to FIs in the normal manner. As a result, if an FI is required to self-assess and pay tax under the existing rules in Division IV, it would not be required to self-assess and pay tax again under the new rule discussed above. In the case of non-FIs, the amended section 220 and all other provisions in Division IV will continue to apply.
The proposed amendment to section 220 is intended to ensure that a transfer of property, or rendering of a service, exists between separate branches of the same person in any case where either resources outside Canada of the person are used in, or costs incurred for those resources are allocated to, a Canadian business of the person. Any time the person meets eitherof these conditions, the person would be treated as having made outside Canada a supply of a service, or of intangible personal property, to itself as the recipient of the supply. The person would also be treated as having paid to itself fair market value consideration for the supply at the end of the person's taxation year. If the person is a non-resident, the person would be considered to be resident in Canada for purposes of Division IV.
Therefore, the deemed recipient of an imported supply would be required to pay tax on the fair market value of the imported supply if that supply is taxable, as is the case for imported taxable supplies under the current rules.
The accompanying document, entitled "Detailed Proposals on the GST/HST Treatment of Imported Supplies", provides the details on the proposed amendment to section 220.- News Release 2005-079 -