Assessing the impact

By Karen Wong
Illustration: Gary Clement

A better understanding of the new standardized accounting rules may minimize the costs to businesses

Have you wondered why you haven’t received a long overdue goods and services tax (GST)/harmonized sales tax (HST) refund? You may have been caught by relatively new legislative rules that affect refunds and change a number of interest and penalty provisions of the Excise Tax Act.

The Budget Implementation Act, 2006, which received Royal Assent June 22, 2006, and became effective April 1, 2007, introduced several legislative amendments to the Excise Tax Act, the Excise Act, 2001, the Income Tax Act and the Air Travellers Security Charge Act. These amendments harmonized a number of accounting, interest, penalty and related administrative and enforcement provisions to provide an integrated set of rules — now referred to as standardized accounting provisions.

The new rules under the GST/HST system have potential consequences for GST/HST registrants. Understanding and effectively navigating these rules will enable businesses to minimize any unfavourable impact of these provisions.

Effective April 1, 2007, businesses expecting a refund after filing GST/HST returns or a rebate application will not receive the refund or rebate amount until all outstanding returns required under the above acts are filed. Prior to 2007, GST/HST refunds were withheld only if there were outstanding GST/HST returns and GST/HST rebate applications were not affected at all.

In addition, effective April 1, 2007, any GST/HST refund, overpayment or rebate owing to a person will not be paid to the extent that the person has any amounts owing under all the acts. Such refund or rebate may be applied against the other debt.

Under the new legislation, interest on net tax refunds for a reporting period ending on or after April 1, 2007, will accrue beginning on the day that is 30 days (previously 21) from the day the return in which the refund is claimed is filed with the Minister, or the day following the last day of the reporting period, whichever is later, to the date the refund is paid.

For GST/HST rebates, interest will be paid beginning on the day that is 30 days after the day the rebate application is filed with Canada Revenue Agency (CRA) and ending on the day the rebate is paid.

The prescribed interest rate paid on a refund or on a rebate of GST/HST is 2% plus the basic interest rate. The basic rate is based on the 90-day Treasury bills, adjusted quarterly and rounded up to the next whole percentage point (expressed as an annual percentage).

Prior to April 1, 2007, an amount owing under the Excise Tax Act was subject to interest at a prescribed rate, which was the basic rate, and a 6% late payment penalty. Effective April 1, 2007, the 6% penalty is eliminated and the outstanding balance is subject to interest only. However, the new prescribed interest rate is now in-creased from the basic rate to the basic rate plus 4%, thus partly offsetting the benefit of the late payment penalty elimination.

A new failure to file penalty is introduced where a GST/HST return is filed late with a balance owing. The penalty is calculated at a rate of 1% of the balance owing on the late-filed return plus 0.25% for each full month the return is overdue, to a maximum of 12 months. The maximum penalty is therefore 4% of the amount owing.

The failure to file penalty applies to any return that is required to be filed on or after April 1, 2007. It also applies to any return that was required to be but was not filed before April 1, 2007, in which case the return is deemed to be required to be filed by March 31, 2007, for the purposes of calculating the penalty.

For example, consider a return for a reporting period due January 31, 2007, with a net tax of $10,000 owing that was filed and received by CRA on April 16, 2007 (i.e. after the due date). Based on the old and new interest and penalty regimes, interest at the prescribed rate in effect for the period from February 1, 2007, to March 31, 2007, plus the 6% annual penalty (both compounded daily), would accrue on the unpaid balance up to March 31, 2007. Since the return was filed late with $10,000 of unremitted tax, a failure to file penalty of $100 (1% of $10,000) applies. For the period from April 1, 2007, to April 16, 2007, interest at the new prescribed rate applies to both the $10,000 outstanding net tax and the failure to file penalty of $100.

In other words, the 6% penalty and interest (calculated at the basic rate) will apply on amounts owing prior to April 1, 2007. Interest at the new prescribed rate (basic plus 4%) will apply to the amounts still outstanding (including interest and 6% penalty accrued) starting April 1, 2007, and ending when the amount is remitted. The new failure to file penalty will also apply to a return that is required to be filed on or after April 1, 2007, and any return that was required to be filed before that date if it was not filed by March 31, 2007.

A person who fails to file a return when required pursuant to a demand issued by CRA is liable to a penalty equal to $250 for any demand that the CRA serves on or after April 1, 2007.

Under the Excise Tax Act, CRA may ex-tend the time for filing a return or to remit net tax or to pay tax. For extensions that expire by March 31, 2007, the 6% penalty does not apply during the extension period, although interest continues to accrue for that period. This was amended so that for any extension of time that expires on or after April 1, 2007, the new interest and late filing penalty provisions will not apply in respect of the return or the amount required to be remitted or paid until after the extension period expires and will only apply in respect of the period after the extension.

The standardized accounting provisions also affect wash transactions. A wash transaction occurs when a supplier fails to charge and collect GST/HST on taxable supplies made to a registrant who would have been entitled to claim full input tax credits (ITC) if the tax had been correctly charged. A wash transaction may also occur if ITCs have been claimed by a wrong entity within a closely related or an associated group of persons.

Prior to April 1, 2007, where there is a wash transaction that is subject to both the 6% penalty and interest, CRA will consider waiving or cancelling the portion of the 6% penalty and interest that exceeds the 4% of the uncollected tax (i.e., effectively 4% of the uncollected tax is being charged as a penalty).

For wash transactions subject to interest at the new prescribed rate as of April 1, 2007, CRA will consider waiving or cancelling the portion of the interest that is in excess of 4% of the uncollected tax. As a result of the transaction qualifying as a wash transaction, the registrant would be assessed a 4% interest charge.

The April 1, 2007, amendment for wash transactions resulted in a change from the flat 4% wash transaction penalty to a flat 4% interest charge. It is noted that the new wash transaction policy will only be applicable to wash transactions on which tax becomes payable or remittable to CRA on or after April 1, 2007, while the 4% penalty policy will continue to be in effect for wash transactions on which tax became payable or remittable before April 1, 2007.

The CRA has established a voluntary disclosures program to promote voluntary tax compliance by registrants with respect to the various acts it administers. For GST/HST purposes, the program allows those who have under-remitted GST/HST or overclaimed ITCs to voluntarily disclose their tax liabilities with protection from penalties and criminal prosecution. For a disclosure to be considered valid under the program, the disclosure must meet four conditions:

it must be voluntary
it must be complete
it must involve a penalty, and
it must include information that is over one year past due, or if less than one year past due, it must not be initiated simply to avoid late filing or instalment penalties.

With the elimination of the 6% late payment penalty on April 1, 2007, if a registrant has filed GST/HST returns on time but determines that it has underpaid or under-remitted GST/HST or overclaimed ITCs, only interest on the outstanding balance would apply (assuming no other penalties apply). Without a penalty being imposed, any voluntary disclosure of unremitted tax would fall outside the voluntary disclosures program and no relief would be provided from the imposed interest.

However, the voluntary disclosures program will still benefit taxpayers with unreported transactions prior to April 1, 2007, where taxes and penalties may be assessed. Filing under this program in these cases will result in the penalty being waived, and payment of tax and interest only. Further, in the case of a wash transaction before April 1, 2007, only the tax is payable. The 4% penalty otherwise assessed would be waived under the voluntary disclosures program.

In summary, for transactions occurring after March 31, 2007, on which tax becomes payable or remittable to CRA, the voluntary disclosures program will no longer benefit taxpayers who are not subject to any penalty. CRA may see a drop in voluntary disclosures as there will be fewer incentives for taxpayers to come forward and disclose known tax liabilities.

Under the standardized accounting rules, businesses may be faced with added expenses if they are not in compliance with the filing requirements. As discussed above, the government will only pay interest on a refund or rebate equal to the basic rate plus 2%, whereas interest charged on outstanding accounts will be at the basic rate plus 4%. Moreover, the interest and late filing penalty that accrue in a taxation year that commences on or after April 1, 2007, will not be deductible for income tax purposes even where such amount relates to a net amount of GST/HST pertaining to a taxation year that began before April 1, 2007. However, the 6% penalty that would only apply to tax owing prior to April 1, 2007 (as this penalty has since been eliminated), will still be deductible in the taxation year in which the penalty is imposed.

The Budget Implementation Act introduced many amendments to the refund, interest and penalty provisions. It is also broader in that other acts administered by CRA fall within its scope. Cross-implications may therefore exist, such as the case of a GST refund withheld because of an overdue filing of a non-Excise Tax Act return. Businesses should try to better understand the impact of the new rules to minimize the cost to their business.

Karen Wong, CA, is a senior manager with Ernst & Young in Toronto. She can be contacted at Karen.A.Wong@ca.ey.com

Technical editor: Trent Henry, tax managing partner, Ernst & Young