Sales and Indirect Tax Update David B. Crawford, CMA Grant Thornton LLP

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1 CANADIAN PETROLEUM TAX JOURNAL Vol. 26, Sales and Indirect Tax Update David B. Crawford, CMA Grant Thornton LLP A special thanks to this paper s contributor goes out to my colleague David Reiner, a manager in our Edmonton office. This paper is intended for non-specialist practitioners to assist them in understanding and complying with the various BC PST and Carbon Tax rules. While it communicates a number of technical issues and references, it also reflects the author s understanding of industry practice, audit experience and personal insight. As such, readers are cautioned to seek specific tax advice to assist them in managing issues like the ones described herein. The paper is intended to be a pragmatic discussion of the current issues and updating the reader on recent developments and is not overly technical in nature. I. Introduction The last several years have seen a multitude of sales tax changes and development of various issues, some of which underpin sales tax principles. Since 2009, we have seen the energy sector go through the introduction of harmonized sales tax ( HST ) in British Columbia and revert back again to a provincial sales tax ( PST ) regime. The energy sector has had to cope with the new place of supply rules for GST/HST as well as dealing with the recaptured input tax credits ( ITCs ) on energy and other inputs in British Columbia (and to a certain extent, Ontario) and now, it must re-implement PST, complete with the self-assessing requirements, exemption certificates, affixed machinery, related services, real property and other non-taxable service contracts, etc. In addition, the energy sector has seen two key court cases come before the courts (although not finally decided upon) in British Columbia and Saskatchewan that may prove to be the deciding factor on taxable and non-taxable services and who pays the PST on materials used in providing such services. Lastly, the province of Manitoba has temporarily increased its PST rate by 1%, which will represent almost a full percentage to energy companies costs of operating in that province for the next 10 years. We hope that the following discussion will provide some insight into these sales tax changes and how they are affecting your energy business. Although this paper is more directed at the upstream energy sector, many of the issues discussed also pertain to the midstream petroleum marketing sector as well as the oilfield services sectors. II. British Columbia PST As of the time of publishing this paper, British Columbia s Consumer Taxation Branch ( CTB ) has done an excellent job of producing several publications, forms and other bulletins and notices to help various taxpayers to prepare for and transition to the new tax regime. However, at the time of writing, the CTB has not yet updated PST Bulletin 113 Oil and Gas Industry Producers and Processors,

2 completion of which would be helpful to the industry stakeholders. As well, specific commentary for the Oil & Gas Industry around HST/PST adjustments, the exemptions for the industry and how the terms affixed machinery and related services will apply to operations would be welcomed. We are aware that the CTB may consider working with industry to re-produce the taxable and non-taxable lists; however it may be some time before we see the results of this effort, leaving taxpayers and advisors to rely on, in part, the former Social Service Tax administration practices. Post-HST adjustments At the time of publishing, we expect that most HST and PST adjustments have been handled by the industry and its suppliers; however for those transactions that have still not been resolved, the following comments require mention. Where the HST has been applied to invoices incorrectly as a result of misapplication of the transitional rules, it is important to stress that a proper credit note (or debit note as the case may be) be issued by the supplier to the customer in accordance with the Credit Note and Debit Note Information (GST/HST) Regulations. In particular, it is important that the supplier can demonstrate that the credit note has in fact been issued and therefore, received by the customer. Where this has occurred, the customer should reverse the original invoice or the tax (as the case may be) in their records. Where PST is in turn charged on the revised invoice (or supplemental debit note), it should be carefully examined to ensure that the goods or services acquired were not eligible for some form of exemption. We continue to see situations where industry customers are continuing to pay the tax and are not utilizing the exemptions available to them under the new legislation. Further discussion of these issues are discussed further below; however suffice to say, the use of exemption certificates is still a complicated and time consuming exercise for producers. At a minimum, it is important to remember, that the customer can still apply for a refund directly with the supplier within 180 days from the date that the tax was paid. Therefore, at the time of publishing, 182 days will have expired since April 1, 2013 and hence, most PST paid in error during April may be refunded to the customer directly by the supplier, provided valid exemption certificates are provided. After 180 days, the customer must apply to the CTB for the refund using the appropriate refund claim forms depending on the nature of the exemption and refund being claimed. It is important to note, that within the 180 day period, customers can still apply directly to the CTB for a refund and have up to four years from the date the tax was so paid in error to claim a refund and no exemption certificates need be supplied to the CTB. In respect of refunds by a registered supplier, where the purchase or lease price of taxable goods or services or software is refunded or reduced, the supplier may refund the applicable tax related to the refunded or reduced purchase or lease price within four years of when the tax became payable (vs. tax paid date) to the customer. We expect however, that most customers would insist on a must refund approach vs. a may refund approach. It is important to note that the four year limitation period is not based on the tax paid date, but rather the date PST was payable (usually the invoice date) for the supply. Where invoices are corrected for PST or HST that has been applied incorrectly, the CTB has provided some verbal guidance on whether and how HST or PST should be corrected. To date, the CTB has not produced a publication or other notice, outlining these rules and guidance around the 2

3 transition period. The CTB has commented that where the invoice is corrected with the original date on new invoice and if the original invoice was issued before April 1, then HST should apply (if applicable); otherwise PST applies, where applicable. This same convention applies even if a new invoice (assume a credit note is issued for the original) is issued after March 31, 2013; then the tax application follows the tax on the original invoice. That is, if HST was charged on the original invoice, then HST should apply to the new invoice, even though it is dated after March 31, If not, then PST would be charged on the new invoice, assuming no exemptions applied. In the case of volume rebates, similar rules apply whereby if HST applied on the purchased volumes, then HST applies to rebate, otherwise PST may apply. For purchases straddling the PST reimplementation date of April 1, 2013, we would expect based on the CTB s verbal comments, that the adjustment of HST vs. PST would be pro-rated for those purchases subject to the volume rebate, on some pro-rata basis. That is, if 50% of the volume rebate was attributable to HST-taxable purchases, then 50% of the rebate would be subject to HST, while the other 50% would be subject to PST, assuming the post March 31, 2013 purchases were subject to PST. Exemptions for exploration and production equipment Prior to the transition period and after the referendum on HST and PST, the CTB continued to confirm that all the pre-july 2010 permanent (i.e. not the time-bounded) exemptions would be re-instated under the new PST regime. However, it was not until mid-march 2013 that these new rules would be finalized under the new Provincial Sales Tax Exemption and Refund Regulation. The CTB reiterated that the administrative application of the exemptions would generally follow that under the former Social Service Tax regime; however with some modifications to the new regulation in order to modernize and improve or clarify the former wording. From a review of the new regulation, it is clear that many new definitions were added which may unnecessarily restrict the exemptions when actually implemented; however time will tell once refund applications are made or the CTB commences auditing suppliers and their customers. A complete discussion of the available exemptions for the oil and gas industry clearly deserves an entire paper (or more) unto itself; however we feel that it is important to emphasize that industry may not be taking advantage of all available exemptions due to the cumbersome nature of evidencing to suppliers, the exemption documentation. Prior to April 1, 2013, the CTB produced most of the necessary approved forms to issue production machinery and equipment exemption certificates for most industries, including the oil and gas sector. In mid-september, the CTB published its refund application for PST paid in error on qualifying equipment and machinery. Very few rulings have been published on this issue under the new legislation, which can be expected and the CTB has not yet published any materials specific to the industry at the time of publishing of this paper. Although the lack of guidance is discouraging, we expect that publications are forthcoming, including new and refreshed taxable and non-taxable lists. For now, historical rulings, publications and the former non-taxable lists may be relied upon by producers to ensure they are taking advantage of all available exemptions at either the point of purchase (using appropriate exemption certificates) or through a refund process directly with suppliers (within 180 days of when tax was paid in error) or directly with the CTB within four years of when the tax was paid in error. 3

4 Further to the notion of acquiring qualifying machinery and equipment and certain services exempt from PST, the CTB has noted that by virtue of entering into a tax payment arrangement with the CTB, qualifying taxpayers such as oil and gas producers, can acquire goods and services exempt from PST and then self-assess those taxable transactions and report and remit. We expect that this program will be very similar to the Special Registration Number rules under the former Social Service Tax regime. However, to date, the CTB has not released any additional guidance or publications on this program. For those producers wishing to employ such a program, they should consult the bulletin under the old regime and determine if they have the systems and processes in place to qualify, as we suspect the CTB will employ similar criteria for any tax payment arrangements under the new PST regime. Non-taxable services vs. real property services The debate between suppliers, producers and the CTB over what is a taxable service and a nontaxable service continues under the new PST regime as it had under the former Social Service tax. We discuss this further below in regards to a recent court case brought before the British Columbia Supreme Court by Burlington Resources Canada Ltd. 1 At the heart of the issue, is the producers concern about suppliers charging PST on materials used in providing their services to producers, where the services are arguably not taxable under the former regime and by extension, under the new PST regime. The argument comes down to whether a taxable retail sale of materials and exempt services and whether PST should be charged on the selling price of the materials by the supplier, or if the supplier should pay or self-assess PST on their cost of the materials. This really boils down to a non-recoverable PST cost (where no exemption exists) on the difference between the suppliers costs of the materials and the selling price outlined on the invoices. The argument from the producers perspective is that although the materials used in performing nontaxable services are itemized on the invoices and field tickets, they are not being purchased at retail by the producer and in fact are being economically and physically (in some cases) consumed by the servicing provider. That is, they are for the consumption and use by the service provider in providing a non-taxable service (i.e. fracturing, acidizing, etc.) and therefore, PST should be borne by the service provider on their cost of the materials. Therefore, producers have (and still are) argued that any PST paid on the selling price of the materials, has in fact, been paid in error and consequently they have and continue to apply for refunds where service providers have charged PST on top of the material pricing. To exacerbate this issue, where some suppliers charge a British Columbia surcharge either on materials or services or both. Some producers see this as an additional charge in relation to PST that is payable on the value of the service providers taxable equipment and tools, but possibly also in relation to the potential PST cost that could be borne by them on the materials costs. From the service providers perspective, they are faced with two very tough choices. That is, they face applying the tax on top of the materials in case the CTB takes the position that a retail sale of the materials has occurred in certain situations or they absorb the PST on their cost and don t charge PST at all on the invoice (i.e. quote and invoice PST-in on materials) and risk being assessed tax on their materials retail selling price. By no means and easy assessment to make, given the current state of uncertainty as a result of the Burlington case. 4

5 For a lot of service providers however, the real problem lies in their accounting and invoicing systems and processes as well as their invoicing, sales and marketing staff to effectively deal with the notion of applying PST on the cost and accurately quoting tax-inclusive pricing on non-taxable services and the related materials. For most service providers, particularly smaller ones with unsophisticated systems and processes, this is a daunting, if not impractical option. Take this concept one step further, where real property improvement projects and contracts are involved. Under the former Social Service Tax regime, the legislation provided as of October 1, 2008, that by default, the service contractor was responsible for paying of self-assessing tax on their cost of materials used and consumed in the course of providing services that were considered improvements to real property. The new legislation provides for a very similar result for such service providers, meaning that producers should not see PST (similar to the argument above for other non-taxable services) on invoices or progress payments in respect of service contracts for improvements to real property. Rather, the contractor should have either paid PST or self-assessed it on their cost on materials and equipment inputs, unless an exemption could be flowed through to the producer opt-out rule to the default treatment of the materials component of services contracts related to improvements to real property. Unlike the rules (and ongoing debate) around materials used by non-taxable service providers, the PST legislation allows for an opt-out, for service contractors undertaking real property improvements to a producer s property. This rule effectively works to tax the selling price of the materials and leave the services exempt as if a retail sale of the materials had occurred from the contractor to the producer. However, in order to effect this rule, there must be a statement in the contract or agreement for the services, that the producer is responsible to pay the PST on the materials. Unfortunately for producers, this produces a higher PST cost than would otherwise apply because the PST is no longer applied to the contractors cost, but rather on the retail selling price specified on the invoice. Fortunately for service contractors, this simplifies the process above whereby they must self-assess (or pay to registered suppliers) PST on their cost of the materials and makes quoting and invoicing much simpler from a systems, processes and people perspective. What the latter approach does accomplish is that it exposes to the producer, the fact that PST has been charged. Where the tax charged is in relation to exempt materials, the producer can react by issuing an exemption certificate, whereas if the materials are not taxed at a retail selling price level and the PST is buried in the service contractors costs, such exemptions may not be as evident to the staff (or systems such as sales tax automation engines) tasked with watching for PST being charged in error. For such situations, there is an exemption form available to the service contractor, to allow them to either purchase the materials PST-exempt; however this option is not always apparent to the producer unless the contract has been carefully examined and the PST planned for up-front. Affixed machinery and related services These new terms were introduced with the new PST legislation in part to modernize and refresh the concepts of fixtures and taxable services respectively, which were employed under the former Social Service Tax regime. Therefore, the concepts are not new, but effectively different terms have been used to replace the former terminology. 5

6 Affixed machinery is defined in the new PST legislation to include any goods such as machinery, equipment and apparatus that is used directly in the manufacture, production, processing, storage, handling, packaging, display, transportation, transmission or distribution of tangible personal property ( TPP ) or the provision of software or a service and is affixed to or installed in a building, a structure or land so that it ceases to be personal property at common law. However, it does not include such goods that are used as HVAC equipment in a building, sewage disposal equipment or most elevators and lifting devices within a building. In addition, any goods that must be constructed on-site and are large enough (including machinery and equipment that does not run on rails or track or that doesn t move around) that they are expected to remain there for their useful life and cannot be removed from the site without being dismantled or causing substantial damage to the real property, are also excluded from the definition. These exclusions would generally capture a considerable amount of goods that are machinery, equipment or apparatus at most producers operational sites. This is a good result, insofar as affixed machinery is deemed to be TPP and therefore, upon sale to a third party (with some related party and production machinery equipment exemptions) would be subject to PST. An example would be underground natural gas gathering lines that become real property and cannot be easily removed and expected to remain in place for their useful life and are not exempt production machinery equipment, would not be taxable upon subsequent sale as they would be excluded from the definition and would not be deemed to be TPP. Lastly, the legislation provides for another exclusion from the definition related to prescribed machinery equipment or apparatus; however at this time, no such provision is provided for in the Regulations that would constitute a listing per se, of such equipment. Further, the definition of affixed machinery is important for the purposes of the new definition of taxable services, referred to and discussed further below, as related services. In addition to related services not applying to most affixed machinery despite being deemed to be TPP, any installation charges otherwise applicable for affixed machinery are also specifically exempt from PST, despite being deemed to be TPP. This is a similar result to real property improvement services whereby no PST is charged by the service contractor on the materials or equipment unless the opt-out rule applies. A complete discussion of the interaction between affixed machinery, related and non-taxable services and qualifying production machinery and equipment (exemptions) is outside the scope of this paper. Suffice to say, there is sufficient complexity involved with these concepts, that it warrants mentioning, that all related contracts and agreements with suppliers be scrutinized to ensure the optimal and correct PST result such that all parties are aware of their tax collection and reporting requirements and all available exemptions are taken advantage of. The interplay with related services and affixed machinery discussed above only addresses the surface of the extent of change in the application of PST related to this new definition. The new PST legislation is somewhat expanded when it comes to what is captured under the notion of taxable or related services. The new definition catches any service provided to tangible personal property or any service provided to install tangible personal property, excluding affixed machinery. However, the definition excludes various services as prescribed in the Provincial Sales Tax Refund and Exemption Regulation as well as services provided to affixed machinery and improvements to real property. In addition, the definition excludes services provided to a person s employer, services provided to 6

7 manufacture TPP that is very different from the raw materials and finally services provided to, or to install, taxable or exempt software. The legislation goes one step further to ensure not every service provided to TPP is taxed as a related service. The Provincial Sales Tax Refund and Exemption Regulation provides further exemptions for services provided to TPP such as those in respect of goods imported into the province to have the service performed and which are immediately removed from the province after the service is performed. Albeit potentially redundant, the legislation further exempts services provided to affixed machinery, except where it relates to travelling cranes and hoists that run on rails or tracks and affixed machinery or related parts that are removed from their original site at which they were affixed or installed. This latter exclusion is important for on-site repairs vs. off-site repairs, resulting in tax applying to the service in the latter case. Several additional provisions in the Provincial Sales Tax Refund and Exemption Regulation appear to have been added (perhaps in retrospect) to further exempt otherwise taxable related services from the PST, such as service provided to farmers, aqua-culturists and commercial fishers. Most importantly, any service provided in respect of qualifying (exempt) production machinery and equipment is also exempt from tax, even though such services (if the equipment was TPP) may be considered to taxable related services. Producers should be aware that if a related service is provided to TPP that is shipped outside the province to have a repair, maintenance or other related service provided to it, PST will apply on the value of the services (as well as any parts added thereto under separate provisions) when the TPP returns to the province. This will be important to monitor for equipment that is sent to Alberta (or elsewhere) for repair, including affixed machinery and related components, unless the equipment or components are themselves exempt such as qualifying production machinery and equipment. Another important distinction to draw is that if certain otherwise exempt services are provided to TPP, and are provided together with a taxable related service, both services become subject to tax. This notion was re-iterated in the CTB s latest iteration of its publication Related Services. Specifically, diagnostic, testing or safety inspections provided to TPP, as well as certain cleaning, cutting, measuring, weighing, grading or classifying TPP is exempt unless the service is provided in conjunction with another taxable related service. In order to ensure that PST is not applied to an exempt related service, producers will need to provide an exemption certificate to the service provider to relieve the tax. To date, no specific form has been created to suit this specific purpose, other than the general PST exemption form FIN 490. This latest publication also suggests that a PST number can be quoted, but it is limited to only certain purchases and would not actually be available to producers to use. Suffice to say, the definition of related services (and related exemptions thereto) has made the determination of PST as difficult, if not more than under the former regime. The topic alone deserves an entire paper of its own. We refer you to the CTB s publication PST Exemptions and Documentation Requirements that contains the most comprehensive table of exemptions by category such as various documentation required by the CTB for various types of exemptions and is an excellent resource. A review of existing processes, may allow for some planning opportunities along 7

8 with savings in systems, processes and valuable staff time dealing with the documentation required to claim exemptions. III. British Columbia carbon tax Although the carbon tax has been around since July 2008, it is still causing a few issues for sellers and buyers of taxable fuels in the province. The carbon tax was put into place with little input from the energy industry; therefore some misunderstandings are still occurring. Purchases for resale outside the province A recent area of interest for carbon tax administration officials, has been the application of security (equal to the carbon tax amount) by a seller in respect of the buyer of taxable volumes of products within the province that are intended for export and resale outside British Columbia. For many years, some sellers (and their customers) have been relying on a key exclusion in the Carbon Tax Act ( CTA ) that permits a purchaser 2 to not pay carbon tax (vs. security) on otherwise taxable fuel when removed for use 3 in certain circumstances. One of these provisions requires the purchaser to have retained a common carrier at or before the time of purchase, to remove the fuel from the province. Although this latter criterion is almost always met, the buyer is not necessarily purchasing for use outside the province. That is, the buyer is often buying for resale purposes, which is not considered use by British Columbia. To reinforce this notion, the buyer/re-seller is not a purchaser as defined in the CTA and therefore is technically not paying carbon tax per se. That is, the buyer is not buying for their own use and is technically not required to pay carbon tax (which the section exempts) but rather they are required to pay security. The problem this causes for re-sellers is that the seller of the taxable fuel in British Columbia, must charge the buyer security equal to the carbon tax on the to be exported fuel and then the buyer is forced to file a refund claim with the province to recoup the security paid. Carbon tax officials note that this is a compliance burden for both them and the taxpayer; however it is important to note that before the refund is issued, there must be evidence of export of all the volumes purchased, which can sometimes be an issue with diversions, etc. Another possible solution that has been explored, but not readily adopted or applied by industry or British Columbia, is the use of section 30(6) which allows the director (i.e. a person administering the CTA) to exempt a collector, deputy collector or retail dealer from having to remit (and recoup from the buyer) security. The director must approve of the arrangement in writing and will place various conditions and restrictions on the seller/collector, which may include maintaining proof of export by the buyer as well as a certification as to the use, which may include a declaration by the buyer that they are not a purchaser and are removing the product from the province for resale purposes. Common carrier vs. lease/owner operators Although the exemption discussed above clearly rules out the buyer from using their own trucks and trailers to remove the taxable product from British Columbia, the use of a buyer s own trailers using independent lease-operators or owner-operators (referred to herein as operators ) is not so clear cut. This is an emerging issue that the author is aware of; however there is no existing guidance from the CTB on the issue that is publicly available. We understand however, that provided the above criteria 8

9 are met regarding the exemption under section 14(2)(c) of the CTA (including that a common carrier is retained before the purchase occurs) then the collector should not need to remit (and recoup from the purchaser ) the carbon tax security. If a buyer has an operator under contract (i.e. the operators cannot be employee, but must be independent) to use their own truck and/or tanker trailer to remove the product from the province, then British Columbia may also permit the exemption to the collector, provided strict conditions are met and documentation retained. This would include situations where the buyer s tanker trailer was used by the operator. However, British Columbia requires extensive documentation from the operators, certifying that they picked up the purchased volumes in the province and delivered all such volumes outside British Columbia. The operator must sign an extensive undertaking letter certifying this and must inform the CTB if either (a) the operator does not deliver all the volumes to a place outside British Columbia for any particular shipment, or (b) the operator s contract with the purchaser changes with the buyer. This signed undertaking must then be provided to the buyer who must give a copy to the seller in British Columbia. Venting emissions and carbon tax During the run-up to the British Columbia election, the NDP party was campaigning in part, on a platform that would see various venting emissions in the oil and gas industry, become subject to the carbon tax. In addition, some carbon tax auditors were seeking to make carbon tax assessments to some industry members prior to the election; however those positions have since been abandoned, presumably due to political will of the Liberal party insisting that they would freeze carbon tax rates. Although freezing rates for several years is welcome news to the industry, expanding the carbon tax base (presumably beyond its original intent) now could appear to go contrary to the Liberal party s intent to freeze rates. Recent discussions with CTB administrators has suggested that venting is currently not subject to carbon tax, so a wild swing in policy would likely need to occur and potentially a clarification of the legislation. However, for greater certainty, some industry members are working to allay such concerns with the CTB and the British Columbia Ministry of Finance to put additional exemption regulations in place to ensure that any otherwise taxable fuels that are not combusted, be unconditionally exempt from carbon tax based on their final actual use. Diluent used in crude oil pipelines Several years ago, an issue arose relating to diluent used to transport crude in pipelines that transited through British Columbia. Initially, the CTB wanted to subject the diluent (mostly taxable condensates defined to be fuel ) however the issue was resolved with no increase cost to the owner of the crude and diluent. Recent discussions with CTB officials reveals that as long as the diluent is inserted into the pipeline outside British Columbia, the CTB considered that no use is made of the otherwise taxable product in the province. This of course, begs the question that if the diluent is inserted into a pipeline in British Columbia to transport crude oil, would it be taxable. Comments by CTB officials suggest that it would be considered use and subject to tax. 9

10 The term use is the pre-cursor to the application of carbon tax and is defined as: includes flaring and incineration of natural gas or refinery gas, and a prescribed type of activity in circumstances, if any, that are prescribed. The term includes certainly opens up the possibilities as well as the prescribing of other activities to allow for a policy expansion of the tax base. At present, there are no prescribed activities; however there are several exemptions in the CTA Regulations for noncombusted uses of otherwise taxable fuel. Given that diluent is an otherwise taxable fuel, but is used in this instance (and others) in a noncombustible manner, it would seem logical for the CTA to contain an exemption for such fuels used in such a manner. Some industry members are working with the CTB and British Columbia Ministry of Finance to ensure that such uses (and any others that industry may put forward) are exempt from carbon tax. An opportunity may exist to put forward suggested changes to the CTA and its Regulations to ensure that the industry is not unfairly burdened with this tax, which by its design and original implementation, was lauded to tax carbon that was combusted and therefore harmful to the environment as emissions. That is, if an otherwise taxable fuel is not combusted (i.e. does not produce emissions) then it should fall outside the scope of the CTA entirely as it would not meet the policy intent. It does not take long to figure out by reading some of British Columbia s own publications on the Internet, that the province s position 4 on the carbon tax is that it was and is intended to capture fuels that are burned or combusted 5 to produce greenhouse gases. One of the benefits of this would be to exclude methane produced by farm animals and rotting vegetation as well as other emissions that are not in fact combusted. Therefore, from a policy intent perspective, it would seem very contrarian to subject diluent or other emissions (not combusted) to carbon tax. IV. GST/HST update With the repeal of HST in British Columbia this past April, the introduction of HST in Prince Edward Island and Quebec s most recent harmonization changes, there has been plenty of GST/HST changes to accommodate for Canadian taxpayers. For those energy industry members with operations across Canada, these changes have proven to be challenge over the past year or so, not to mention the re-implementation of PST in British Columbia. For those companies with employee pension plans or other financial institutions within their structure have also seen a new compliance burden placed upon them for both GST/HST as well as Quebec sales tax. Budget 2013 and pension plan changes In the 2013Federal Budget, the federal government announced changes for employers with pension plan entities. The first proposed change applies to employer participating in a registered pension plan. Currently, such employers must account for tax on both actual and deemed supplies made by the employer to the pension entity. The proposed change will allow employer to jointly elect with a pension entity of that pension plan to treat an actual taxable supply by the employer to the pension entity as being for no consideration where the employer accounts for and remits tax on the deemed taxable supply. This will eliminate the need to issue tax adjustment notes and simplify pension administration. The second relief measure only applies to certain employers and their pension entities whose total deemed supplies made by the employer fall below de minimis thresholds. Under existing rules, an 10

11 employer is required to calculate and remit an amount of GST/HST on deemed supplies in respect of the employer s resources acquired, used or consumed in the course of pension activities. An employer may be relieved from the deemed supplies rule if they meet the following two thresholds: the amount of GST related to deemed supplies made by the employer and other related employers in the preceding fiscal year is less than $5,000, and the above amount of GST on deemed supplies is less than 10% of the total net GST paid and deemed to be paid by all pension entities in the pension plan. As of writing, these rules have been introduced in Parliament via a Notice of Ways and Means motion, but have not yet been passed into law; however it is expected they will be. GST/HST enforcement activity In late May, the Canada Revenue Agency ( CRA ) and Institute of Chartered Accountants of Alberta held their annual roundtable in Ponoka, Alberta. Among many of the great discussions was an announcement by the CRA of their top 10 enforcement initiatives for the coming year. We have distilled these down to a top 5 (in no particular order of importance) that would be relevant for the energy sector as follows: 1. Recaptured ITCs ( RITCs ) although CRA did not point to a particular jurisdiction, we expect that RITCs will be targeted towards energy companies operating in British Columbia from July 1, 2010 to March 31, 2013; however for some large integrated energy companies, RITCs in Ontario should not be ruled out. CRA did not specify which areas they would target, but we would expect the greatest risk to CRA and in terms of value would be RITCs related to energy consumed in nonproduction environments as well as a focus on the proxy approaches to ensure companies qualified and used them correctly. 2. ITCs in general for several years, CRA enforcement has focused on ITCs generally, so this is not a surprise; however recent examples of significant ITC assessments should be a reminder that this issue is not going away and that it is important that suppliers (and their customers) ensure that the correct entity is named as the recipient on the invoice or written agreements regarding a supply and that all, prescribed documentary requirements are met. In addition, CRA is focusing on expenditures that are not those of the recipient and that have not been re-invoiced to the proper person. For instance, one company may be invoiced and pay for an expense that actually belongs to another person, which has never been re-invoiced to that person. In such situations, the CRA has successfully denied the ITC on the grounds that it was not for use in the recipient s commercial activities. Therefore, it is important to ensure these costs get allocated and re-invoiced to the correct person for use in their own commercial activities wherever possible. Further to this issue, situations can occur in the upstream sector whereby a producer wants for competitive reasons, to keep the ownership of a well undisclosed to the public. These are sometimes referred to as phantom wells and the actual operator of the well will use a shell company to act as its face with regulators, the public and suppliers. By their very nature, such relationships typically fall under a principal-agent arrangement, although the full scope of which, is not always well documented. 11

12 Locally, CRA has taken exception to the use of the shell company as the recipient where there is no written evidence (i.e. an agency agreement) properly documenting the principal-agent relationship between the well operator and the shell company or its beneficial owner, despite the fact that the accounting and GST/HST reporting accord with an agency relationship. Well operators claiming ITCs in the name of such shell companies should be prepared for such challenges and ensure that written agreements exist to duly authorize the agent shell company to be a procurement centre/agent for the principal producer/operator, in accordance with the GST/HST regulations. 3. ITCs for holding companies this has not historically been a major deployment area for CRA s audit resources; however today CRA is noting this has been an area of tax leakage for ITCs. Presumably, CRA is going to take a close look at whether the provisions of section 186 of the Excise Tax Act ( ETA ) are being met. Otherwise, it would be expected that CRA would seek to deny ITCs claimed by any holding companies that have not otherwise re-allocated or re-invoiced those costs to the proper related company. This issue came to the fore in two Federal Court of Appeal cases, Stantec 6 (2009) and Lyncorp 7 (2011). Certainly a lesson that can be drawn from Lyncorp was that if the expenses that were disallowed for income tax purposes and the ITCs denied for GST/HST purposes had instead been allocated and re-invoiced to the underlying operating companies, they may have been allowed. That is, the Federal Court of Appeal agreed with the Tax Court s findings that the flight expenses of the holding company (i.e. Lyncorp International Ltd.) were not deductible for income tax purposes because they were not incurred to produce income of the holding company. The ITCs were denied because the expenses were not eligible under section 186 nor were they ultimately related to the commercial activities of the holding company. Although the two cases are different in many ways, including very different facts, the importance of both cases is that they are some of the very first cases in GST/HST history dealing with section 186 in a meaningful way and we trust that they will set the foundation for future policy and any cases that come after them. Lyncorp reminds us that at least for GST/HST purposes, making sure that inputs to a holding company s business should be allocated and re-supplied/invoiced to the person to whom they belong (i.e. the operating companies) so that the re-supply input is in the course of the holding company s commercial activity. If possible, the re-supply can be made without GST/HST as long as the parties involved qualify to utilize an election under section 156 of the ETA. 4. Joint ventures, bare trusts and qualifying activities although CRA s comments were more directed at commercial real estate joint ventures and the use of bare trusts and nominee companies, we understand that CRA has also been taking a closer look at GST joint venture elections under section 273 of the ETA. Presumably, CRA is checking to ensure that the activities outlined in the joint venture agreement match what the election under section 273 is set up for and that those activities are qualifying activities under the same section and/or the Joint Venture (GST/HST) Regulations. We also understand that CRA has been taking a very restrictive approach to what they consider to be exploration or exploitation of mineral deposits which, among other activities, is the main qualifying activity for purposes of section 273 and the energy industry. The debate comes down to the meaning of exploitation and how far that extends beyond the well site. Recently, CRA has been in the process of revising its publications and policy on this matter; however to date, it is 12

13 maintaining its position that exploit or exploitation means the extraction of minerals from the earth and any related processing and transportation to the battery, but generally nothing further. Until this policy is updated to reflect a more modern approach to exploitation (see Dunbar case) to extend beyond the well site/battery to include all pipeline transportation up to a refining point where the product is commercially and economically usable, operators and producers should be careful to ensure that the activity for which the election covers, does not extend beyond the well site/battery which may, in CRA s view, go beyond exploitation. The consequences of not meeting the criteria in the election can be quite severe for upstream activities, including the complete denial of ITCs to the operator as well as the potential pro-rata assessment of any GST/HST collectible by each of the venture participants on their pro-rata share of taxable revenues. Therefore, it is important to check all agreements dealing with the GST/HST joint venture election wording and the responsibilities of the parties to ensure they meet the criteria outlined in section 273 (or the Regulations) and that the actual activities match those in the agreement/election. 5. Non-resident and resident importation issues and ITCs this issue has been around for several years and CRA announced several years ago that they were focusing on this area for nonresidents; however the enforcement could be expanded to include resident importers as well, especially those claiming ITCs under section 180 on behalf of non-residents. For non-residents who are registered for GST/HST, there are a myriad of issues to face when it comes to claiming ITCs for Division III GST paid at the time of importation, the greatest of which stems from the place of supply in the case of TPP sold to a Canadian customer. Given that an entire paper could be devoted to this issue, suffice to say that CRA is taking a closer look than ever before, so nonresidents will need to pay close attention to the terms of delivery (Incoterms 2010, etc.) when importing goods into Canada to ensure all the documentation lines up to entitle them to claim ITCs Perhaps more importantly are the issues that resident registrants may face, including the use of the drop shipment rules. Although specifically cited as an area of concern, issues connection to section 179 of the ETA would be typically part of CRA s non-compliance work in the areas mentioned. Other areas which could be on CRA s agenda include the claiming of ITCs by resident registrants under section 180 on behalf of unregistered non-residents that have made supplies in Canada. However, the typical issue we expect the CRA to review is the documentation maintained by the resident registrant to show that it is the de facto importer that is entitled to claim the ITC, despite the actual name of the importer of record noted on the Canada Customs accounting document B3. Therefore, it will be important to ensure that B3 s are available and not simply the customs broker s invoice or statement. Ideally, the auditors will be looking to see that the importer of record is the same as the recipient; otherwise the importer claiming the ITC, will need to demonstrate via purchase and shipping records that it was the de facto importer that caused the goods to be imported into Canada. V. Energy issues case update The upstream energy sector has seen many new issues evolve in terms of PST in recent years, particularly around the treatment of materials provided with service contracts and whether a separate 13

14 sale of the materials occurs. Three separate cases have been heard on this issue both north and south of the 49 th parallel under both PST and state sales tax regimes. Noble Energy, Incorporated vs. Colorado Department of Revenue 8 The first of these situations was seen in 2008 in Colorado with Noble Energy, Incorporated ( Noble ) filing refund claims for fracturing fluids, sand and other materials charged by oilfield service companies in performing fracturing service contracts on various well sites throughout the state. After a series of debates with the Colorado Department of Revenue, a district court trial and finally the Colorado Court of Appeals, Noble s claims were allowed in April 2010 (along with several other claimants) on the basis that no separate sale of TPP was made at retail when the service companies invoiced the materials in addition to the services, a practice which is still common in Canada. That is, the materials were not sold to Noble and were simply incidental to the non-taxable services, which were the true object of what was acquired. Although the Court did not comment specifically on who was responsible for the applicable state and local sales tax on the materials, it did make a brief comment on the fact that one of the oilfield service companies did collect the tax as instructed by the state s regulation related to contractors. It is presumed that the oilfield service companies providing the non-taxable fracturing services would be considered the user or consumer of the inputs and required to pay sales tax or self-assess use tax on their acquired cost. Fast forward to 2012, when Burlington Resources Canada Ltd. appeared before the British Columbia Supreme Court to appeal a decision of the CTB s audit department. Burlington Resources Canada Ltd. vs. British Columbia 9 This case was first heard in early June 2012 in relation to an assessment of PST under the former Social Service Tax Act for PST that was not paid on materials invoiced to Burlington Resources Canada Ltd. ( Burlington ) by its well services provider, BJ Services Company Canada ( BJS ), for the period July 1, 2003 to March 31, Unlike the facts in Noble where state sales tax was paid in error and refunds were sought by Noble, Burlington was challenging an assessment by the CTB. The CTB asserted in its assessment of Burlington, that PST was due on the materials invoiced to Burlington by BJS in respect of well cementing services and well stimulation services as well as other services such as pressure testing services and under balance drilling services. That is, regardless of the form of contracts entered into between Burlington and BJS, the materials were a distinct taxable supply of TPP by way of retail sale that was subject to PST; however the parties agreed that the services themselves were all considered non-taxable. Like the Noble case, Burlington s counsel demolished many of the key assumptions and findings of fact by the CTB in their assessment on several grounds, but most importantly, it came down to the true object of the contracts being those for services provided to Burlington by BJS. That is, the Supreme Court determined that Burlington was not a purchaser of the materials and did not acquire materials used by BJS in the performance of its non-taxable services. Rather, BJS was effectively the user or consumer of the materials in the performance of the various services provided to Burlington. 14