Tax Alert Canada. Changes to the large business simplified method and clarification for its application to expenses incurred before 1 January 2014

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1 2013 Issue No July 2013 Tax Alert Canada Changes to the large business simplified method and clarification for its application to expenses incurred before 1 January 2014 EY Tax Alerts cover significant tax news, developments and changes in legislation that affect Canadian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. The simplified method currently applicable to large businesses (the LB simplified method) is a well-known method for calculating an input tax refund (ITR) in respect of an expense reimbursement. That being said, following analyses by the Agence du revenu du Québec (ARQ), it appears that the LB simplified method no longer meets the basic principles that originally justified its implementation. Burgeoning application difficulties as well as a series of interpretation issues surrounding the notion of personal expenses have caused the ARQ to make changes to the current LB simplified method. These changes, announced at the 2013 edition of the Association de planification fiscale et financière Commodity Tax Symposium, in fact reflect in the agreement reached on 28 March 2012 between the federal and Québec governments to harmonize the Québec sales tax (QST) with the goods and services tax (GST). Following is a brief recap of the basic principles of the current LB simplified method. The method is optional and it s not necessary to file an election to use this ITR calculation method in respect of an expense reimbursement. It must be applied from the start of a reporting period until the end of the fiscal year that includes the reporting period. If used, it must also be applied to all expenses reimbursed on presentation of an expense account report for all of the entity s employees. In paragraph 3 of Interpretation Bulletin TVQ.212-1/R4, the ARQ defines expense account as a statement of the personal expenses incurred by an employee in the course of the employer s activities and reimbursed to the employee by the employer. If used, the current method must also be applied to all of an entity s divisions and branches unless authorization pursuant to section 475 of the Act respecting the Québec sales tax (RSQ, c T-0.1) (the AQST) applies. This method provides that

2 expenses reimbursed to an employee on an expense account basis must be expenses incurred in Québec of which all or substantially all (90% or more) are for taxable supplies other than zero-rated supplies. The current LB simplified method also provides that expenses subject to the restrictions applicable to large businesses set out in subsection of the AQST are included in the ITR calculation. Furthermore, the specified percentage for the purposes of ITR calculation is 5% for expenses incurred starting 1 January A rate of 4.1% applies in the case of expenses incurred after 31 December 1997 and before 1 January 2011, and a rate of 4.5% applies in the case of expenses incurred after 31 December 2010 and before 1 January Proposed changes The ARQ is proposing both changes to the current LB simplified method and clarifications for application of the method to reported expense account amounts incurred before 1 January Proposed changes to the current LB simplified method. The ARQ s intention to change the current LB simplified method involves the following measures: Termination of the current LB simplified method as of 1 January 2014 Replacement of the current LB simplified method by a method applicable to small and medium businesses (SMBs), adapted for large businesses Withdrawal of interpretation bulletins TVQ.211-5/R1 and TVQ.212-1/R4. The current LB simplified method is to be terminated as of 1 January 2014, insofar as the ARQ s stated intentions take concrete form. The current LB simplified method would be replaced by an SMB simplified method called adapted for large businesses (adapted SMB simplified method). This new method is to be harmonized with the method applicable under the GST system. So, starting 1 January 2014, it will be possible to make ITR claims in respect of an expense reimbursement pursuant to the provisions of section 212 of the AQST or according to the adapted SMB simplified method. Following on the changes to the current LB simplified method proposed by the ARQ, interpretation bulletins TVQ.211-5/R1 and TVQ.212-1/R4 would be withdrawn. Based on statements by the ARQ, the basic principles of the new adapted SMB simplified method are to be substantially the same as those that define the current LB simplified method. The method will be optional and it will not be necessary to file an election to use it. The method will have to be applied from the start of a reporting period until the end of the fiscal year that includes the reporting period, in respect of all expenses reimbursed on presentation of an expense account report. The new method will also be applied to all of an entity s employees and all of an entity s divisions and branches unless authorization pursuant to section 475 of the AQST applies. The adapted SMB simplified method will further provide that expenses reimbursed to an employee on an expense account report must be expenses incurred in Québec of which all or substantially all (90% or more) are for taxable supplies other than zero-rated supplies. However, the new adapted SMB simplified method will include certain distinctive principles, namely: The calculation method elected by an entity, either the method described under section 212 of the AQST or the new adapted SMB simplified method, will have to be used consistently for each category of amounts reimbursed throughout the fiscal year 2

3 At least 90% of the supplies for which a reimbursement is claimed must be subject to the QST ITR calculation. Accordingly, no ITR may be claimed in respect of this type of expense. The ITR restrictions provided for under subsection of the AQST will have to be applied by large businesses The required documentation will be the same as that applicable for the current method under the GST. For instance, take an employee of an entity using the current LB simplified method. The employee presents an expense account report itemizing the following expenditures: hotel expenses of $100, meal expenses of $200 and a per-kilometer allowance of $54. The following table summarizes the impact of the ARQ s proposed changes in respect of expenses itemized in an expense account report. Note that our assumption is that the abovementioned expenses are personal expenses and meet the previously stated criteria for application of the LB simplified method. Description Amount GST QST Total of expense (rounded) (rounded) Hotel $100 $5 $10 $115 expenses Meal $200 $10 $20 $230 expenses* Per-km $ $54 allowance Total $399 ITR calculation according to the current LB simplified method = 5% X $399 = $19.95 ITR calculation according to the adapted SMB simplified method = (9/109) X $115 = $9.49 * These expenses are subject to the restrictions under subsection of the AQST. Clarifications for the LB simplified method application to reported expense account amounts incurred before 1 January 2014 The ARQ is adding clarifications concerning application of the current LB simplified method to reported expense account amounts, provided such amounts are incurred before 1 January First, a restricted expense pursuant to subsection of the AQST and which is not a personal expense must not be included in the On the other hand, an ITR may be claimed in respect of an expense that is not subject to the restrictions under subsection of the AQST, whether they are personal expenses or not. Determining whether an expense is a personal expense is a question of fact. The ARQ states that certain factors must be reviewed, such as the nature of the expense, the duties of the employee who presents a claim for reimbursement using an expense account report and the number of guests attending a meeting with a client. Of course, these factors are not comprehensive, but they establish guidelines for determining whether an expense is a personal expense. The ARQ also provides some examples of personal expenses (this list is not comprehensive): Monthly cell phone expenses where the telephone contract is in the employee s name Expenses itemized on an expense account report of an employee who incurs entertainment expenses on the road, except for certain specific cases Expenses for gifts to a client, insofar as it is reasonable to consider such an expense as entertainment expenses of the employee Expenses for food and beverages incidental to events such as an invitation to take a client out to a restaurant to discuss a file or travel for employee training. The ARQ explains that if several employees travel to the same location and only one of them pays for all the employees of a large business and claims a reimbursement from his employer using an expense account report, the expense is a personal expense that qualifies for the LB simplified method only insofar as each employee could have claimed the reimbursement of his own expense using an expense account report. 3

4 The ARQ also provides some examples of expenses that are not personal expenses: The purchase of a computer, stationery or other office supplies Learn more For more information, please contact your EY or Couzin Taylor advisor or one of the following professionals. The cost of a business activity such as training given to the clients of a large business, whether the employee attends or not The cost of tickets or a box to attend a hockey game Expenses for food or beverages incidental to specific events such as a colleague s departure, a celebration for several employees passing an exam, an end-ofproject celebration, whether the client attends or not, a Christmas celebration or any other activity held at the head office of a large business East Jean-Hugues Chabot jean-hugues.chabot@ca.ey.com Manon Jubinville manon.jubinville@ca.ey.com Daniel Legault daniel.p.legault@ca.ey.com Mary Anne McMahon maryanne.mcmahon@ca.ey.com Central The ARQ s intention to change the current LB simplified method and the clarifications for application of the method in respect of reported expense account amounts incurred before 1 January 2014 are now known, but it remains to be seen how these changes will be integrated into everyday life. Stay tuned... Dalton Albrecht dalton.albrecht@ca.ey.com Sania Ilahi sania.ilahi@ca.ey.com West Ken Ghag ken.k.ghag@ca.ey.com David Robertson david.d.robertston@ca.ey.com 4

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