Insurance Issues: Risk Management
2012: No. 2 Summer
GST traps for the unwary
“GST is a trap for the unwary. It is even a trap for the wary. I suppose creating better awareness of the issues and pitfalls is all that can be done.” – advice from a lawyer who reported a claim when the company he had acted for in the sale of a commercial property was assessed the GST that the purchaser ought to have paid, but never did.
We took this lawyer's advice to heart. In this Insurance Issues, we first give details of the GST pitfalls that lead to reports to us. We then draw on our experience and those of reporting lawyers to offer tips that you can follow to avoid getting trapped. Because the risks we identify exist regardless of whether the tax is assessed as Goods and Services Tax (GST) or as part of the Harmonized Sales Tax (HST), we refer to both as “GST.”
This Issues is of particular relevance to real estate and commercial lawyers. However, because GST issues can surface in other areas of law, it is recommended reading for all lawyers. And although we touch on some law in relation to GST, it is not a legal authority. GST is a complicated area involving various legal issues, including statutory liability, exemptions, rebates and elections, and lawyers must understand how it affects their practice. However, as with the Winter 2010 Insurance Issues that dealt with the risky business of income tax, the tips we offer will help you navigate those risky waters more safely.
Trap: Not flagging the GST issue
Sometimes lawyers don’t realize that potential GST implications exist. Here are some examples from lawyers acting on real estate transactions:
- A lawyer didn’t appreciate that, because his vendor client was in the business of buying and selling properties, GST needed to be collected from the purchaser and remitted to Canada Revenue Agency (CRA).
- A lawyer acted for the purchasers of a condominium that was part of a rental pool. The purchasers were pursued by the vendor after the vendor was assessed GST, and then claimed against the lawyer.
Lawyers providing other types of services have also missed the lurking GST issue. For example:
- A lawyer filed a builder’s lien for a subcontractor and forgot to include GST in the lien amount.
- A lawyer advised a director on a company’s liability risks but failed to warn about the risk of unpaid GST.
GST can also affect settlements, as seen by these reports:
- A lawyer negotiated a settlement of a client’s sales service contract that made the client liable for statutory payments, and later realized the client was liable for GST.
- A lawyer’s client was provided with a first mortgage as security for the settlement of a lien claim. CRA later claimed priority over the mortgage for unpaid GST, and the client claimed against the lawyer.
- As part of a settlement, monies owed to a lawyer’s client for royalties and other amounts under a licence agreement were set off against the client’s debt. The lawyer did not consider whether GST was payable on the set-off amounts and the client may be exposed to a claim by CRA.
In some cases, the Excise Tax Act also deems a settlement payment to include GST – a trap for the unwary litigator whose client may be liable to pay the GST portion of a hard-won settlement over to the government.
Lawyers get caught giving the wrong advice on whether a matter attracts GST. Here are some examples from lawyers acting on real estate transactions:
- A lawyer acted for a vendor selling a newly constructed home and wrongly allowed his client to sign a GST exemption certificate on the basis that the property was “used residential.”
- A lawyer acted for a vendor claiming that the sale of vacant land was GST-exempt when it was not, as the land was subdivided. The vendor claimed against the lawyer.
- A lawyer acted for a purchaser of land from a corporate vendor, and wrongly advised that the transaction was GST-exempt as it was bare land. In fact, the exemption did not apply as the vendor was a corporate entity.
We receive reports from other areas of law, as well:
- A lawyer acted for a company that sells franchises, and gave preliminary, and possibly incorrect, advice about the applicability of GST to franchise fees.
- A lawyer acted for a tenant leasing property from the provincial government, and may have wrongly assumed that GST does not apply in the particular circumstances of the transaction.
Other times, the lawyer knows that GST is attracted, but is mistaken about how it operates:
- A lawyer acted for a developer of homes on land held pursuant to a long-term lease. The lawyer assumed that the GST operated as it would if the transaction involved fee simple sales, and wrongly structured the direct 99-year-subleases so that the “purchasers” were charged GST.
- A developer’s lawyer calculated a GST rebate. The purchaser assigned the rebate to the developer who submitted it and received a credit from CRA. CRA reassesses as the developer included extras in the statement of adjustments that were not considered by the lawyer in calculating the rebate, and is not entitled to the amount of the rebate claimed.
Trap: Making bad assumptions about your client’s circumstances or GST knowledge
Make assumptions about your client’s circumstances or knowledge of GST at your peril. We see reports in which lawyers get the GST issue wrong because they didn’t adequately canvass all the facts relating to a transaction with their client:
- A lawyer acted for both parties on a conveyance and assumed that the transaction was GST-exempt. In fact, the vendor was in the business of property development and GST may be applicable.
- A lawyer acted for the vendors of recreational property who were registrants and had claimed an input tax credit for the GST payable on their purchase –commonly referred to as a “GST deferral.” As a result, their sale was subject to GST, and they didn’t ensure that the purchasers paid the GST. The vendors were reassessed by CRA and blamed the lawyer.
Lawyers can also find themselves targeted if they rely on a client’s (incorrect) advice about whether or not GST is attracted. For example:
- A lawyer allowed his vendor client to sign a GST exemption certificate sent (inappropriately) by the purchaser, based on the client’s assurance that no GST was payable. The lawyer later discovered that his client based his understanding on the contract term stating that GST was the purchaser’s responsibility.
- A lawyer acted on the sale of a residential property on acreage, held by a family company. The son advised that he had investigated the matter and the transaction was GST-exempt. In fact, it was not, but the lawyer had nothing in writing to confirm the son’s advice.
Trap: Not adequately reviewing contracts and related documents
Sometimes, mistakes are made simply because lawyers don’t carefully review contracts or related documents. For example:
- A lawyer acted for a client selling equipment and understood that the purchaser would be liable for the GST, but overlooked a term in the contract providing that the vendor was liable.
- A lawyer acted for the purchaser of residential property and misinterpreted the agreement of purchase and sale. Contrary to the terms of the contract, the lawyer proceeded on the basis that the purchaser, if not entitled to the GST rebate, was required to pay the developer an amount equivalent to the rebate.
- In a real estate conveyance in which the purchaser assumed liability for self-assessing the GST, the vendor’s notary placed the lawyer on an undertaking to provide the purchaser’s GST registration number. The registration number was never provided and, in fact, the purchaser was not registered.
Trap: GST registrants
The Excise Tax Act requires a vendor of real estate to collect GST unless the purchaser is registered for GST purposes (for most types of sales). Generally, purchasers who sell taxable goods and services can recover GST paid on real estate purchases by registering before closing, then self-assessing and claiming input tax credits. They do not pay GST, nor are the vendors required (or able) to collect and remit GST. Lawyers should note that the Act requires such purchasers to be registered, not registrants. However, they are commonly referred to as “GST registrants,” and we use that term in the descriptions below. The concept is a trap for lawyers, with a number of triggers.
The first is the GST registration process itself:
- A lawyer allowed a purchaser client to sign the GST registrant certificate when, in fact, it had not yet taken the necessary steps to become a registrant.
Lawyers also get caught wrongly assuming that a party is – or is not – a GST registrant:
- A lawyer acted for a vendor selling property that was listed at a certain price, plus GST. The purchaser advised that it was a GST registrant and provided a GST registration number, so the lawyer did not include GST in the purchase. In fact, the purchaser was not a GST registrant and had no valid certificate.
- A lawyer for a vendor relied on the purchaser’s GST certificate and did not collect GST. The purchasers were not registrants, but the lawyer relied on other lawyers and notaries whose clients appeared to have lied to them.
- A lawyer acted for purchasers who paid GST that the vendors remitted to CRA. In fact, the purchasers were GST registrants who should not have paid the GST to the vendors. CRA could assess the purchasers to pay the tax a second time since they have not discharged their statutory obligation to self-assess or pay the government directly. If assessed, they will blame the lawyer.
Wrong assumptions can also lead to problems when the vendor is not resident in Canada. In that case, the purchaser must pay the GST directly to CRA, regardless of its registration status. Failing to do so leaves the purchaser open to assessment.
The GST registrant status of one party can also distract a lawyer from digging further:
- A lawyer acted for a vendor selling commercial real estate and the purchaser took title as bare trustee for another company that acquired the beneficial interest. As the purchaser was a GST registrant, no GST was collected. The vendor was later reassessed for failing to collect and remit GST as the lawyer had overlooked that it is the beneficial owner as opposed to that holding bare legal title that must be a GST registrant.
And finally, timing can be everything when it comes to GST registration. In corporate reorganizations, for instance, the “newco” acquiring taxable assets may have no right to recover applicable GST if it registers after the transfer.
Trap: Not clearly passing the GST buck
Sometimes, a lawyer is targeted when a problem develops out of a GST matter that the lawyer understood the client or the client’s accountant was handling. For example:
- A lawyer acted on a mortgage transaction. The borrower was buying out his partners in a property and part of the deal was the transfer of an interest in another property. The parties were handling the matter of GST themselves, thinking they would not have to pay any. In fact, they did, and may turn on the lawyer for not providing them with proper advice.
- A lawyer acted for purchasers who were denied a GST rebate because one of the purchasers did not occupy the property as a primary residence. The lawyer had assumed that the clients were dealing with the rebate issue themselves.
- A lawyer acted for a group of companies in relation to a mixed residential and commercial development. The clients’ accountants created the corporate structure pursuant to which the project would be completed, and various GST issues have now arisen. The lawyer may be at risk for not clearly confirming that the GST issues fell entirely to the accountants, and that he was simply following their direction.
Trap: Dropping the GST ball
In many reports, the lawyer knows exactly what needs to be done in terms of the GST issue but somehow a step is overlooked. For example:
- A lawyer acted for the vendor of a hardware store business. The parties agreed there would be no GST payable, a permissible election in the circumstances. However, the lawyer never noticed that the purchaser forgot to provide an election form. CRA is now seeking payment of GST, and the vendor is claiming against the lawyer.
- A lawyer assumed that a purchaser had a GST registration number and would provide the usual certificate. It seems that the issue completely slipped the lawyer’s mind, and neither a certificate nor number was provided.
- A purchaser was entitled to a GST rebate, but her lawyer missed the deadline for filing the rebate application.