Taxpayer Non-Compliance with Input Tax Credit Rules: Data and Policy Options for Canada

Abstract

Input tax credits (ITCs) are a mechanism for businesses to recover the goods and services tax (GST)/harmonized sales tax (HST) paid on expenses related to their commercial activities. While many businesses claim ITCs in accordance with the rules, instances of non-compliance are apparent. Canada uses an invoice credit system that relies on the claimant's retention of documentation that can be checked to detect any overstatement of ITC entitlement. Absent an audit, businesses are generally not required to provide tax authorities with details of their transactions.

This article draws on a study of case law relating to section 169 of the Excise Tax Act over the five-year period 2014-2019. Section 169 contains the general principles and rules for claiming ITCs. The study highlights various reasons for non-compliance with the ITC system in Canada, both intentional and unintentional. There are several recurring themes: the prevalence of fraudulent practices in certain industries, burdensome documentation and verification requirements, and taxpayers' misunderstanding of the rules for claiming ITCs, owing to ambiguous or otherwise complicated legal tests. In particular, the substantive rules concerning what constitutes a "commercial activity" for the purposes of claiming ITCs are often misapplied or misunderstood by claimants. Undisclosed agency relationships also cause problems where they result in the wrong name appearing on the documentation supporting an ITC claim. These issues point to certain flaws in the implementation of the rules under the GST/HST regime in Canada.

In response to instances of suspected fraud, Canadian tax authorities have been results-driven in implementing increasingly onerous supplier verification requirements that must be met before an ITC is claimed, particularly where the supplier did not remit the applicable tax. This contributes to a high compliance burden for taxpayers. Some proposals have been made for changes that would mitigate the issues associated with undisclosed agency relationships, but there are still problems with the documentation requirements and other substantive rules for claiming ITCs that need to be addressed.

The article concludes with a review of reform options proposed or adopted in other jurisdictions with a value-added tax. It also discusses a compliance measure implemented in Quebec (the attestation de Revenu Québec), which could be applied in other provinces. Specific recommendations are made for the adoption of e-invoicing and increased reporting requirements to address some of the reasons for non-compliance in Canada. A number of countries have moved toward implementing periodic or near-real-time reporting requirements. These measures show promise and suggest that Canada could move in that direction as well.