Agency, Reimbursements, and GST/HST

A question that commonly arises is whether reimbursements are subject to GST/HST. If expenses are incurred by an agent, reimbursement by the principal is non-taxable. However, expenses incurred as inputs to taxable property or services are part of the taxable consideration, even if the expenses were initially exempt. Agency can therefore be an effective way to ensure that expenses remain exempt from GST/HST upon reimbursement.

The SCC recently denied leave to appeal (March 31, 2011, 33895 (SCC)) from the FCA's decision in Canada v. Merchant Law Group (2010 FCA 206), a case that addresses some key features of an agency relationship.

The taxpayer, a law firm, acquired various goods and services from third-party suppliers in the course of providing legal services to its clients. It treated the cost of some of the goods and services as disbursements that it incurred as the agent of its clients, and it therefore did not charge and account for GST/HST. The minister assessed the taxpayer for failing to collect and remit GST/HST on the disbursements.

The TCC sided with the taxpayer. On appeal, the FCA focused on whether the taxpayer, as the putative agent of its clients, had the capacity to affect a client's legal position and, in particular, whether the taxpayer's clients were "bound by the contracts with third-party suppliers and were, therefore, liable for payment under the contracts and also exposed to any risk as a party to the contracts." The FCA allowed the appeal on the basis that the taxpayer failed to adduce any evidence showing that its clients were bound to the third-party suppliers.

The FCA's decision illustrates how agency can be used to avoid creating unrecoverable GST/HST costs. An exempt disbursement effectively becomes taxable if it is an input to a taxable service. For example, the disbursements at issue would have included government licence fees that were exempt when the licences were acquired by the taxpayer. However, they effectively became taxable when reimbursed, since they were inputs into taxable legal services. The tax cost would be unrecoverable by clients that are unable to claim input tax credits (for example, a non-registrant or a financial institution). In contrast, the expense would have retained its exempt status had it been incurred by the taxpayer acting as agent.

The FCA's emphasis on an agent's capacity to affect a principal's legal position and, in particular, on whether the purported principal is liable to third-party suppliers also raises two practical points. First, it underscores the importance of expressly documenting this aspect of the agency relationship. Second, it raises the question of how to meet the requirement in the common situation where the agency relationship is undisclosed to third parties. Unfortunately, the FCA did not comment on this question.

Simon Thang and Jung Ah Kwon
KPMG LLP, Toronto
[email protected] and [email protected]

Canadian Tax Focus
Volume 1, Number 1, May 2011
©2011, Canadian Tax Foundation