Written by Laurent Moons
Sales tax is not usually the first thing on the minds of Quebec tech entrepreneurs, but there are compelling reasons why it should be taken seriously. For any company, sales tax represents a risk that needs to be properly managed at every stage of development.
In this piece I want to outline certain elements of the Canadian sales tax regime that are critical for a Quebec startup to consider in order to avoid an unpleasant visit with the tax man.
For a Quebec company, the most important sales taxes are the Goods and Services Tax (“GST”) and Harmonized Sales Tax (“HST”), imposed at the federal level, and the corresponding provincial taxes, one of which is the Quebec Sales Tax (“QST”). Generally, unless it qualifies as a small supplier (i.e., less than $30,000 in annual sales), a Quebec company is obligated by law to invoice and collect GST or HST (for customers in Canada) and QST (for customers located in Quebec).
While a number of exemptions exist, they are not common in the tech industry.
Firstly, a company has to determine the exact nature of what it sells and how the supply is categorized under the tax laws. For example, many of the supplies that are commercially referred to as software-as-a-service (SaaS), actually qualify as supplies of intangible personal property (“IPP”) for sales tax purposes, not services. The categorization of a supply has fundamental implications for its Canadian sales tax treatment.
Imagine a Montreal company called “MooJooTech”. MooJooTech has developed an online game which is sold for $0.99. In reality, what the company sells is the right to access the game online. At no time during the registration process or the game itself does the customer have any contact with MooJooTech’s employees.
At first glance, for Canadian sales tax purposes, MooJooTech’s offering qualifies as a supply of an IPP. Furthermore, such supply is deemed to be made in Quebec (and, hence, subject to the GST and QST rules) inasmuch as it can be used in Quebec. Whether the game is actually used in Quebec or not is irrelevant. The user may be sitting in Montreal’s Mile-End, Djibouti or Singapore. The operative criterion is whether, contractually, the user has the right to access the game in Quebec.
Unless the contract includes a specific exclusion (and this is generally the case), this right brings MooJooTech’s supply under the GST/QST net.
Even if MooJooTech’s sales may potentially be subject to Canadian sales taxes, rules exist that allow for the zero-rating of such sales to players located outside of Canada. But zero-rating the supplies requires that MooJooTech fulfill several conditions. For instance, the company must be able to demonstrate to the tax inspector that its customer:
- Is a non-resident of Quebec/Canada (providing an IP address located abroad is not sufficient – the tax authorities often require a “tick the box” type declaration by the customer, supported by secondary proof, such as the address of the bank that issued the credit card used for payment);
- Is not registered for GST/QST purposes (this is usually done through a self-declaration by the customer);
- Being an individual, is not present in Canada at the time of the supply (the tax authorities usually require the use of geolocation software).
It is to be expected that these conditions are not easily fulfilled when selling a C$0.99 game. In the time that it takes for your customer to answer all of the necessary questions to determine the correct tax treatment, s/he will probably have moved on and bought your competitor’s game.
MooJooTech could rely on the platform operator (Facebook in our example) to determine the correct application of taxes. This approach is flawed for the following reasons:
- In the tax authorities’ view, MooJooTech would remain responsible for the correct application of the taxes (the tax authorities would not audit Facebook, but MooJooTech); and
- More often than not, the sales report issued by the platform operators does not meet the minimum requirements set by the authorities for zero-rating supplies based on the customer’s location, status and residence.
A simple twist illustrates that a company like MooJooTech needs to understand the sales tax rules beyond GST and QST.
Imagine that the company has customers in Vancouver. British Columbia (in addition to Manitoba and Saskatchewan) still imposes its own provincial sales tax (“PST”), which differs significantly from the GST. As a result, the prudent managers of MooJooTech should carefully review the company’s tax footprint in British Columbia. Depending on its presence in the province (an office, a server, a sales representative, an employee, etc.), it is possible that, at some point in time, it will have to apply the PST on its sales to customers located in BC.
The catch for MooJooTech is that if the auditor identifies a tax liability (i.e., sales on which MooJooTech did not apply tax where it should have) during a tax audit, it may be near impossible for MooJooTech to go back to its customer, an individual, and charge the tax not originally collected. In other words, any amount of additional tax assessed by the authorities will have to come from MooJooTech’s pocket. With tax rates going up to 15 per cent in Canada (plus potential penalties and interest), the bill can grow fast.
Our case demonstrates the utmost importance of understanding the basics of sales tax and appropriately managing the associated risk. As tempting as it may be, pushing this exercise to a later date may not be the wisest of business decisions.
Laurent Moons is Deloitte Montreal’s Senior Manager – International indirect taxes.