A sales tax matter that all organizations reimbursing expenses to employees in Canada have to address is which method should they use? There are 2 methods to choose from as advertised by tax authorities: the exact method or the factors method. (See also our Exact Method VS Factors Method page).
1 – The Exact Method
Claiming GST HST rebate and input tax credit (ITC) is governed by Part IX of the Excise Tax Act (ETA). There are specific provisions that address reimbursement of expenses to employees, members of a partnership, members of the board and, volunteers of non-profit organizations such as section 175 of the ETA. That section states that if any of the persons mentioned before paid the tax payable, as indicated on an invoice, with respect to an acquisition that is subsequently reimbursed by the employer, then the tax paid by the employee and all is deemed paid by the employer. Assuming the employer respects all conditions in claiming a GST rebate, a HST rebate or an ITC, such as when the acquisition is used in relation of the activities of the employer, then simply put, the tax paid on an invoice is the tax to claim by the employer. That is what Canadian tax authorities called the “exact method” but that is nothing more than the law applied to employee expenses.
2 – The Factors Method – The Origin
At the time of the introduction of the GST in 1991 when there was a single federal tax rate across the country of 7%, the QST wasn’t effective, the economy was based on paper documents, there was no internet; the federal government introduced an administrative method called the factors method. That method could be applied to reimbursement of expenses, but not to allowances, had to account of the 50% reduction applicable to meals/entertainment and could only be applied when 90% of all expenses of an expense report are taxable, other than taxable at a rate of 0%.
Back then that method had a certain appeal despite the obvious shortcomings of being an administrative method so organizations have no legal recourse in case of litigation with tax authorities and the 90% test per expense report is somewhat problematic as you need to use the exact method on each expense report to see if you would qualify to use the factors method, which defy the purpose.
Yet the administrative task of handling expense reports supported entirely by paper receipts and the fact that there was only one value added tax rate for the entire country made the factors method an attractive method for several.
3 – The Factors Method – 32 years later
Fast forward 32 years later in an environment where there is HST at 15%, HST at 13% GST at 5% across Canada and a QST at 9.975% and more purchases from foreign suppliers where tax is not collected are made by employees so the question as to whether expense reports qualify to a significant extent to the factors method under the 90% rule is more problematic than ever. Registrants may simply not be entitled to recover any tax on expense reports despite incurring some taxable expenses on it, simply because 90% of those expenses are not taxable. Furthermore, the fact that the factors method is purely administrative removes legal ground to challenge assessments.
4 – The Exact method: Technologies to the Rescue
On the other hand, the paper handling issues of expense reports that existed 30 years is no longer as huge as it was. Today employees get more and more only digital images of those receipts as several organizations no longer issue paper receipts in the first place. As for those still issuing paper receipts, mainly restaurant bills and parking receipts, taking pictures of their receipts with their smartphone and uploading them in an app where fields can be deciphered with the OCR, so it is an efficient way of handling these documents. As for handling the current sales tax rules of the Canadian tax landscape, Advataxes incorporates matrices at the provincial level as well as at the expense level, there are no tax codes to create and to choose from.
5 – Tax Codes and Meals with Tips Issue
The tax code method on a meal expense with various percentages of tip amount where the latter one is not subject to tax is an issue since the tax code is supposed to calculate the tax to recover. What percentage can be used on one expense representing one supply, where one part is subject to tax (the meal) and another one is of a discretionary amount (the optional tip) not subject to tax? Is the exact recoverable amount posted?
6 – Safeguards from software
Safeguards and rules have been implemented in Advataxes for recoverable GST/HST and QST. For instance, GST/HST and QST payable is triggered for the year 2023 on KM allowances for a maximum of 68 cents in 2023 in a province and for 72 cents in a territory. On meal expenses there is a specific box for tip amount so the tax to recover is solely based on the expense amount before tip. It’s the exact amount that is recovered.
7 – Conclusion
The exact method is today a wise choice in an environment with substantial Canadian sales tax automation and where the organization has meaningful sales tax recoverable amount (see our page Simulation). If an expense qualifies for a tax refund, then claim it, and when an expense doesn’t qualify for a tax refund, don’t claim it. This is Advataxes sales tax management approach; it is implemented at the expense level. Advataxes is built so each digital receipt can be attached to each expense. All digital receipts can be attached to an expense report with a smartphone and the OCR can populate most fields. It is an easy way to fill out an expense report. The benefit of this cloud solution is how easy it is to review an expense report. A reviewer has access to each expense report and all digital images, side by side with each expense.