Exporting Vehicles and the Agency-Principal Relationship
The cost to purchase vehicles (especially luxury vehicles) is frequently much cheaper for Canadian consumers than consumers in other countries. Sometimes vehicles in Canada retail for between just 25%-50% of what the exact same make and model would cost in another jurisdiction. While there are various reasons that contribute to this price discrepancy (known in market terms as a “grey market”), this variance creates an opportunity for Canadian businesses to export these vehicles at a profit.
However, recently an increasing number of Canadian vehicle exporters have been subjected to audits by the Canada Revenue Agency (CRA) for one specific reason: the CRA has alleged the Canadian vehicle exporter to be an “agent” for a foreign “principal”. Where the CRA is successful in establishing agent/principal relationship between the vehicle exporter and its foreign buyers, the vehicle exporter can lose entitlement to Input Tax Credits (ITCs) claimed on the purchase of the exporter’s inventory.
The difference in a business’ characterization as a legitimate business or an agent/principal relationship is a legal distinction that depends on a factual analysis of key components of the relationship between a vehicle exporter and its buyers. Though nuanced, for a Canadian vehicle exporter this distinction can be the difference between operating a lucrative, profitable business and the loss of all (or substantially all) profits earned.
This blog entry will discuss how the CRA conducts factual analyses of a principal/agent relationships and what is necessary for Canadian vehicle exporters to establish to avoid this designation.
What is an Agent/Principal Relationship?
If the CRA alleges that your business amounts to an agent/principal relationship, they are essentially saying that your business (the “agent”) exists only to serve the interests of an off-shore party (the “principal”) and does not offer legitimate services of its own.
The effect of this designation is to disallow the exporter’s claims to ITCs, or credits issued by the Canadian government to offset the incurrence of HST on the vehicles purchased in Canada for international export. In many cases, this would greatly reduce (or negate) the profits earned by the exporter.
Hallmarks of an Agent/Principal Relationship
In order to evaluate whether an exporter is a legitimate business or merely an agent to a foreign principal, the CRA must conduct an analysis into the nature of the relationship between the exporter and its buyer(s). The analysis considers two main sets of criteria in evaluating the relationship:
- the “essential qualities” of a principal/agent relationship; and
- other “indicators” of a principal/agent relationship.
“Essential qualities” of a principal/agent relationship are: (i) whether the parties have consented to having the agent act on behalf of the principal; (ii) whether the agent has the authority to act on behalf of the principal in a legally binding manner; and (iii) whether the principal exerts some degree of control over the actions of the agent.
If these qualities are determined to be present in the relationship between an exporter and a foreign buyer, it is likely that the CRA would determine that a principal/agent relationship exists. This would have the effect of barring any claim to ITCs on the part of the exporter.
Other “indicators” of a principal/agent relationship include:
- if there is limited assumption of business risk on the part of the exporter;
- whether the accounting practices of the exporter suggest a principal/agent relationship;
- the payment history between the parties;
- if the exporter makes any alterations to the vehicles;
- whether the exporter uses the vehicles prior to export;
- the substance of the contractual payment relationship between the exporter and buyer; and
- the nature of the vehicles’ ownership.
The CRA uses these two sets of criteria conjunctively to issue a factual determination as to whether an exporter is in substance just the agent of a foreign principal.
What do I do if my Business gets Audited?
As outlined above, if your vehicle exporting business is selected for audit, the CRA will be conducting an in-depth factual analysis into all aspects of your business to issue its determination. As the CRA’s audit powers are only increasing, it is imperative that if your business is audited, you prepare a complete and circumspect defense and/or rebuttal to the CRA’s position.
Any single misstatement or missed deadline could be the difference between an entirely successful defence and the loss of all profits during the audit period. As principal/agent relationships are factual determinations based on nuanced legal arguments, it is often a prudent decision to retain a tax lawyer to defend yourself during the audit process or to carefully plan your business affairs prior to being audited to mitigate the risk of the CRA determining that your business is nothing more than a principal/agent relationship.
If you would like to know more about how a lawyer can assist you through the audit process or with planning your business in general, contact a tax professional at Rosen Kirshen Tax Law today! We are here to help!
This article provides information of a general nature only. It does not provide legal advice nor can it or should it be relied upon. All tax situations are specific to their facts and will differ from the situations in this article. If you have specific legal questions you should consult a lawyer.