Harmonization of Sales Taxes of Prince Edward Island and De-Harmonization of Sales Taxes of British Columbia Audit

Final Report
November 2014


Table of Contents


Executive summary

Background:

The provinces of New Brunswick, Nova Scotia, Newfoundland and Labrador, Ontario and Prince Edward Island, referred to as the participating provinces, harmonized their provincial sales tax with the Goods and Services Tax (GST) to create the Harmonized Sales Tax (HST). The Canada Revenue Agency (CRA) assesses and collects the sales tax for the participating provinces and supplies the Department of Finance (DOF) with information that is used to allocate distributions to these provinces.

The GST and HST assessed from all provinces (as applicable) are combined into one revenue pool. The revenue pool in conjunction with the straddle allocation formula is used to allocate federal and provincial shares of revenues from the assessment of GST and HST. The straddle allocation formula is applied to allocate the revenue pool amongst periods of time that straddle the calendar year, periods when tax rates for GST/HST change, or when additional provinces harmonize or de-harmonize their sales taxes. Remittances to the CRA are processed through existing GST and Revenue Ledger (RL) systems.

The province of Prince Edward Island (PEI) adopted the HST framework on April 1, 2013. The new HST has a combined rate of 14% for PEI, representing the provincial portion of nine per cent and the federal portion of five per cent. With the implementation of HST, registrants in PEI became responsible to collect and remit this tax at the new rate. Between July 1, 2010 and March 31, 2013, British Columbia (BC) was a participating province with the HST rate of 12%. Effective April 1, 2013, BC opted out of the HST framework.

The remittances by registrants in PEI straddled April 1, 2013 (HST implementation date) and their total remittance would effectively include both 5% GST collected prior to March 31, 2013 and 14% HST from April 1, 2013.

Whereas, the remittances by registrants in BC straddled to include 12% HST collected prior to March 31, 2013 and 5% GST from April 1, 2013.

As a result of these changes, Finance and Administration Branch (FAB) requested an independent assurance that the required system and process changes were implemented effectively (i.e. meeting prescribed FAB requirements). Additionally, the Office of the Auditor General (OAG) relied on Internal Audit Division’s work in carrying out their financial statement audit of the CRA for the year ending March 31, 2014. 

Objective:

The objective of the audit was to provide assurance with respect to the accuracy and completeness of the automated flow through of HST information, and that the straddle allocation formula is functioning as intended.

The examination phase took place between May and June 2014 and was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing.

Conclusion:

The enhancements relating to the new accounts created for PEI were considered to be appropriate and mapped to the correct RL accounts. The flow through of data transmitted from the source documents to the RL systems was complete. The straddle allocation formula was applied correctly with respect to the allocation of GST/HST remittances for BC and PEI and the amounts posted to the RL were accurate. The sample analysis of BC audit reassessments did not identify any concerns with BC GST cut-off as of March 31st, 2013. The Average Effective Tax Rates provided by the DOF were properly reflected in the RL to calculate the subsequent Revenue Pool to allocate federal and provincial shares of revenues post April 1, 2013.

Introduction

The provinces of New Brunswick, Nova Scotia, Newfoundland and Labrador, Ontario and Prince Edward Island, referred to as the participating provinces, harmonized their provincial sales tax with the Goods and Services Tax (GST) to create the Harmonized Sales Tax (HST). The Canada Revenue Agency (CRA) assesses and collects the sales tax for the participating provinces and supplies the Department of Finance (DOF) with information that is used to allocate distributions to these provinces. The DOF is responsible for forecasting provincial sales tax payable to the participating provinces for each taxation year (calendar year), and ensures that appropriate installment payments are made.

The GST and HST assessed from all provinces (as applicable) are combined into one revenue pool. The revenue pool in conjunction with the straddle allocation formula is used to allocate federal and provincial shares of revenues from the assessment of GST and HST. The straddle allocation formula is applied to allocate the revenue pool amongst periods of time that straddle the calendar year, periods when tax rates for GST/HST change, or when additional provinces harmonize or de-harmonize their sales taxes.

The province of Prince Edward Island (PEI) adopted the HST framework on April 1, 2013, replacing the previous Provincial Sales Tax and the GST in the province. The new HST has a combined rate of 14% for PEI, representing the provincial portion of 9% and the federal portion of 5%. With the implementation of HST, registrants in PEI became responsible to collect and remit this tax at the new rate. Remittances to the CRA are processed through existing GST and Revenue Ledger (RL) systems.

Between July 1, 2010 and March 31, 2013, British Columbia (BC) was a participating province with the HST rate of 12% representing the provincial portion of 7% and the federal portion of 5%. Effective April 1, 2013, BC opted out of the HST framework.

The remittances by registrants in PEI straddled April 1, 2013 (HST implementation date) and their total remittance would effectively include both 5% GST collected prior to March 31, 2013 and 14% HST from April 1, 2013.

Whereas, the remittances by registrants in BC straddled to include 12% HST collected prior to March 31, 2013 and 5% GST from April 1, 2013.

As a result of these changes, Finance and Administration Branch (FAB) requested an independent assurance that the required system and process changes were implemented effectively (i.e. meeting prescribed FAB requirements). Additionally, the Office of the Auditor General (OAG) relied on Internal Audit’s (IA) work in carrying out their financial statement audit of the CRA for the year ending March 31, 2014. 

The CRA did not significantly change the systems and processes used to receive HST as enhancements were implemented when HST was initially implemented. Required changes to the systems and process have been implemented in order to facilitate the orderly flow-through of GST/HST information. 

Focus of the audit

The objective of the audit was to provide assurance with respect to the accuracy and completeness of the automated flow through of HST information, and that the straddle allocation formula is functioning as intended.

The examination phase took place between May and June 2014 and was conducted in accordance with the International Standards for the Professional Practice of Internal Auditing.

Findings

1. Effectiveness of system processes as they relate to the accuracy and completeness of HST related data posted in Revenue Ledger (RL) for PEI

Mapping of new accounts:

IA reviewed the mapping of new accounts created for the inclusion of PEI. To test-check the transaction flow to the newly mapped accounts, IA selected a random sample of 35 PEI-HST returns from the transaction data download from RL that affected the new PEI accounts. The samples data included amounts in line 105 posted for HST reported, in line 108 posted for Input Tax Credits (ITC’s) claimed by the registrant, and in line 109 posted for a clearing account (either net tax owing or refund payable).

For these sample returns, IA extracted the data from GST/HST Return and Adjustment Processing System (GHRAPS) and verified their posting to Standardized Accounting (SA) as well as to the relevant RL accounts. IA reviewed each transaction to determine whether key line items (lines 105, 108 and 109 from HST returns) were properly mapped and posted to the new RL accounts. All the samples were mapped properly to the RL accounts relating to amounts posted in SA and RL. No exception was noted.

Based on our sample review of the applicable changes, the enhancements relating to the new accounts created for PEI were considered to be appropriate.

Completeness and Accuracy of posting of transactions:

IA selected a sample of 30 HST returns’ information for PEI (as agreed upon with the OAG and FAB), processed after its integration into the HST framework. The key line data items gathered from these sample returns, source documents and electronic filings, were compared to the assessed tax, credit and payment or refund amounts in GHRAPS. IA also traced and verified that the HST returns’ information was posted to the proper registrants’ accounts in SA. Thereafter, the flow of data was verified from GHRAPS to the RL system for accurate and complete posting of all key line items.

The sample review confirmed that the flow through of data transmitted from the source documents to SA and posting of amounts to RL systems was accurate and complete.

2. Effectiveness of the Straddle Allocation Formula as it relates to the accuracy of FAB revenue allocation and reporting

Accurate use of the Straddle Allocation Formula:

The harmonization of PEI to HST and BC opting out of the HST framework would have required the use of the straddle allocation formula, which attempts to determine the correct entries to the RL for the periods both before and after the straddle date (March 31, 2013). The formula uses the Average Effective Tax Rate (AETR) from each period to weight the division, and ensure that the participating provinces in each period receive their appropriate share.

IA selected a sample of 10 returns each from both PEI and BC (as agreed upon in conjunction with the OAG and FAB), whose filing period overlapped the straddle date. Both the GST (Line 105) and ITC’s (Line 108) were reviewed as they were posted separately to the RL and have the straddle calculation applied independently. Items were posted to the RL in group entries with similar returns so the line items were traced to their group. The straddle formula was recalculated for each group and compared to the amounts posted to the RL.

Based on our sample, the straddle allocation formula was applied correctly with respect to the allocation of GST/HST remittances for BC and PEI and the amounts posted to the RL were accurate.

Post De-Harmonization Compliance:

The decision by BC to opt out of the HST framework required BC registrants to file returns using the 5% GST rate as of April 1, 2013. This created the potential for registrants to over claim ITC’s from their expenses or over collect GST from customers by the continued use of the 12% HST rate. Compliance Programs Branch (CPB) has noted no concerns regarding the BC registrant’s compliance to the new rates after the cut-off of March 31, 2013. To examine registrant compliance to the new rates, IA reviewed a sample of returns that had already been reassessed by CPB.

The purpose of the test was to obtain a comfort level that the correct GST/HST rate is being used. The population of BC GST returns that had been audited and reassessed post de-harmonization was obtained by IA. No change reassessments were removed from the population. IA then selected a stratified sample of 70 returns (as agreed upon with the OAG and FAB) to review whether the reassessments were due to the registrant not adjusting to the new GST rate for Input Tax Credits claimed.

IA was informed that the CPB risk assessment model was adjusted to reflect BC opting out of HST. This strengthens the probability that the BC credit returns selected for review were of the highest risk GST credit returns filed. From our sample, there were only 2 returns noted where the incorrect GST rate was used. The rate and amount of the reassessments were small and they were detected by the CPB auditors through the normal review process.

The outcome of the analysis of the sample of 70 BC reassessments supports CPB’s statement that there are no concerns with BC GST cut-off as of March 31, 2013.

3. AETR calculated by the DOF, was properly reflected in the calculation of the subsequent Revenue Pool post April 1, 2013

IA was provided with the copy of 2013 AETR received from the Department of Finance. The rates posted in the RL for the PEI and BC provinces were compared to the AETR. IA also obtained and reviewed related documentation from RL-Business division for the implementation of proper AETR in RL. The AETRs posted in RL that are being used for HST Revenue Pool calculations as of April 1, 2013, were verified.

The AETRs provided by the DOF appears properly reflected in the RL which are used to calculate the subsequent Revenue Pool to allocate federal and provincial shares post April 1, 2013.

Conclusion

The enhancements relating to the new accounts created for PEI were considered to be appropriate and mapped to the correct RL accounts. The flow through of data transmitted from the source documents to SA and posting of amounts to RL systems was complete.

The straddle allocation formula was applied correctly with respect to the allocation of GST/HST remittances for BC and PEI and the amounts posted to the RL were accurate. The BC audit reassessments support that there are no concerns with BC GST cut-off as of March 31, 2013. The AETRs provided by the DOF were properly reflected in the RL to calculate the subsequent Revenue Pool to allocate federal and provincial shares of revenues post April 1, 2013.

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