'Accidental' GST legislation set to grab extra $1 billion from insurers

OTTAWA – Canada’s insurance industry faces a $1-billion GST bill at the end of this month, thanks to a federal tax move critics say smacks of a “banana republic.”

The massive tax hit applies to some financial services that insurers say were never before subject to GST.

The GST now owed is retroactive seven years, back to 2005, when the federal Finance Department issued a news release saying it planned to amend tax legislation — something it didn’t get around to implementing until 2010.

Critics say that apart from the body blow to the books of domestic insurers, the “massively distortive” tax grab sends a signal to global investors that Canada is no place to do business. That message, they say, challenges any claim the Harper government is a tax-cutter and a good steward of the economy.

“I have lost count of the number of times that global tax directors have used the words ‘banana republic’ when I describe this legislation to them,” says Michael Firth, a tax partner at PricewaterhouseCoopers Canada, and chief among the critics.

“They don’t believe it. They go, ‘You’re kidding me? Can they really do this?'”

For its part, the Finance Department says it hasn’t changed GST legislation at all, but rather clarified rules that were poorly drafted when the GST was born in 1991.

The slow-motion train wreck began with an obscure Tax Court of Canada ruling in 2003, in which the judge sided with insurer State Farm against the Canada Revenue Agency.

The company successfully argued the GST does not apply to certain common financial transactions, and therefore it owed no money to the taxman.

The Finance Department issued a statement and background document on Nov. 17, 2005, saying it planned to amend GST legislation to effectively overturn the judge’s ruling, warning the amendments would be retroactive to the date of the release.

Controversial draft legislation appeared Jan. 26, 2007, and the measure was finally passed in an omnibus budget bill in 2010, whacking certain kinds of financial services with GST retroactively.

The amendments, however, have sown as much confusion as the original law, at least as it applies to the arcane world of insurance financing.

Only last year did the industry wake up to the reality that the revamped GST rules left them exposed to as much as $1 billion in back taxes.

“In discussions I have had with affected insurers, most only became aware of the issue in 2012,” Denis Brown of MSA Research Inc. wrote in an industry newsletter this April.

“Like me, many did not take it seriously until December of 2012, always assuming that wiser heads at Revenue and Finance would intervene and fix the problem.”

Insurance companies caught by the new rules must pay their now-higher GST bills for 2012 by June 30, and face having their filings for the previous six years retroactively revised upward.

The rules directly affect companies who have cross-border transactions with related firms for reinsurance, a term for the method by which insurance risk is spread around by insuring the insurers.

Calculating just how much extra GST is owed has been likened to counting moonbeams, with no consensus on precisely what gets counted as taxable or how. The original 2005 release and backgrounder from Finance Canada did not mention reinsurance at all; only in 2011 did the Canada Revenue Agency indicate that some reinsurance transactions could be caught by the new rules.

Joel Baker, president and CEO of MSA Research Inc., which closely monitors the property, life and health insurance industries, has estimated the additional GST bill for 2012 alone could be up to $200 million, or more than $1 billion in total once retroactivity to November 2005 is counted.

Baker notes not all insurers will be affected, and that the impact on premiums for customers is unclear.

The beneficiary of all that tax money is the federal treasury, as well as provincial treasuries where the GST has been harmonized with provincial sales tax. Many insurance firms are based in Ontario where the so-called HST or harmonized sales tax is 13 per cent.

“The unduly expansive and retroactive application of this initiative based upon a 2005 news release, creates an unreasonable and unmanageable retroactive liability that is incompatible with the commercial certainty that should be inherent in tax policy,” Frank Swedlove, president of the Canadian Life and Health Insurance Association Inc., complained to Finance Canada in a letter last August.

Finance Canada, meanwhile, insists it has not changed any GST rules.

The GST amendments “were introduced in response to court decisions that extended tax relief beyond what was intended under the GST/HST,” spokeswoman Stephanie Rubec said in an email. “The amendments did not change tax policy in this area.”

The insurance industry is clinging to the faint hope Finance Minister Jim Flaherty will cede ground before June 30. In the meantime, industry accountants are busily completing 2012 GST forms for the end of June.

Finance Canada created a small internal group last year charged with reviewing how GST impacts the financial sector, which is generally exempt from the value-added tax. But the result of the exercise, which is examining tax regimes in other countries, is at least a year away.

Firth says Canada’s tightening of the screws on the financial sector is the polar opposite of the policy of the European Union, whose countries also have value-added taxes like the GST. In Europe, policy-makers do not want their financial sector tax-hobbled, unable to complete with global financial leviathans.

But in this country, he said, federal politicians are acutely aware that big financial institutions have little sympathy among ordinary Canadians.

“The government seems to be confident that if you extinguish the rights of financial institutions, it is an unattended funeral,” Firth said.