Paul Smith & Joanna Doolan: Could Canadian tax attack happen here?

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Canada's insurance services sector is reeling from a C$1 billion-plus (NZD$1.2b) GST bill as its tax authorities pursues unpaid tax stretching back to 2005.

That's the date of a press release issued by Canada's Revenue Authority, saying it intended changing the law to overturn a court ruling where a judge had decided that GST did not apply to certain financial transactions.

The legislation was passed in 2010 but was so poorly drafted it was only in 2012 that the insurance industry realised the changes applied to them.

Even then, it was assumed the authorities would step in and fix the problem. Not so. Critics describe the revenue authority's move to claw back GST for the past nine years as taxation by stealth, a "slow-moving train wreck" and "banana republic"-type behaviour.

Could it happen in New Zealand? Quite easily.

The tax uncertainty around the ongoing use of our tax avoidance rules is one area ripe with possibility.

And while New Zealand has a relatively simple GST regime, it's dangerous to assume it can't change.

For example businesses making assumptions around the scope of our exemption for supplying financial services could find themselves on the wrong side of the law.

Unlike Australia, financial intermediary services are generally exempt from GST in New Zealand. But there is significant danger in thinking this means the IRD will be generous with its interpretation or that New Zealand has a simple boundary around the scope of the exemption.

If you are expanding your existing business into financial services, or you're a new entrants to the financial services sector, you should not assume you will automatically qualify for an exemption from GST.

The main area of risk is in relation to "arranging" or facilitation services and payment solution services.

We are seeing an increasing number of binding rulings for exemption being declined by the IRD. We are also seeing this area under attack during the IRD's audit activity, with the tax office seeking to reassess taxpayers for GST for the past four years, with penalties and interest.

This is often experienced by businesses which traditionally make supplies that are fully subject to GST but then branch out into the financial services sector. It is almost as if the IRD is saying that unless you are a traditional financial services institution, you cannot use the exemption for GST purposes.

It is important to note the GST legislation does not restrict the exemption to traditional financial institutions such as registered banks.

The current narrowing of the GST exemption in New Zealand underlines the need for suppliers of new financial products to obtain specific advice that does not leave the business exposed to unexpected GST bills, thus eroding its already squeezed profit margins.

While the outcry about playing dirty continues in Canada, with the faint hope that the Finance Minister will realise this type of tax uncertainty is not good for the Canadian economy, New Zealand needs to take notice.

Tax uncertainty of any sort is not good for the economy. The continuing use of our ill -defined tax avoidance rules must be addressed, and the commissioner and our own beleaguered Revenue Minister need to focus on what is best for the long-term economy, rather than using the rules to squeeze out the most tax dollars in the short-term.

Paul Smith (paul.smith@nz.ey.com) is an executive director at Ernst & Young and specialises in indirect taxes. Joanna Doolan (joanna.doolan@nz.ey.com) is a senior tax partner with Ernst & Young.