The sales tax treatment of third-party product commissions for auto dealers

Automotive dealerships have a wide array of activities that generate revenue streams, including sales of automobiles, parts, repair services, and commissions related to their sales of warranties, third-party protection products, insurance, and arranging for leases and financing.

The sales tax treatment for each of the revenue streams varies based on each particular fact pattern, creating challenges for dealerships to administer the collection of the appropriate taxes. Dealerships with both taxable and exempt revenue streams bear the responsibility of determining whether they are entitled to claim input tax credits to recover tax paid on their purchases and overhead costs based on several factors.

Third-party financing businesses pay a commission, often called a dealer reserve, to dealers in exchange for them facilitating the granting of a lease or loan to a dealership's customer.

A dealership is required to collect GST/HST where the commission relates to a lease. If the commission relates to a loan or conditional sale agreement, the CRA's published view has been that the GST/HST status of the commission depends on the level of the dealer's involvement in arranging for that financing. If the dealer's role is viewed as one of only preparing the loan application and providing information to the applicant, those particular activities on their own are considered to be preparatory and administrative in nature, which are excluded from the definition of financial service and therefore taxable.

The courts¹, however, have been supportive of the position that the end goal of those activities and the predominant element of the service in those cases was to arrange for that financing, which is an exempt financial service. While acknowledging that the determination of whether a supply is an exempt financial service or a taxable administrative or preparatory service should be considered on a case-by-case basis, recent court decisions lend support for dealers treating their commission for arranging loans as exempt from GST/HST.

In Applewood Holdings Inc.², the court ruled that an automotive dealership's role in the sale of third-party insurance to a customer was a service of arranging for the insurance, and therefore an exempt financial service. It provided some certainty to dealerships with the same arrangements that they could rely on this decision to treat their insurance revenues as exempt from tax.

While these decisions determining particular revenues to be exempt may be viewed by many as a win, entitlement to input tax credits for dealers may be restricted to the extent they relate to the provision of certain exempt financial services—particularly if the dealer is deemed to be a financial institution for GST/HST purposes by virtue of its exempt activities. For added complexity, input tax credits may be available in certain cases where the input relates to making supplies of financial services that relate to commercial activities of the dealer.

Even though automotive dealers may not be required to collect GST/HST on certain exempt commission revenue streams, they should examine their processes for claiming input tax credits to ensure eligibility. Where an allocation is required, a model that clearly sets out the basis for the allocation should be documented and readily available in the event of a CRA audit.

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Our national indirect tax team focuses on assisting automotive dealers navigate the complexities of an innovative and evolving industry. Please contact us to discuss whether these issues affect your dealership, or how we can help your business.