The GST/HST “drop shipment” rules apply where a non-resident of Canada who is not registered for GST/HST purchases goods in Canada or imports them to have a commercial service performed and resells or retains the goods in Canada. GST/HST is the Canadian value-added tax.

Unregistered non-resident holding goods in Canada

An unregistered non-resident typically has limited presence in Canada and does not carry on business or have a permanent establishment in Canada. They would generally retain title to a good in Canada for one of the following purposes:

(a)   to store the good prior to resale;

(b)   to use the good;

(c)    to have a commercial service performed on the good; or

(d)   to provide the good as a raw material to a person who is manufacturing another good in Canada on behalf of the non-resident under a service contract.

The drop-shipment rules override the general GST rules, which would create inappropriate tax results in those circumstances. Unfortunately, the drop-shipment rules are complicated and opaque to anyone who is not familiar with them. An unregistered non-resident who has goods in Canada in the above situations should seek professional assistance.

The drop-shipment rules apply technically where[1]:

a)     a GST registrant (usually a resident of Canasa) holds physical possession in Canada of a good owned by a non-resident[2] who is not registered for GST/HST, and

b)     the registrant transfers physical possession, at a place in Canada, to a third person or to the non-resident.

Goods sold to an unregistered purchaser

The most common application of the drop shipment rules occurs where an unregistered non-resident purchases a good in Canada for resale, generally at a price higher than the purchase price. The non-resident instructs its GST registrant supplier to drop ship the goods to the non-resident’s customer at a place in Canada.

If the Canadian customer, such as an individual consumer, is not registered for GST, the general rules would have caused non-recoverable tax to apply only on the “wholesale” price charged by the GST registrant supplier to the non-resident[3]. The general principle underlying GST is that the final non-recoverable tax applies at the retail level.

The drop shipment rules correct this problem by requiring the GST registrant supplier to collect tax from the non-resident based on the fair market value of the goods at the time physical possession is transferred to the customer; i.e., approximately the non-resident’s retail sale price[4].

For example, let’s assume that an unregistered non resident acquires a vehicle from a registered dealer in Edmonton for $20,000 and resells it to an unregistered individual in Calgary for $30,000. The dealer drop ships the vehicle directly to the individual. Although the consideration for its sale to the non-resident is $20,000, the dealer must collect tax of $1,500 (5% of the retail value of $30,000) from the non-resident. There is no tax on the sale by the non-resident to the individual[5].

The challenge here is that the GST registered supplier must be aware of these special rules. If they are not, perhaps because they make few sales to unregistered non-residents, they will collect tax under the general rules they are used to applying. The supplier may be exposed to assessment.

Goods sold to a registered purchaser

It is also common for an unregistered non-resident to acquire a good in Canada and resell it in Canada to a person who is registered for GST.  Absent the drop-shipment rules, non-recoverable tax would apply where the good is being used in the registered purchaser’s “commercial activities”, below the retail level. This would also run counter to the general principles underlying the GST.

To correct this problem, the drop-shipment rules remove tax from the purchase and resale transactions provided that the GST registered recipient provides to the GST registered supplier a “drop shipment certificate” which:

a)     states the recipient’s name and GST/HST registration number;

b)     acknowledges that the recipient is acquiring physical possession of the goods as the recipient of a supply made by a non-resident person who is not registered for GST/HST;

c)      acknowledges that, if the recipient transfers physical possession to a person specified by the non resident who does not provide a drop-shipment certificate, the recipient is required to collect tax from the non-resident based on the fair market value of the goods at that time, and

d)     acknowledges that, if the recipient uses the goods in exempt activities, the recipient will self-assess GST/HST on the value of the goods[6].

To illustrate, let’s alter the facts in the example above such that the non-resident resells the vehicle to a registered dealer in Calgary. If the Calgary dealer provides a drop-shipment certificate to the Edmonton dealer there is no tax on the transaction and the Calgary dealer, who will be reselling the vehicle to a customer on a taxable basis, assumes no liability under the drop shipment rules.

This certificate mechanism works well when all three parties are aware of it and understand its implications. Unfortunately, some registrant “consignees”, with limited or no experience with these rules, refuse to provide a drop-shipment certificate when they encounter subparagraph 179(2)(d)(iii) of the legislation. That provision begins with the phrase “the consignee acknowledges that the consignee is assuming liability to pay or remit any amount that is or may become payable or remittable by the consignee” and then refers by number to three other parts of the legislation[7] which, if one turns to them, are unintelligible to a normal businessperson, or to most lawyers and accountants in general practice.

Commercial service performed in Canada

The drop-shipment rules also apply in situations where an unregistered non-resident imports or acquires goods in Canada for the purpose of having a commercial service other than storage performed on them. The term “commercial service” is broadly defined to include any service other than shipping goods by carrier or a financial service.

To expand on the example above, let’s assume that the vehicle acquired by the unregistered non-resident for $20,000 is a vintage 1960s car.  The non-resident has agreed to sell the car on a restored basis to an unregistered individual in Calgary for $100,000. The non-resident contracts to have the restoration service performed by an auto body shop in Calgary for $60,000.

The drop-shipment rules work as follows:

1.      When the auto body shop acquires physical possession of the vehicle, it provides a drop-shipment certificate to the Edmonton dealer. The Edmonton dealer is relieved from its responsibility to collect tax from the non-resident.

2.      When the auto body shop transfers physical possession of the vehicle to the individual who purchased it from the non-resident, the auto body shop collects GST of $5,000 (5% of the fair market value of $100,000) from the non-resident. The consideration of $60,000 for the restoration service is not taxable.

If the non-resident had instead sold the vehicle to a Calgary dealer who is registered, the Calgary dealer would provide a drop-shipment certificate to the auto body shop. The auto body shop would be relieved from its responsibility to collect tax from the non-resident. The Calgary dealer would then collect GST when ot resold the vehicle.