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Issues — Children's Clothing and Footwear Exemption

If there is one issue which consistently tops the polls when RCC surveys its BC members about their priorities for PST reform — it is the provision in the Social Service Tax Act exempting from tax the purchase of children's clothing and footwear. It is appropriate, then, that this issue lead off Retail Council of Canada's submission to the Provincial Sales Tax Review.

History and Background:
The exemption for children's clothing and footwear up to specified sizes was introduced by the B.C. government in 1954 in conjunction with an increase in the sales tax rate from 3 percent to 5 percent. The rationale for the exemption was that retail sales taxes tend to be regressive and that an exemption for children's clothing and footwear would help protect lower income families.

The extension of the exemption to larger sized (adult) clothing and footwear for children under 15 years of age, and the introduction of a certification system was introduced in 1966 in response to complaints that larger children were unable to benefit from the exemption.

Under the certification system for the larger sized clothing, the customer is required to complete at the time of purchase Form FIN417, Certificate of Exemption for Clothing and Footwear, certifying that the merchandise is being purchased for a child under 15 years of age. The form requires that the customer fill in the date, the items purchased, the price, his or her address, and sign the form. It must be retained by the retailer in order to prove that an exempt sale has taken place.

As part of the audit of a retailer, Ministry of Small Business and Revenue officials may review the transactions for a period of time to determine whether the correct amount of tax has been collected. Where there is a sale of clothing or footwear for which no tax has been collected the retailer is required to provide a signed exemption form. If no form is provided, the amount due is assessed against the retailer. Further, the period of time chosen is taken as a representative sample of the transaction the retailer has carried out, and the proportion of failures to secure a signed exemption certificate is applied to the transactions for the whole audit period which is usually three years. The retailer must then pay this amount plus any applicable penalties.

In 2004, the children's clothing and footwear exemption cost the government approximately $25 million in foregone revenue, based on the tax expenditure report in Budget 2004.

Problems:
The problem is not the exemption on children's clothing and footwear per se. Where the exemption is based on the size of the clothing and footwear, it is clean, clear and simple: If the size tag identifies the garment or shoe as one that can normally be worn only by a child — it is tax-free.

The problem is restricted to those instances when adult sizes are purchased for children. The problem can be traced back to the certification system and the need to ensure the purchase is genuinely intended for a child.

This has several implications:

• Lost revenue to government
  The sheer abundance of anecdotal evidence from B.C. retailers suggests it is not uncommon for some adults to avoid payment of PST on adult-sized clothing by misrepresenting the purchase as being for a child.

  The stories are legion, with clothing retailers now almost ritually trying to outdo each other with stories of customer audacity — including the pregnant woman who, while purchasing a maternity dress, certified that the garment was for her 14 year old daughter.

  It is no more possible to quantify the loss of government revenue than it is to measure the PST system's loss of public credibility as a result of this highly visible abuse of the Social Service Tax Act.

• Costs to retailers through assessments
  In recent years, audits of retailers have resulted in significant assessments, even where the retailer has been trying in good faith to comply with the requirements of the law. Retailers that have made significant attempts to provide training and guidance to sales staff have still experienced large numbers of exempt sales not supported by certification documents. Staff turnover, the pressure to keep the line moving at the cash register, and human error all contribute to making this an onerous system to maintain.

• Staff
  The certification requirement also creates significant problems among store staff. Retailers experience a high level of staff turnover, hire many part time employees, and have employees who are not committed to retailing as a career. Under these circumstances, it is a challenge to keep all staff trained in the administration of the exemption certificate and to secure their active cooperation. Some employees also become annoyed or cynical when they see customers taking unfair advantage of the exemption. They then become lax in their administration of the requirements. Staff members also report that some customers become annoyed when they perceive another customer is cheating.

• Potential customer privacy issues and inconvenience
  B.C.'s new Personal Information and Privacy Act compels retailers to safeguard the personal information of its customers. Yet Form FIN 417, Certificate of Exemption for Clothing and Footwear, requires customers to fill out personal information on a next-on-the-list basis in an often crowded and busy environment where it is a matter of no small practical difficulty for sales staff to ensure privacy security.

  With increased awareness of and sensitivity to the provision of personal information, our members report that more customers are unwilling to fill out the form putting retailers in the awkward position of losing the sale or providing an unsupported exemption for which they are financially liable.

  Completion and verification of the certification form takes time — which can be an irritant and inconvenience to other customers who are waiting in line to make their transaction. At very busy times, a customer may leave before a retailer realizes the form is not properly filled out.

• Retailers: tax police with no badge
  The retailer is required to police the system and ensure that only those persons entitled to an exemption receive it. However the retailer has no power to carry out this responsibility. If a customer indicates that the purchase is for a child under the age of 15, the retailer has no authority to challenge the claim, even if he or she is quite sure that is not the case. Moreover, many retailers' health and safety policies would preclude any challenge of a customer — particularly when many front-line retail staff members are young people.

  If a customer refuses to complete FIN417, completes it inadequately, refuses to sign it, or signs it with a false name, again the retailer has no authority to secure compliance.

Recommendations:

• Eliminate the children's exemption for adult-sized clothing and the need for a certification system.

  The solution need only involve families with children in the 12 - 14 age group; those most likely to have children of sufficient size to possibly require adult clothing and footwear.

• Establish a family tax credit for each child aged 12 to 14 through whatever vehicle government deems appropriate to achieve its larger policy objectives. (For example, eligibility for the tax credit could also be income-based.)

  In weighing whether implementation of this recommendation is revenue neutral, government needs to consider the additional revenue that would be derived from plugging the revenue leakage occurring through customer abuse of the current exemption.