New HST on the home front

The Budget Announcement

On March 26, 2009, Ontario Finance Minister, Dwight Duncan, (the “Minister”) proposed in the province’s 2009 Budget that, starting July 1, 2010, Ontario adopt the harmonized sales tax (“HST”). The HST rate in Ontario will be 13%, which includes an 8% provincial portion (the same rate as the current retail sales tax (“RST”) combined with the federal goods and services Tax (“GST”) of 5%.

The HST will apply to new homes at 13%. Currently, RST applies to building supplies used in the construction of new homes but no RST is collectable on the final sale price. Accordingly, RST is embedded within the price of a new home sold in Ontario. Citing a Canada Mortgage and Housing Corporation study, the Minister estimates that this embedded RST ranges from about 2 to 3% percent, on average, on the final sale of a new house in Ontario.

To avoid imposing an additional tax burden on new homes under $400,000, homeowners purchasing a new primary residence will be able to claim a rebate of part of the provincial portion of the HST. The rebate will be 75% of the provincial portion of the tax for homes priced under $400,000. The rebate is reduced for homes priced between $400,000 and $500,000 and eliminated entirely for more costly properties. Where a full rebate is available, the provincial portion of the HST will be effectively reduced from 8% to 2%.

Implementation Guidance

The Budget provided only a brief overview of the tax. Details as to transitional and other technical rules will be released at a later date. This publication will describe our views of what builders can expect those rules to be, based on the rules implemented when New Brunswick, Nova Scotia and Newfoundland and Labrador harmonized their provincial sales taxes with the GST. We caution that the legislation put in place for Ontario will likely differ, to some degree, from these provisions and must be considered upon release.

As with each of the GST rate changes, the implementation process will involve a series of dates. Agreements entered into before a predetermined date will be treated differently than those after that date. When the rate of GST was reduced, the date used was the date of the budget announcement. We can therefore expect that agreements entered into prior to March 26, 2009 will be subject to transitional provisions. Unlike the rate changes, however, no transitional rules were available on March 26. In the Maritime Provinces, the transitional rules provided for an “announcement day” which was the day on which the federal Department of Finance released a Technical Paper outlining the transitional rules. We expect that a similar process will be followed in Ontario. Those provisions will affect not only the tax to be collected on the sale of the property but also the ability to claim input tax credits (“ITCs”) with respect to the provincial portion of the HST paid on construction costs and an ability to recover the embedded RST in a project by way of a rebate.

The Maritime Provinces announced harmonization on April 23, 1996 with implementation on April 1, 1997. The detailed transitional rules were released on October 23, 1996. We can therefore expect that rules for Ontario will be released in the fall of 2009 and on that release, Ontario’s “Announcement Day” will be determined. However, it is possible for Ontario purposes that “Announcement Day” may be the date of the budget, March 26, 2009. We expect, therefore, that agreements entered into prior to March 26, 2009 will be subject to transitional rules and likely those entered into subsequent to that date but prior to an as yet undetermined Announcement Day will also be subject to those rules.

Anticipated Implementation Process – Sales of New Homes

The following is an outline of what we expect the implementation rules to be with respect to sales of new homes, residential condominium units and residential condominium complexes:

1. Sales Agreements entered into on or before Announcement Day

(a) Ownership and possession transferred before July 1, 2010

• Builders will collect only GST, HST will not apply
• Builders will not be entitled to claim ITCs with respect to the provincial portion of the HST paid (if any),
• No rebate will be claimable with respect to embedded RST

(b) Ownership and possession transferred on or after July 1, 2010

• Builders will collect only GST, HST will not apply (even on payments made after July 1, 2010)
• Builders will not be entitled to claim ITCs with respect to the provincial portion of the HST paid
• No rebate will be claimable with respect to embedded RST

2. Sales Agreements entered into after the Announcement Day but before July 1, 2010

(a) Ownership and possession transferred before July 1, 2010

• Builders will collect only GST, HST will not apply
• Builders will not be entitled to claim ITCs with respect to the provincial portion of the HST paid (if any)
• No rebate will be claimable with respect to embedded RST

(b) Ownership and possession transferred on or after July 1, 2010

• Builders will collect HST on entire sale price, even where payments made prior to July 1, 2010. There may be a requirement to pre-collect the HST on payments made after a particular date
• Builders will be entitled to claim ITCs for the entire amount of HST paid
• A transitional rebate will be available with respect to RST paid on construction materials

Construction Costs – Labour and Materials

In addition to knowing what amount of tax will be charged on sales, to properly plan builders must be aware of what taxes they can expect to pay on their purchases of goods and services in the course of construction.

Where ownership and possession of goods such as construction materials are transferred prior to July 1, 2010, RST, but not HST, will apply. Where goods are transferred on or after July 1, 2010, HST will apply. Where an invoice is received or a payment made prior to the Announcement Date, HST will not be payable on the goods (but they may be subject to RST) even where delivery occurs after July 1, 2010. However, where the prepayment occurs after the Announcement Date for delivery of goods after July 1, 2010, HST will apply. The supplier may be required to account for and remit the HST for prepayments occurring after a particular date – in the Maritimes this date was two months prior to the effective date of the HST.

HST will apply to payments for services, such as subcontracted trades and other labour (but not amounts paid to employees) where the payment becomes due on or after July 1, 2010. There is likely to be a grace period, such that if all or substantially all of the work is performed prior to July 1, 2010 and the invoice is rendered prior to the end of that grace period, HST will not apply. In the Maritimes, a one-month grace period was allowed. Payments becoming due after the grace period will be subject to HST regardless of when the work was completed (with very limited exceptions for certain trustee, legal and similar services).

As set out above, the ability to recover the HST paid by way of ITC will depend upon the date of the Sales Agreement. In addition to the transitional limitations on ITCs related to the construction of homes, businesses with annual sales in excess of $10 million will be subject to ITC restrictions for the first five years of harmonization. The restrictions will then be phased out over the following three years, after which affected businesses will be able to claim full ITCs. Those businesses will not be able to claim ITCs on energy, certain telecommunications services, road vehicles weighing less than 3,000 kilograms (and parts, fuel and certain services associated with those vehicles) and food, beverages and entertainment.

Transitional Rebate of Embedded RST

Although not specified in the budget, it is likely that a transitional rebate for new homes will be announced that will allow builders to claim an amount to compensate for the RST embedded in the cost of the new home. Without such a rebate, new homebuyers would be subject to double taxation where the builder paid RST on the purchase of building materials and is also required to collect the HST on the sale. A simple solution for this would be to provide a rebate to builders equal to the actual amount of RST paid on materials used in such homes. However, to streamline administration, it is likely that the rebate will be calculated using a standardized amount.

For the purpose of transitional rebates, the Maritime Provinces based their estimates of their provincial sales taxes embedded in new homes on the size of the dwelling and set those amounts at $50 per square metre in Nova Scotia and New Brunswick and $55 per square metre in Newfoundland. The amount of the rebate was determined based on the degree of completion of the residence on the effective date of the HST as set out in the following chart:

To view table click here.

For example, the builder of a home in Nova Scotia that was 40% complete on April 1, 1997 where the HST would apply on the final price was entitled to claim a rebate of 50% of the estimated Nova Scotia retail sales tax content. The rebate would be $25 per square metre.

In Ontario, the Minister estimates the RST embedded in a new home ranges from about two to three percent, on average, of the final sale price. It can be expected that the amount of any rebate will be based on similar statistics applied in a manner similar to that used in the Maritimes.

New Housing Rebate

Ontario will offer a rebate to new home purchasers intended to offset the increased tax on new homes. For homes under $400,000 the rebate will be ¾ of the provincial portion of the HST, reducing the rate of tax from 8% to 2%. The amount of the rebate will be reduced for homes between $400,000 and $500,000 and completely eliminated for homes in excess of $500,000.

Of the Maritime Provinces, only Nova Scotia offers a rebate to new home purchasers, but it is only available to first-time homebuyers and the amount is considerably lower than the proposed Ontario rebate. Accordingly, we cannot expect the provisions in the GST legislation relating to Nova Scotia’s rebate will apply for Ontario.

We expect that eligible new homebuyers will be able to assign the rebate to the builder. Builders will then be able to offer a stated price net of rebate, as is presently done under the GST. However, as neither the budget nor the Memorandum of Agreement between Ontario and Canada provide explicitly for this, builders should use caution when entering into agreements that contemplate such an assignment prior to the release of further information. Where a rebate has been assigned, the amount so assigned will be considered part of the value of the consideration payable for the home, so the complex circular calculation presently required to determine the relevant amounts will now become more complicated. We expect the release of a GST/HST Memorandum providing detailed formulae and charts that will assist in this determination. The following table sets forth a series of examples of what may be expected:

To view table click here.

In addition to the GST rebate offered to purchasers of owner occupied homes, an equivalent rebate is also available to owners of new rental accommodations. Nova Scotia does not provide a rebate of the HST to landlords in that province. As there is no mention of such a rebate in the Ontario Budget, we expect Ontario will restrict its rebate to owner-occupied homes.

Potential Problem Areas

At this time, entering into an agreement with respect to the supply of a newly constructed home where ownership and possession of the property is expected to pass to the purchaser in spring or summer of 2010 may result in unanticipated consequences. The following is a list of some potential issues:

1. Until the transitional rules are announced, it will not be clear whether agreements entered into prior to such announcement (including those entered into prior to the date of the budget) will be subject to HST if ownership and possession are transferred after July 1, 2010.

2. If transitional rules apply to eliminate HST on homes transferred after July 1, 2010 where the agreement is entered into prior to a particular date, and a substantial amount of the work is done after July 1, 2010, the builder will not be able to recover HST paid with respect to costs incurred after July 1, 2010. Although builders will have taken into consideration in their selling price the cost of the embedded RST on materials, the additional provincial HST on labour could result in significant potentially unanticipated costs.

3. Where an agreement is entered into after the Announcement Day (therefore likely not protected by transitional rules), anticipating a transfer of ownership and possession prior to July 1, 2010, but delays cause the actual transfer to occur after July 1, 2010, the HST will apply to the selling price rather than just GST. Where the agreement provides for a tax-inclusive net of rebate price, the actual amount the builder will receive will change depending upon that date. For example, where a home is sold at a stated price net of rebate of $300,000, where only GST applies, the net consideration that the builder will receive is $290,698. Under HST, it is anticipated that the net consideration will be $285,171, a difference of $5,527. If the transitional rules provide for a rebate of embedded RST, the builder may be able to recover some or all of that difference through that rebate. In entering into agreements, builders must take this into consideration if offering net pricing.

4. If transitional rules apply to exempt the transaction from application of the HST, but the deal is altered significantly such that the agreement is determined to have been cancelled, the transaction may become subject to HST.

A Final Note

At the present time, it is difficult to predict exactly what costs and benefits can be expected for builders of new homes where ownership and possession of those homes is expected to occur in spring and summer of 2010. Not only do we not know what transitional provisions will apply, we cannot even say with total certainty that Ontario will harmonize its sales tax with the federal GST (although it appears very likely). Until more details are available, builders should approach any agreement where completion is not expected to occur until spring of 2010 or later with caution.