The Ontario Retail Sales Tax (“RST”) will be harmonized with the federal goods and services tax (“GST”) into a “single VAT” at 13% effective July 1, 2010. The current RST is a single stage retail sales tax (imposed on all users without any recovery or credit) at an 8% rate and it applies to almost all property and services sold in Ontario, including new housing (with certain rebates and transitional tax). The new tax is a multistage, value added type tax, whereby the tax is refunded to most businesses, it is being referred to as the “OVAT” or “Single Sales Tax” or SST. This significant tax change has caused a lot of discontinuity and uncertainty. Fortunately, there have been some Transitional Rules recently issued, on June 18, 2009.
The SST will apply to all supplies of property and services, including construction contracts performed after June 30, 2010, subject to transitional rules. There are significant issues for builders such as the application of the Transitional Rules applicable to new construction. Will projects straddling the implementation be taxable? Will builders receive input tax credits (ITCs) for the 13% HST tax (single sales tax) paid on projects on which the tax is not charged on the final output?
Tax Relief for Most Businesses
The most significant impact of the OVAT or single sales tax will be to alleviate the RST burden on most businesses with operations in Ontario. The primary benefit of harmonizing the RST is that it would, effectively, “exempt” all business inputs from sales tax and, therefore, should stimulate business investment. In other words, the current RST exemptions for goods purchased for resale, manufacturing machinery and equipment, and research and development equipment will be extended to all inputs as the new single VAT will be fully creditable tax to most businesses. Similar to the GST, the credit would include tax paid on purchases of desks, computers, office supplies, real property construction contracts, etc., that were previously taxable but not creditable. The result of this 8% RST savings to the business community will be a major tax reduction in the cost of doing business in Ontario.
Disincentive for Commercial Construction
An undesirable sideswipe of this proposed change is that there could be a 15 month hiatus in major business capital expenditures in Ontario. As the effective date of this tax is July 2010, there is an incentive to delay business purchases to after that date, other than for items currently exempt from RST as noted above. For example, if a business was planning on making a $100M expansion to an existing facility, and assuming the cost of materials and rental of equipment is $60M, this would result in a current RST cost of at least $4.8M. If the construction begins after the harmonization, the 8% tax ($4.8M) would be recoverable, thereby saving the company $4.8M (the embedded RST). If this construction must begin prior to the harmonization date and would overlap the harmonization date, the business should consider planning to mitigate the full RST “cost” or investigating other opportunities with the government. Any construction contracts entered into straddling July 1 should have clauses to deal with the HST issues and ITCs.
Impact on New Home Builders - Transitional Issues
The recently released Single Sales Information Tax Notice (June 18, 2009) provides some answers to the Transitional issues, at least for new home builders. Somewhat surprisingly, new homes (including condominiums) contracted on or before June 18, 2009 will be “grandparented” (or “grandfathered”). This means that these sales will not be subjected to the 8% provincial portion of the tax where both ownership and possession of the houses are transferred after June 2010 (that is, the new tax only applies where the supply is completed after June 30, 2010). This is somewhat surprising given that the measures were announced on March 26, 2009, as past history suggests that the “grandfathering” rule would apply only for contracts entered into prior to that date. Furthermore, in a significant change from the March 26 announcement, the new housing rebate will be significantly enhanced (enriched) so that it will apply on all new homes up to $400,000 in value by providing a rebate to reduce the tax to effectively 2% on the first $400,000 in value for all homes, which is, the current estimate of the amount of the already embedded RST.
Significantly, a major concern that builders had concerning the availability of ITCs for grandfathered deals was addressed. Builders will be entitled to ITCs (subject to the restrictions applicable to all large businesses even if the home is a low rise, condominium or rental apartment complex) not subject to the new HST. Nevertheless, they will be required to pay a “transitional tax adjustment” to account for the RST tax that is already embedded in the new homes (2%) based on a sliding scale of completion. The intent of this transitional tax is to claw back at least some of the ITCs that would be taken where homes are finished after June 30, 2010 and builders took ITCs on the building materials. This is a welcome relief, as it has been anticipated, based on the earlier transitional rules for the HST in the Atlantic provinces, that builders would not be entitled to any ITCs for grandfathered homes.
Newly constructed or partially renovated homes completed in full or in part prior to July 2010 will also have RST embedded in the cost and this will be rebated where those homes are subject to the 8% provincial portion of the single sales tax. In other words, this rebate is only available where the new OVAT or Single Sales Tax of 8% will apply to the home purchase; that is, it is not applicable where the purchase and sale agreements are grandfathered. Generally, the rebate is calculated as a proportion of the estimated embedded RST in the new home, based on the degree of completion of the home as of July 1, 2010. Two methods will be offered to determine the estimated embedded RST; namely, the embedded RST is calculated as a prescribed amount per square meter of fl oor space (for example, $55/sq.m was applied in HST provinces) or 2% of the total sale price. This amount, however determined, would be applied based on the percentage of completion (similar to the transitional tax adjustment).
In the case of new condominiums, the rebate will be paid directly to the builder (apparently to compensate them for the additional lead time and uncertainty) and will be paid irrespective of the “grandfathering” status. In other words, the builder will receive the rebate directly (on the assumption it would be assigned to the builder in any event, and will receive it even if the purchase is not subject to the HST).
New Disclosure Requirement for New Builders
A significant administrative burden for housing providers is that for all new agreements entered into after June 18, 2009 (up to the transitional date of July 1, 2010) the builder is required to disclose in the agreement of purchase and sale whether the single sales tax or the OVAT portion of the tax will apply to the sale and, if so, whether the price in the agreement includes the applicable tax (net of rebate). If the transaction is subject to the single sales tax (8% OVAT portion) and a disclosure is not made, then the price is deemed to include that tax. This is a very significant development as a mistake in this regard could be quite expensive for a builder as the builder would be required to remit the tax calculated as 8/108ths of the purchase price and could not collect it from the purchaser. These Transitional Rules have been released in general form and do not yet have the specific legal wording but care will have to be taken by builders.
It will be important to make sure the clause only applies where the closing is after July 1 (but it is an open question as to what happens where the builder closes earlier or later than anticipated in the contract). Care will have to be taken in drafting the HST applicability and rebate clauses, particularly as the new housing rebate is applied differently for the SST than for the GST.