On September 30th, after extensive discussions on the issue, Prime Minister Stephen Harper and Premier Jean Charest finally announced the conclusion of a Memorandum of Agreement (MOA) on the harmonization of the QST with the federal GST. The MOA deals with two essential issues: 1) harmonization of the tax base and rules applicable to both the QST and GST, and 2) the payment of sums totalling $2.2 billion to Quebec to compensate the province for the costs of implementing the harmonization measures. It is to be recalled that British Columbia and Ontario have, respectively, collected $1.6 billion and $4.3 billion as compensation for harmonizing their provincial sales taxes into a Harmonized Sales Tax (HST), (though British Columbia will likely have to pay this amount back to the Federal Government if it "deharmonizes" as it has proposed following a provincial referendum). From a political perspective, Quebec could make the case that the compensation has come, at least in part, more than 20 years late, since the QST which Quebec implemented on July 1, 1992, was a value-added tax regime that was already substantially harmonized with the GST, which had been introduced only 18 months earlier.
On the flip side of the coin, however, disparities always existed between the Act respecting the Québec sales tax and the federal Excise Tax Act in relation to the GST/HST. As a result, negotiations between Quebec and the federal government were necessary to reach agreement on how to harmonize the relevant tax rules and eliminate the Quebec disparities that the federal government saw as "irritants".
Contrary to what some have asserted, under the MOA, Quebec will retain its separate legislation and Quebec will not become a "participating province", which means that HST will not apply in Quebec as it does in Ontario and (for the moment) in British Columbia. The MOA also contemplates that Quebec will retain its administration of the GST/HST and the QST in the province. As a result, taxpayers who are registered for the QST (including those established outside Quebec) will continue to have to prepare separate QST returns and will remain subject to tax audits by Revenue Québec officials. Quebec has agreed to implement the Amended QST by January 1, 2013.
For the average consumer, the harmonization that has been announced will change almost nothing from an economic point of view. By contrast, the impact on businesses could be quite significant in certain circumstances, especially for financial institutions. Pension plans will also be adversely affected.
In what follows, we take a closer look at the main elements of the MOA as well as the resulting impact on the relevant taxpayers.
Quebec has agreed to eliminate the GST from the tax base of the QST. In practice, this will mean that the QST will no longer apply on an amount that includes the GST. To offset the resulting loss in revenue, however, the QST, which was in any event scheduled to rise to 9.5% next January, will ultimately increase to 9.975% in January of 2013. The effect on the consumer will be the same as before, but invoicing will have to be adjusted to take account of the change.
Place of Supply Rules
The Act respecting the Québec sales tax will need to mirror the rules relating to place of supply that are applicable under the HST regime. In essence, the QST should not be applicable at the same time as the HST. Similarly, if the supply is in Quebec, only GST should apply, in addition to the QST. In this context, it is to be recalled that Quebec had already begun a process of harmonizing these rules. Quebec businesses will certainly look favourably on this development, since it will result in simplified invoicing.
The tax treatment of financial services under the QST will be harmonized with the GST treatment. In short, financial services will become exempt from the QST rather than zero-rated. This will have a major impact for many financial institutions, since they will lose their right to receive input tax refunds (ITRs) for QST paid on their inputs relating to the supply of exempt financial services. In addition, it is to be noted that the compensatory tax that had been adopted to partly compensate for the QST refunds that these institutions were receiving not only will not be abolished immediately but a temporary increase in that tax may remain in place until March 2014. Accordingly, financial institutions could end up, bearing the brunt of the harmonization. Lobbying efforts to obtain the simultaneous abolition of the compensatory tax can be anticipated.
As to what planning steps might be considered, financial institutions could consider accelerating certain purchases as well as determining whether they should terminate certain leases and convert them to purchases. Lastly, certain intra-group elections should be re-examined in detail by tax professionals specializing in consumption taxes.
Restricted ITRs for Large Businesses to be Eliminated
The MOA contains at least one good piece of news for large businesses. Quebec has agreed to eliminate its policy relating to the restriction of ITRs for large businesses, however, the phase-out may take up to eight years! Although the delay of eight years may seem surprising, it should be observed in fairness that in 2010 Ontario and British Columbia adopted similar transitional rules in relation to the HST, and it would, therefore, have been surprising if the federal government had asked Quebec to immediately abolish its ITR restrictions for the QST.
As of April 1, 2013, the governments of Canada and Quebec mutually undertake to pay GST/HST and QST on government purchases. This measure will simplify the tax compliance process for businesses.
Selected Listed Financial Institutions
In relation to GST/HST, suppliers of financial services are not entitled to recover the GST/HST on their inputs from supplying exempt financial services. In this connection, certain suppliers of financial services that are considered to be selected listed financial institutions (SLFIs) must make an adjustment to the net tax using a Special Attribution Method (SAM). The adjustment is necessary to prevent suppliers of financial services which are SLFIs from selecting their own suppliers of services in a province or territory not covered by the HST with the objective of minimizing the economic impact of the tax.
It is expected that Quebec will harmonize its legislation relating to SLFIs. As well, the MOA provides that the GST/HST applicable to SLFIs, as well as financial institutions that would be SLFIs if Quebec were an HST-participating province (Specified Financial Institutions - SFIs), will be collected and administered by the Canada Revenue Agency. Lastly, the Amended QST applicable to SLFIs and SFIs will also be collected and administered by the CRA.
At present, a pension plan trust is generally authorized to claim a rebate of 33% of amounts of GST/HST actually, or deemed to have been, invoiced to the plan, whether by the employer or by third parties (the trust cannot claim input tax credits because it makes only exempt supplies). In Quebec, since financial services were zero-rated for the purposes of the QST, pension fund trusts were generally eligible for a refund of 100% of the QST. Although the MOA remains silent on the subject, it is expected that Quebec will harmonize the regime applicable to pension plans. It remains to be seen whether the reimbursement will be 33% or a different rate (the MOA specifies that the tax base for the Amended QST can diverge to a certain degree from the base for the GST/HST). An increase in employer contributions is foreseeable to take account of the non-recoverable QST and the additional costs this will entail for pension plans.
QST Rebates for Public Service Bodies
At present, municipalities do not have the right to claim any rebate for QST that is not recoverable as an ITR (since the rebate rate is set at 0%). Under a tax and financial partnership agreement signed in 2006 between Quebec and its municipalities, however, Quebec agreed to reimburse municipalities for the amount of QST paid on their purchases of goods and services. The rate of reimbursement is scheduled to reach 100% in 2014 (which is the same rate as for the GST). In this connection, to take account of the 2006 agreement, the MOA stipulates that Quebec will adopt the administrative, structural and definitional parameters that apply to GST rebates for municipalities, effective January 1, 2014.
For other public service bodies, the MOA is somewhat cryptic and stipulates only that Quebec can set the rebate rates applicable to the QST for universities, schools, colleges, hospitals, charitable organizations and qualifying non-profit organizations, subject to matching the administrative, structural and definitional parameters for the GST/HST relating to such rebates.
As mentioned above, Quebec has committed to working toward implementation of the Amended QST by January 1, 2013. This leaves very little time for businesses to adapt to the new measures to be implemented in the coming months. Accordingly, businesses should immediately begin to ask themselves what potential effects the proposed changes may have on their operations.