On March 26, 2009, the Ontario Minister of Finance, the Honourable Dwight Duncan, announced "significant sales tax reform" in the Province of Ontario. Effective July 1, 2010, the province of Ontario plans to harmonize its retail sales tax ("RST") with the federal goods and services tax ("GST"). Sales tax harmonization represents a tax regime change of significant proportions and will involve more proactive steps by business beyond a mere alteration of the tax rate in a point-of-sale computer program and accounting records. Many businesses will experience dramatic effects and need to prepare for the change far in advance of the July 1, 2010 date.
The GST is a value-added tax imposed by the Government of Canada at the rate of 5%. The GST rate was reduced by the Harper Conservative Government from 7% to 5% since 2006. Without the GST reductions, the effect of harmonization on consumers and some businesses would be far worse.
GST is payable on most supplies of property (including tangible personal property, real property and intangible property) and services. The Excise Tax Act (Canada), which imposes the GST, includes schedules setting out: (1) exempt supplies (no GST payable, but no recovery of GST paid on business inputs), (2) zero-rated supplies (GST is charged at a rate of 0% and recovery is allowed for GST paid on business inputs), and non-taxable supplies.
Since the GST is a value-added tax, businesses that are engaged in "commercial activities" are entitled to claim input tax credits and recover GST paid in respect of business inputs, provided that proper documentation and information is retained.
The Excise Tax Act (Canada) (also known as the "GST Legislation") is not perfect and requires its own amendments in areas such as partnerships, trust, joint ventures, healthcare, prepared foods, etc. In addition, the GST is a relatively young tax and a number of interpretation issues are complex and unresolved. These problems will carry over into the harmonized RST/GST.
The Retail Sales Tax Act (Ontario) can be viewed as imposing a number of different consumer taxes on various types of sales at various tax rates. The RST is a single stage sales tax payable by purchasers, consumers and users located in Ontario and is imposed at the rate of 8% (for most taxable sales). RST is payable on most sales of tangible personal property in the province of Ontario, with the exception of exempt goods. Goods that are exported from Ontario for consumption and use outside Ontario are exempt provided certain documentation is maintained.
RST is not payable on a service unless the service is a "taxable service" as defined in the Retail Sales Tax Act (Ontario) (e.g., labour to install, assemble, dismantle, adjust, repair or maintain tangible personal property, labour to install, configure, modify or upgrade a computer program, etc.). There are a few exemptions for specific services caught by the definition of "taxable service". In recent years, RST auditors have expanded their interpretations of the statutory definition of "taxable service" with the result that many service businesses have faced uncertainty and large RST assessments.
HARMONIZATION = CHANGE
Things are about to change for some businesses located in Ontario, or businesses carrying on business in Ontario and/or with Ontario-based businesses. Harmonization means that a federal harmonized RST and GST (referred to herein as "RST/GST") will be imposed with federal and provincial components and RST remains for limited items.
Most significantly, most of the RST exemptions for goods will no longer be available. All services, intangible property and real property will become taxable under the harmonized RST/GST regime, unless there is specific relief.
It is not possible to list all of the changes in this article. However, starting on July 1, 2010: (1) businesses engaged in exempt activities; and (2) consumers will pay more sales tax on many purchases.
While businesses that are engaged in "commercial activities" should be able to recover the increased RST/GST costs, businesses engaged in exempt activities and purchasers which were not registered for GST purposes (including some non-residents) will not be able to recover the increased cost.
Ontario has announced temporary restricted input tax credits for large businesses (i.e., businesses with annual taxable sales in excess of $10 million) and financial institutions (including de minimis financial institutions) relating to energy (except where purchased by farms or used to produce goods for sale), telecommunication services (other than internet access and toll-free numbers), certain road vehicles, and foods, beverages and entertainment. After July 1, 2015, full input tax credits would be allowed on these purchases after a three year phase-in starting July 1, 2012.
One of the more significant regime changes for Ontario-based businesses involved the requirement to determine whether the supply is inside or outside Ontario, or whether a pro-ration is required. Implementation of the RST/GST is expected to give rise to "place of supply" issues for any businesses that operate across Canada. Businesses that are engaged in the exempt activities may be incentivized to shift costs to a lower tax jurisdiction and the tax authorities will be interested in reviewing such transactions.
The following are a few examples of businesses that need to: (1) carefully consider how harmonization affects their business; and (2) take steps to prepare and/or consult with Ontario and/or the Government of Canada regarding the impact of harmonization. Do not wait until June 2010 as there may not be sufficient time to make the needed adjustments.
Importers of Goods
The Canada Border Services Agency ("CBSA") currently collects GST at the border on imported commercial goods, but does not collect RST. At the time of importation, the CBSA will collect RST/GST on imported commercial goods starting on July 1, 2010. RST/GST will be calculated at the rate of 13% of the value for customs duty purposes. As a result, it will be more important than ever for importers to be registered for GST purposes (if they are carrying on business in Canada and engaged in "commercial activities" in Canada) and determine: (1) whether they are a purchaser in Canada, (2) whether they are using the correct valuation method for customs duty purposes; and (3) whether any deductions are permitted from the invoice price, etc..
If an importer is carrying on business in Canada, registered for RST/GST purposes and engaged in commercial activities, it may be entitled to claim full input tax credits. However, the CBSA does not apply wash penalty administrative rules permitted in respect of domestic transactions. As a result, the CBSA does assess GST (and will assess RST/GST in the future) and interest despite the fact that a business would be entitled to a full input tax credit. The assessment risk and unrecoverable liability could increase after harmonization.
A number of non-resident businesses (or their Canadian subsidiaries) are not properly registered for GST purposes and currently pay GST at the time of importation. However, the CRA may determine that the non-resident is not carrying on business in Canada, or is not engaged in commercial activities, or is not making a taxable supply in Canada. When this occurs, the non-resident may be deregistered and input tax credits may be denied.
Many service businesses operating in the province of Ontario (such as stylists, consultants, lawyers, engineers, accountants, financial advisors, advertising agencies, architects, website designers, movie producers, etc.) do not currently charge RST on their services and will have to charge RST/GST at the rate of 13%. This change will affect both final consumers and businesses.
Under the Excise Tax Act (Canada), a service is deemed to have been made in Canada and is subject to GST if the service is performed in whole or in part in Canada. If the RST/GST rules replace "Canada" with "Ontario", Ontario service businesses will be at a competitive disadvantage when providing services to persons located in Ontario and outside Ontario. Bidding on fixed fee contracts will require a good understanding of the RST/GST consequences of a transaction. While there are zero-rating provisions for many services exported to non-residents, not every service is covered.
What will be of great importance to Ontario service suppliers is the extent to which Ontario buyers will purchase services from providers outside the province of Ontario in order to save the extra 8% sales tax. The border officers cannot see services crossing the border and such imported services would only be discovered during a purchase side audit. The added 8% tax may incentivize foreign head offices to use foreign service providers rather than sourcing services in Ontario.
These service businesses need to take steps to maintain their competitiveness while complying with the new rules.
Advisory businesses which involve services that have a financial nature (e.g., an investment advisor, valuation or business consultant, accountant, lawyer, etc.) may provide a taxable supply if a transaction is structured in one manner, (e.g., an asset sale) or an exempt transaction if structured in a different manner (e.g., a share sale). When the RST/GST rate increases to 13%, clients will want to save tax and the assessment risk will increase. Some of the information relating to the provision of services could be confidential in nature, but will have to be disclosed to support exempt RST/GST treatment. However, it is also possible that auditors will want to deny input tax credits and will be aggressive in their audits redetermining certain services to be exempt in order to deny input tax credits and accepting the RST/GST collected from recipient of the services. These businesses need to take steps to understand the harmonized RST/GST and how the rules may be applied to their businesses.
Multi-national businesses often have a choice of jurisdiction in which to establish head offices, regional offices, subsidiaries and/or an other local presence. Many multi-national businesses have centralized purchasing for the global operations. Such businesses will have to consider assessment risks associated with the harmonized RST/GST and alter their operations (e.g., change from a branch to a subsidiary structure for operations) and/or establish improved internal controls to ensure compliance with the harmonized RST/GST and minimize assessment risk. For example, businesses that engage in exempt activities in part will be required to self-assess in respect of imported taxable services and intangible property from outside Ontario. Such businesses should develop transfer pricing agreements and revisit exiting advance pricing ("APA") and new services and intangible property are addressed in the APA.
Many multinational businesses currently operating in Ontario may require assistance to extricate themselves from Ontario and/or clearly delineate the operations that are subject to the RST/GST and those operations that are outside Ontario.
Many of Canada's financial institutions are headquartered in the province of Ontario and will be affected by harmonization. Financial institutions (including some holding companies that satisfy the requirements of a de minimis financial institution) provide exempt supplies, and therefore are not entitled to claim full input tax credits on their business inputs. In addition, many financial institutions provide some taxable services, which entitle them to claim partial input tax credits. In 2007/2008, financial institutions were required to work with the Canada Revenue Agency to establish financial reporting and percentage allocations for input tax credits. When the RST/GST rate increases to 13%, the application of the allocation ratios will become more important and the effect on the bottom line will be greater and the assessment risk will exponentially increase.
The exemption for publications will not longer be available and subscriptions will be subject to the RST/GST. In addition, the purchase of advertising space by businesses in publications will be subject to RST/GST. Advertising agencies and graphic design firms, photographers, and public relations services will also be subject to RST/GST.
In the 2009 Ontario Budget, Minister Duncan indicated the RST/GST rebate for municipalities would be 78%. However, the GST rebate for municipalities is 100%. As a result, it is unclear why the province of Ontario has indicated that the rebate will be 78% and that harmonization will be "fiscally neutral". It will be important for municipalities to seek clarifications on this issue.
Builders of Multi-Unit Residential Complexes
Builders of multi-unit residential complexes (e.g. apartments) will be required to self-assess RST/GST at the rate of 13% at the time the first resident moves into a residential unit and remit that RST/GST to the Receiver General. Residential rents are exempt for GST purposes. As a result, if the fair market value of the apartment building is C$15 million, the RST/GST that must be self-assessed will be C$1.95 million (instead of the current C$750,000). While there is an embedded RST cost on the building supplies, fair market value is determined by calculations over and above the costs of building supplies. Therefore, harmonization will result in a significant unrecoverable cost. As a result, builders of multi-unit residential complexes will need to consider the effects of the higher RST/GST in construction planning, financing arrangement, real property valuation, business plans, rental charges, etc.
Experience informs us to expect special transitional rules that will apply to transactions and activities that straddle the July 1, 2010 implementation date. Buildings of multi-unit residential complexes should consider becoming involved in the dialogue to develop the harmonized RST/GST regime.
Builders/Renovators and Operators of Long Term Care Homes and Retirement Homes
Harmonization will have a significant effect on builders and operators of privately owned long term care homes and retirement homes. Builders of seniors' residences will be required to self-assess RST/GST at the rate of 13% at the time the first resident moves into a residential unit and remit that RST/GST to the Receiver General. Since long term care homes receive government funding, the application of the Excise Tax Act provisions could have negative effects for builders/operators/residents. The 2009 Budget does not include such builders/operators in their list of persons who will be fiscally neutral as a result of harmonization.
In addition, the Canada Revenue Agency has issued an unchallenged ruling that certain goods and services provided in long term care homes and retirement homes are subject to GST. There is uncertainty concerning this ruling, which will be enhanced by the increase in the applicable sales tax rate. It will be important to manage assessment risk and disagreements between residents and operators for the rules to be clarified.
Ontario businesses should take proactive steps to get ready for harmonization. We cannot list all the steps in this article as what is necessary must be determined on a company-by-company basis. Some of the many general prudent steps that should be taken by most businesses are as follows:
- Determine what taxes the business must charge, collect, remit and pay;
- Determine to whom the taxes should be remitted;
- Determine whether the business is making taxable, zero-rated, or exempt supplies and make adjustments to internal controls and accounting systems;
- Determine whether the business must self-assess on imported taxable services and intangible property and make adjustments to internal controls and accounting systems;
- Determine whether the business is entitled to claim full or partial input tax credits or refunds and make adjustments to internal controls and accounting systems;
- Determine whether the business is to provide point-of-sale rebates and make adjustments to internal controls and accounting systems;
- Determine if there is any uncertainty concerning the application of the rules. If there is uncertainty concerning the application of the rules, seek an advance ruling or interpretation from the relevant tax authority as soon as possible;
- Determine if the business will not be able to recover all RST/GST paid on business inputs;
- If the business will not be able to recover all RST/GST paid or self-assessed, consider making representations to the government as soon as possible; and
- If the business will not be able to recover all RST/GST paid, or self-assessed, (e.g. financial institutions, real property contractors, long term care home and retirement residence builders/operators, etc.) they should review their upcoming purchases, accelerate major acquisitions that are not subject to ORST, such as business assets, real property, computer software, advertising, etc. to reduce the cost for harmonization.
The most significant audit problem is lack of documentation required to claim input tax credits. During an audit, the auditor will deny input tax credits if the taxpayer does not maintain adequate records which include all the required elements in the GST/HST Input Tax Credit Regulations. When the RST/GST rate increases to 13%, risk management should involve internal controls relating to review of documentation and ensurance of retention of the required information.
If an Ontario business exports zero-rated goods, services and intangible property, documentation must be retained that is satisfactory to the Minister as proof of export. When the RST/GST rate increases to 13%, risk management should involve internal controls relating to review of documentation and ensurance of retention of the required information.
If Ontario business imports taxable services and/or intangible property, harmonization will result in transfer pricing issues relating to the self-assessment of the RST/GST on the imported taxable services and intangible property. When the RST/GST rate increases to 13%, risk management should involve internal controls and a transfer pricing agreement.
Apart from adjustments to internal controls and accounting systems, experience informs us to prepare for transitional rules that will apply to transactions and activities that straddle the July 1, 2010 implementation date. These rules are yet to be provided by the government.