On February 1, 2010, the Ontario Ministry of Revenue released Information Notice No. 5, dealing with the proposed restrictions on the claiming of input tax credits (“ITCs”) by certain taxpayers in connection with the July 1, 2010 implementation of the 13% Harmonized Sales Tax (“HST”) in Ontario.
HST will consist of an 8% provincial component and a 5% federal component. The new harmonized tax will function as a flow through tax much like the present GST; those that supply taxable goods and services will generally be entitled to claim ITCs to recover their HST expenses. However, unlike the present GST, there will be temporary restrictions put into place that will limit the ability of certain entities to claim full ITCs on the provincial portion of the HST.
- The ITC restrictions apply to large business with annual taxable supplies in excess of $10 million and to certain financial institutions
- The restrictions apply only to the 8% provincial component of the HST
- The restrictions apply to specified property and services that a large business or financial institution acquires or brings into Ontario including: energy, telecommunication services, meals and entertainment and road vehicles.
- The restrictions will be phased out over a period of 8 years. The first 5 years require complete recapture and the following three reduce the rate of recapture incrementally.
The Temporary Restrictions on Input Tax Credits for HST:
Who do the restrictions apply to?
The restrictions on ITCs apply to large businesses with annual taxable supplies in excess of $10 million and the following financial institutions (or persons related1 to them):
- Trust companies
- Credit unions
- Segregated funds of insurers
- Investment plans
An entity is considered a large business regardless of whether they have a permanent establishment in Ontario. If an entity is considered a large business at the beginning of a recapture period (July 1 in each of the applicable years), they are subject to the ITC restrictions throughout the period. The converse also holds true: if an entity is not a large business on July 1, they would generally not be subject to the ITC restrictions until the beginning of the next recapture period.
What goods or services do the restrictions apply to?
The restrictions apply to the types of property and services described below that are acquired or brought into Ontario by a large business and used within Ontario. Therefore property or services that fall within these classifications but will be used outside Ontario will not normally be subject to the ITC restrictions. These will generally be referred to as “specified property” or “specified services”.
There is to be a general carve-out from specified property and services where the sole purpose of property or a service is to produce items for supply by the large business, such that this property or service will not be considered “specified property” or a “specified service”. By way of example, the portion of a company’s electricity that it uses to operate machinery to produce goods for sale will not be a specified service and therefore the company will not be restricted from claiming ITCs on the HST payable to purchase such electricity.
Specified Road Vehicles:
These are motor vehicles under 3,000 kgs that must be licensed for use on public highways and are purchased, leased etc. by the large business. Also included in this category are vehicle parts, services and motor fuel (but not diesel) that are used in specified road vehicles and are brought into or acquired in Ontario within 12 months of obtaining the vehicle. Parts or services that are for routine repair and/or maintenance are generally excluded from the specified road vehicle category.
This includes electricity, gas and steam energy and also any incidental supply services for these items. As noted above, the ITC restrictions generally do not apply to specified energy used by a large business for the sole purpose of producing tangible property for sale. This concept of ‘production’ is expansive and includes the production equipment (molds, dies, prototypes, media etc.) used to do so. Large businesses eligible for SR&ED exemptions should also note that this same carve-out generally applies to specified energy used by the business for SR&ED activities.
To simplify the determination of which energy needs meet the “sole purpose” exemption, many large businesses can use a proxy process. This allows the company to fit itself into an industry category that has an allocated standard percentage to determine the portion of specified energy used to produce personal property for sale. A special proxy formula is also available to determine which energy needs are used directly for SR&ED activities.
Note also that there are specifically enumerated categories of businesses to which this “Production for Sale” exception generally does not apply (including financial institutions, regulated professions, hotels/restaurants etc.).
Specified Telecommunication Services:
The services in this category include local and long-distance telephone service, cable and satellite television, fax, e-mail, video, audio and computer link-ups and data transmission, but do not include Internet services, web-hosting, toll-free telephone services and other services provided via telecommunication that are not themselves telecommunication (e.g. building surveillance). Proxies may also be used by large businesses to calculate the total telecommunication services not subject to recapture. The proxy in this case involves a formula based on whether the specified services are included in invoices which also cover other goods, other services, or other goods and services.
Specified Meals and Entertainment:
For the most part, this category includes meals and entertainment that are currently subject ITC repayment requirements; including business dinners, theatre tickets and entrance/admission fees to clubs or sporting events. There is a carve out however for events or meals where all employees are invited (e.g. office holiday parties).
How long do the restrictions apply for?
The restrictions will be phased out over a period of 8 years, in accordance with the following schedule:
- 100% for the period from July 1, 2010 to June 30, 2015
- 75% for the period from July 1, 2015 to June 30, 2016
- 50% for the period from July 1, 2016 to June 30, 2017
- 25% for the period from July 1, 2017 to June 30, 2018
- 0% on or after July 1, 2018.
What are the reporting requirements?
In general, those covered by the restrictions must report their recaptured ITCs in their GST/HST NETFILE return for the reporting period when the ITCs first become available. That said, those large businesses that are already required to repay ITCs under the ETA (e.g. for meals/entertainment) are generally required to recapture ITCs during that reporting period.
Most importantly, those subject to the ITC restrictions must be aware that they cannot simply chose to avoid claiming ITCs in order to fulfill their HST requirements. They must report all ITCs they would have been entitled to claim were it not for the recapture requirements.
There are also transitional measures in place to address situations whereby a large business purchases specified goods or services in advance (but after October 14, 2009) for delivery on or after July 1, 2010. In these circumstances, the large business is generally required to self assess these amounts by November 2010, but the deadline may be earlier in certain circumstances.
To simplify reporting requirements, those subject to ITC restrictions will be given an estimation/instalment option. Under this approach, the large business must elect to estimate before the HST is introduced in July 1, 2010. They are then required to submit an estimate (which cannot be less than their actual ITCs for the previous fiscal year), make periodic instalments based on the estimate and reconcile against actual ITC amounts at the end of the period.
With respect to large businesses that bring specified property or services into Ontario from another jurisdiction, it is important to note that there is still an obligation to report the ITCs that could be claimed were it not for the temporary restrictions. Accordingly, for those large businesses engaged entirely in commercial activities that are accustomed to importing goods or services from outside of Canada and not being required to self-assess and remit GST pursuant to Division IV of the Excise Tax Act, there will now be a requirement that the provincial component of the HST be self-assessed on the import of specified property or services into Ontario.
Special rules surrounding related party transactions:
The Information Notice released by Ontario also indicates that there will be special rules to deal with the application of the ITC restrictions on non-arm’s length transactions made for less than fair market value, as well as for those entities that enter into elections pursuant to section 156 of the Excise Tax Act to deem supplies amongst related entities to be made for nil consideration.