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In July, Ontario will be harmonizing its provincial sales tax with the federal Goods and Services Tax. The result will be a new federally administered sales tax, the HST, of 13 percent on all goods and services. The HST is designed to simplify the tax system and reduce administrative costs but, as everyone who deals with taxes knows, tax systems are never simple. Here are some of the things that Ontario municipalities should consider as the countdown to harmonization gets underway.
On December 9, 2009, the Ontario legislature passed the harmonized sales tax, introducing the biggest single tax reform in the province in twenty years. At the same time, MPs in the House of Commons in Ottawa were clearing the way for the provincial government’s new tax, voting 253-37 in favour of a harmonized sales tax for Ontario and B.C. The federal bill allows the two provinces to blend their provincial sales tax, currently eight percent in Ontario, with the five percent federal goods and services tax. The new HST will come into effect on July 1, 2010.
The provincial government defends the new sales tax, arguing that with $1.1 billion in sales and property tax credits and $2.3 billion in new personal income tax cuts, the HST will only add about $133 million annually to the province's tax base. At the same time, the Ontario Liberals say that by unifying the tax, companies will save $500-million in compliance costs and the federal and provincial governments will benefit from the cost efficiencies of administering a single tax.
Not everyone agrees. Critics argue that the new tax will allow the province to add $3.5 billion to its coffers and that consumers will now have to pay the provincial sales tax on a range of previously exempt items including vitamins, domestic air travel, mutual fund fees and Christmas trees.
So far, the critics seem to be winning the battle of public opinion. While many economists and business leaders are in favour of the new tax, according to an Ipsos Reid poll in early December, almost three-quarters of Ontarians oppose the government’s plans.
Not All Sales Taxes are Created Equal
Sales taxes are nothing new to Ontario. The Ontario provincial sales tax has been around since 1961 and the federal government introduced the Goods and Services Tax, thirty years later in 1991. But while both the PST and the GST are sales taxes, there are some fundamental differences.
The 8% provincial sales tax is a consumption tax collected by retailers at the point of sale. While most goods are taxed, there are a number of exemptions including food, children’s clothing and
The GST, on the other hand, is a value-added tax based on the European model. Currently 5% after two recent reductions by the current Conservative government, the GST is levied on almost all goods or services other than groceries, residential rent, and medical and financial services. Businesses pay the GST on all goods and services used in their commercial activities but are allowed to deduct the amount of GST they paid from the amount of GST they charged. In other words, GST is only paid on the value added by businesses on goods and services on their way to the final consumers.
On July 1, 2010 the provincial sales tax will be harmonized with the federal GST to create a federally administered tax of 13% on all goods and services that are currently subject to GST, of which the Ontario portion will be 8%. Books, children’s clothing, new homes costing less than $400,000, and a few other select items will not subject to the provincial component of the HST.
The provincial government will provide up to $400 million in one-time sales tax credits to help small businesses make changes to point-of-sale and accounting systems and families earning less than $160,000 a year will get a $1,000 rebate in the first year of the tax.
From One Government to Another
Just like any other organization or individual, municipalities will pay the harmonized sales tax on the goods and services that it purchases. However, the rules that cover GST do not necessarily apply to the HST and that’s where it starts to get complicated.
The GST Portion:
There are a number of municipal services that are GST exempt. Municipalities, for example, do not charge GST on water and sewage services, public transit, recreational programs, ferry and bridge tolls, or meals and accommodation for needy people.
Since the GST is a value added tax, a municipality charges GST on the value of taxable items that it sells and deducts the GST as an input tax credit on all the goods and services that it purchased to create those items. Similarly, where taxable activities are performed in the HST regime, full input tax credits can be claimed on the related purchases. However, since municipalities do not charge GST on exempt activities (which are the majority of the services that they supply), they cannot claim the input tax credit on the purchases related to those activities. Instead, they receive a rebate.
Originally the rebate was set at 57.14 percent, which was equivalent to 4 percentage points of the 7 percent GST at the time. After some vigorous municipal lobbying, the federal government on February 1, 2004 increased the rebate to 100 percent. In other words, municipalities get a full refund on the GST paid on their inputs.
With the introduction of the HST, municipalities will continue to get the full rebate for the 5 percent GST portion of the HST.
The PST Portion:
Municipalities currently pay PST on purchases of most tangible goods and certain services: equipment (trucks, trailers, construction equipment, and office equipment, for example), computer equipment and software, materials, supplies and consumables. Under the HST, a portion of the provincial component will be recoverable, which will reduce the amount of tax that a municipality pays.
However, goods and services that were previously exempt from PST will now be subject to the full HST. These include:
Unlike the federal government, however, the provincial government will not be giving a full rebate on inputs for exempt services. Instead, municipalities will receive a rebate of 78 percent of the 8 percent provincial component of the HST. The 78 percent rebate was designed to keep things cost neutral, but that is a generality for all municipalities. Some may win, some may lose, but the amount either way should not be significant.
Rebates for Exempt Services
As previously shown, municipalities will be receiving a full rebate of the GST portion of the HST and a 78% rebate of the provincial portion of the HST for purchases related to exempt services.
Take, for example, a municipality spending $100,000 on equipment for its water treatment plant. When the equipment is purchased, it pays $13,000 HST. After it files, it will get a rebate of $5,000 for the GST portion of the purchase and a rebate of $6,240 for the provincial portion of the HST. It will have paid $13,000 in sales tax and received a rebate of $11,240 for a net sales tax payment of $1,760.
In other words, municipalities will be paying an effective sales tax of 1.76 percent on goods and services bought for exempt services.
On June 30, 2010, municipalities will pay the GST and PST on any taxable goods and services that they purchase. On July 1, 2010, they will pay the HST on goods and services. As one door closes, the other one opens. But what happens with transactions that straddle the July 1, 2010 implementation date?
The government will be issuing rules for credits, price adjustments, penalties and bonuses related to work in progress as of July 1, 2010. As of January, the transitional rules had not yet appeared in the legislation. The provincial government, however, has issued some information notices. The legislation when passed will probably reflect the current informational bulletins but may include some nuances and fine-tuning.
In general, PST will apply to the taxable sale of goods when the goods are delivered or ownership of the goods is transferred to the purchaser before July 1, 2010. The HST would generally apply to goods when the goods are delivered, and ownership is transferred, to the purchaser on or after July 1, 2010.
The transitional rules will be designed so that any prepayments made from October 14, 2009 (when the transitional rule was released) to June 30, 2010 are not done simply to avoid paying taxes. The HST component may have to be self-assessed or charged by the seller. Since municipalities are not eligible for full input tax credits, any inappropriate tax avoidance will be caught under the transitional rules.
In September 2009, in response to a request from the Ontario Road Builders’ Association, the Ministry of Transportation changed the wording of a tax-related clause in its general conditions of contract in anticipation of the federal and provincial sales tax harmonization.
The new clause states that: “Where a change in Canadian federal or provincial taxes occurs after the date of tender closing for this contract, the owner will increase or decrease contract payments to account for the amount of tax change.”
Clearly as the deadline for switching to the HST draws closer, there is bound to be some confusion as to who charges what and how much. Municipalities would be well advised to check all bids and tenders for goods and services to make sure that suppliers have based their quotes on the appropriate tax system.
Large organizations (defined as those with revenue greater than $10 million in the previous year) will no longer be able to claim input tax credits for the 8 percent portion of the Harmonized Sales tax for certain items including:
Since the tax is not recoverable, business costs for these items will increase. After five years, these restrictions will be phased out over a three-year period, which means that these items will have full input tax credit by 2018. In the meantime, municipalities can expect to pay more for these items.
The most critical issue for every municipality in the run-up to the HST is to make sure that it knows which of its activities are taxable. If an activity is deemed taxable, then the municipal government is responsible for collecting the tax. If it does not collect the tax and it is found that it should have then it will be charged not only for the amount owing but interest as well.
The rules are the same as they were for the GST but with the sales tax increasing from 5 percent to 13 percent, the exposure after July 1 will have almost tripled.
Every municipality should review its general ledger, line by line, to ensure that it is charging sales tax on whatever services are appropriate.
Will municipalities be better off with the HST? Some purchased services previously exempt from PST will now cost more since they will now be subject to the HST and municipalities will not receive a 100 percent rebate on the tax paid. A few costs will increase as companies pass on added costs for the relatively short list of items on which they can no longer claim full input tax credits. On the other hand, municipalities will now get a tax rebate on a wide range of goods and services for which they previously paid PST.
Whether or not a municipality is better off or not after July 1 will depend upon the mix of the goods and services that it purchases but for the most part, the impact should be relatively minor either way.
One of the objectives of harmonizing the provincial and federal sales taxes is to simplify the tax system and reduce administrative costs for businesses and government. However, preparing for the transition to HST is another matter.
Here are some things to consider:
Finance and Budgeting
Kal Ruprai is a Partner - Indirect Tax with Meyers Norris Penny in Toronto. He can be contacted at 416.515.3811 or [email protected].
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