May 21, 2009

No. 2009-17

Ontario’s PST-GST Harmonization —
Planning Your Next Steps

Companies that do business in Ontario will be affected by the province’s proposal to harmonize its provincial sales tax (PST) with the federal goods and services tax (GST) to create a single, value-added harmonized sales tax (HST) at a 13% rate, effective July 1, 2010.

Although July 2010 is more than a year away, businesses need to start preparing for the transition and determining the resources they will need to make the necessary changes as they plan their financial budgets, capital expenditures and human resource allocations for the coming year.

This issue of TaxNewsFlash-Canada outlines suggestions that may help your company start getting ready for the Ontario HST, based on the PST-GST harmonization measures announced in Ontario’s 2009 budget and some anticipated transitional rules.

Background

The proposed Ontario HST will include a 5% federal component and an 8% provincial component. This tax should be implemented under the federal GST legislation and should generally use the same tax base as the GST, with some exceptions. The Ontario HST will be administered by the Canada Revenue Agency (CRA) and the Canada Border Services Agency (CBSA).

Transitional rules
Ontario and the federal government have yet to provide transitional rules for the Ontario HST. However, they may look to the rules that applied when Nova Scotia, New Brunswick and Newfoundland and Labrador harmonized their PSTs with the GST in 1997 (the 1997 model) for guidance in developing their position.

Canada and Ontario note in their March 10, 2009 memorandum of agreement (the Canada-Ontario Agreement) that they will use their best efforts to conclude a comprehensive HST agreement by September 10, 2009 and complete the policy and administrative details by March 31, 2010. 

A similar timeline was followed when Nova Scotia, New Brunswick and Newfoundland and Labrador introduced the HST on April 1, 1997.

KPMG observation

Until transitional rules are released, companies may find it difficult to determine the full impact of the proposed harmonization on their businesses, including the impact of the HST on existing agreements and proposed transactions. For that purpose, the 1997 model may provide some clues as to what’s in store.

For example, when the HST was introduced in 1997, special transitional rules were introduced to limit some opportunities to prepay certain expenses that would become taxable under the HST system.

What should you do now to get ready?
Though transitional rules are not yet available, businesses can take steps to start preparing for the HST.

For example, you may want to review your business’ accounting and IT systems to see whether you need to develop better internal controls for GST/HST purposes because, among other things, the cost of an error in determining the tax status of goods may increase to 13% (from 5%) of the sale price in many cases.

Your business may also want to consider the following ideas to start planning for the change to the HST:

· Budget for the financial and cash flow implications of the HST transition in the 2010 financial plans you are developing now

· Determine the IT resources you will need to change your systems to accommodate the HST

· Consider whether you want to submit comments to the government

· Consider tax planning opportunities such as deferring purchases until after July 1, 2010, if practical, so you can claim input tax credits on the provincial portion of the HST as well as the GST portion.

You may want to review how the current HST place of supply rules and provincial sales taxes rules in other provinces may interact on the same goods and services, particularly if you supply intangible personal property or services in several jurisdictions. 

GST and HST registration
Based on the existing GST/HST rules, we anticipate that GST-registered businesses will automatically be considered registered for the Ontario HST and will be required to collect the tax, where applicable. This was the approach followed under the 1997 model.

KPMG observation

Ontario HST will likely add another layer of complexity for GST-registered businesses located in non-harmonized provinces and other jurisdictions. Based on the 1997 model, these GST-registered Canadian and non-resident businesses will likely be required to collect the Ontario HST if the place of supply of the goods or services is determined to be in Ontario.

Claiming input tax credits
Businesses selling taxable or zero-rated goods should generally be able to claim input tax credits for the HST paid on their purchases, subject to the following input tax credit restrictions for large businesses.

Large businesses (with annual taxable sales exceeding $10 million) and financial institutions will be unable to claim input tax credits on the following purchases:

· Energy, except where purchased by farms or used to produce goods for sale

· Telecommunication services other than Internet access or toll-free numbers

· Road vehicles weighing less than 3,000 kilograms (and parts and certain services) and fuel to power those vehicles

· Food, beverages and entertainment.

These restrictions will apply only to the 8% provincial portion of the HST. After the first five years of HST implementation, input tax credits on these businesses’ taxable supplies will be phased in over three years.

KPMG observations

Canada and Ontario have yet to elaborate on the calculation of the $10 million threshold for large businesses. Under the Quebec Sales Tax (QST) system, which has similar restrictions, the threshold calculation includes items such as the value of taxable supplies made in Canada by the person and its associates, the value of exports and the value of supplies made between closely related corporations deemed made for nil consideration under joint elections.

The Canada-Ontario Agreement noted that restricted items would not apply beyond the items that are currently subject to restrictions under the QST system, which include basically the same restricted items as Ontario proposed. The issue is whether the same rules related to these items will apply, such as restricted items purchased for resale.

In Quebec, input tax refund (ITR) restrictions remain an important audit issue. Businesses that will claim input tax credits for HST paid on restricted items, for example, the electricity used to produce goods for sale, may have to explain their input tax credit entitlement on such items to CRA auditors.

Measures for retailers
Retailers will likely have to make several adjustments to their systems to follow the transitional rules. These rules will presumably address, among many other items, price adjustments, volume rebates, coupons, returned goods and bad debts.

Ontario proposes point-of-sale rebates of the 8% provincial portion of the HST for books, diapers, children’s clothing and footwear, children’s car seats and car booster seats and feminine hygiene products. Retailers will preserve their ability to claim input tax credits.

KPMG observation
Under the existing HST systems, a retailer has three options to disclose the tax payable to its customers, as illustrated in the following example of a bookstore selling an art book priced at $100:

Option A	Option B	Option C
Book price:        $100.00 13% HST              13.00   Subtotal           $113.00 8% Rebate              8.00 Amount due       $105.00	Book price:        $100.00 HST*                      5.00 Amount due       $105.00 *This amount equals 13% HST – 8% Rebate, i.e., $13.00 – $8.00 = $5.00	Book price:        $105.00 Amount due       $105.00 5% HST included

Tax-inclusive pricing
The 2009 Ontario budget did not include any specific measure with regards to tax-inclusive pricing rules.

KPMG observation

When the HST was introduced in 1997, the prices were to be shown to consumers as HST-inclusive. Businesses expressed concerns about the proposed measure, which was amended prior to implementation. The federal government may re-introduce tax-included pricing but has previously committed not to do so until at least 51% of taxing provinces (i.e., in total population) have enacted tax-inclusive pricing themselves. For now, this requirement has not been fulfilled.

Measures affecting financial institutions
Since the Ontario HST will have the same tax base as the GST, with a few exceptions, financial services will generally be exempt from HST. As such, providing exempt financial services under the Ontario HST system is likely to result in higher costs for financial institutions as they will pay the 13% HST on more expenses but generally will not be able to claim input tax credits to recover the tax.

Some financial institutions must use a complex formula known as the special attribution method (SAM) to calculate their Atlantic provinces HST liability. A key component of the method involves multiplying the unrecoverable GST incurred by an 8/5 factor and the provincial allocation to harmonized provinces, less actual HST incurred. It seems likely that the SAM formula will also apply under the Ontario HST.

Financial institutions not required to use the SAM formula may also face the additional cost of anticipated self-assessment requirements under the Ontario HST for imports of goods and services into Ontario from other provinces or outside of Canada.

Insurance companies should note that Ontario will retain an 8% PST on the same types of insurance premiums that are taxed under the current PST system.

Measures affecting landlords and builders
Landlords of GST-exempt residential rentals will likely see their operating costs increase under the Ontario HST as many services and some goods not currently subject to Ontario PST will be taxed at 13%. Landlords cannot claim input tax credits for GST paid on expenses relating to GST-exempt activities. This rule will likely apply under the Ontario HST. Expenses such as management, maintenance and lawn care services and electricity are only a sample of services that will become taxable at 13% (increased from 5%).

Currently, a vendor of a “supply and install contract” with regards to real property is required to pay Ontario PST on its inputs. Under an HST system, a vendor should be entitled to claim input tax credits for the HST paid on its inputs. Businesses may wish to consider the effect of the proposed Ontario HST if they intend to negotiate and enter into a long-term contract for such services.

Builders of new homes will be entitled to claim input tax credits for most HST paid on their inputs. However, new homes in Ontario that are currently subject to the GST will become subject to the provincial component of the HST. These rules may be subject to anticipated transitional rules.

An Ontario HST housing rebate will apply to certain new homes. Buyers will be able to claim a partial rebate of the 8% provincial portion of the HST for new homes priced up to $500,000. The rebate for new primary residences under $400,000 will be 75% of the provincial portion of the tax (or 6% of the purchase price), with the rebate amount reduced for homes priced between $400,000 and $500,000.

It’s not clear whether the HST housing rebate will be available to landlords who buy or build new multiple-unit residential complexes, as the GST rebate is.

In some cases, builders may have to review standard agreements and change tax calculations to provide for the proposed Ontario HST.

For further information on the effect of the Ontario HST on builders, see TaxNewsFlash-Canada 2009-15, “Real Estate Developers and Ontario Sales Tax — What Lies Ahead in the Transition to HST?”, available at kpmg.ca.

Small business measures
Under the current PST system, Ontario compensates vendors for collecting and remitting the tax. Under the new system, this vendor compensation will end. Vendor compensation will continue to apply for PST returns filed up to and including those filed for the period ending March 31, 2010 under the existing PST system.

A one-time small business transition credit of up to $1,000 will be available to most businesses, other than financial institutions, with less then $2 million in annual revenue from taxable sales.

Public service bodies measures
Public service bodies will be entitled to partial rebates for the 8% provincial portion of the HST. The 2009 Ontario budget notes that the net effect of the tax would be fiscally neutral relative to the amount of PST currently paid by each of these sectors.

The rebates will vary from 78% to 93% of the provincial portion of the tax paid (i.e., municipalities (78%), hospitals (87%), universities and colleges (78%), school boards (93%), charities and qualifying non-profit organizations (82%)).

KPMG observation

While the budget aims for fiscal neutrality for public service bodies, the impact of the proposed Ontario HST on both cash flow and costs will obviously differ from one organization to another. For example, important purchases will become subject to HST, such as electricity, construction contracts, some research equipment and real property leases. The impact of the loss of the PST exemption on these items will depend on an entity’s upcoming projects and purchases over the next few years.

We can help
KPMG can help you with these or other federal or provincial indirect tax matters that may affect your business. We can also keep you abreast of the progress of the Ontario tax harmonization proposals as they make their way into law and help you bring any concerns you may have to the attention of the Ontario Ministry of Finance. For details, contact your KPMG adviser.

Information is current to May 20, 2009. The information contained in this TaxNewsFlash-Canada is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavour to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation. For more information, contact KPMG’s National Tax Centre at 416.777.8500.

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