Ontario Sales Tax Harmonization

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Episode 3: Ontario Sales Tax Harmonization

Release date: June 9, 2009
Guest: Brian Wurts
Running time: 6:30 minutes

Ontario’s plan to harmonize federal and provincial sales taxes by July 1, 2010 presents a range of implications for different industries and businesses. Are you prepared?

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Ontario Sales Tax Harmonization

Welcome to this PricewaterhouseCoopers podcast — another in a series on Canadian and international tax issues affecting businesses and individuals in Canada.

In its March 2009 budget, the Ontario government announced its intention to harmonize its sales tax system with the federal GST. Economists have broadly hailed the proposal as a step in the right direction for the economy. Before raising some important concerns, here are the basics.

The budget proposes a 13% Harmonized Sales Tax (or HST) rate in Ontario – 5% federal and 8% provincial – to be administered by the Canada Revenue Agency. Businesses will not have to track Ontario HST and GST separately. Instead, the tax will be pooled for purposes of remitting tax collected and claiming input tax credits.

Although the new HST broadly mirrors the GST, some exceptions could create compliance problems for businesses.

First, items such as books, children's clothing and feminine hygiene products will be subject only to the 5% federal tax but not the 8% Ontario portion. This will create complications for vendors.

A more significant deviation from the GST is that financial institutions and large businesses with taxable revenues over $10 million will be denied claiming any input tax credits for the provincial portion of the tax for the first five years, and partly restricted for the subsequent three years, for expenditures on:

  • Energy, including electricity, and heating fuel
  • Telecommunications services
  • Automobiles, including fuel and related services
  • Food, beverages and entertainment

This restriction has the potential to create severe headaches. For example, manufacturers can claim credits only for electricity used directly in the production process, so they will have to categorize their uses of electricity to work out the credit they can claim.

Although the harmonization initiative will be generally beneficial to the business sector, two particular sectors are expected to suffer – financial services and new housing construction.

Financial services are exempt under the GST. Therefore, they generally cannot claim input tax credits for the GST they pay on their expenses. Because a large proportion of expenditures by the financial services sector are currently not subject to Ontario RST, the move to a harmonized tax will increase the tax on many of their purchases from 5% to 13%. This will substantially raise the cost of doing business in Ontario for this important sector.

The other sector that will be dramatically affected is residential housing construction.

Under the RST, tax was not paid on the sale price of a house, but was paid by the developer on building materials. This worked out to be approximately 2% of the price of the house. Under the HST, the 8% provincial portion applies to the sale price – an effective tax increase of 6%.

The Ontario budget recognized that some relief was required. For dwellings of up to $400,000, it proposed a rebate of 6%, keeping the tax roughly at its current level. The Ontario rebate will be clawed back for houses in the $400,000 to $500,000 range. Above that, the full 13% rate will apply.

This is fraught with difficulties. First, it may well result in a dramatic decrease in housing starts in the affected price range. Second, the proposed clawback of the rebate has the potential to permanently distort the way houses are sold in Ontario. The lower tax for homes below $400,000 creates a strong incentive to sell new "stripped down" new houses – without appliances, finished basements or landscaping. Because of the way the rebate is clawed back as the value increases, any of these or other amenities that increase the price above $400,000 would effectively be taxed at an astonishing 43%, rather than at 13% if sold separately.

What happens now?

We anticipate that in early to mid summer 2009 Ontario will issue a follow-up release setting out transitional rules. After that, the draft legislation likely will be released. These will outline a number of changes to the key "place of supply rules" now used in the HST. The aim will be to strengthen the current criteria that restrict businesses from reducing taxes by relocating their offices.

The effects of harmonization will vary, depending not only on the industry but on the specific business. All businesses should consider what preparations are needed, in light of their specific circumstances.

One particularly productive approach is to form a harmonization transition team to monitor events and to accumulate information. Some businesses might consider lobbying the federal and provincial governments.

Businesses should review any purchase agreements that straddle the July 1, 2010 implementation date to consider how harmonization will affect the supply. The goal is to identify and capitalize any benefits that may come from harmonization and avoid any problems. Contracts that should be reviewed include those for:

  • Construction
  • Outsourcing
  • Supply and installation
  • Software

Businesses should particularly consider the potential effect of harmonization on their purchases of capital assets, and plan appropriate strategies to either accelerate or defer large purchases.

PricewaterhouseCoopers' indirect tax specialists are helping businesses implement strategies to optimize the effects of harmonization. Our specialists have in-depth knowledge of the sales tax system and are experienced in helping organizations in all industries avoid pitfalls and identify opportunities.

Copyright 2009 PricewaterhouseCoopers LLP. All rights reserved. PricewaterhouseCoopers refers to PricewaterhouseCoopers LLP, an Ontario limited liability partnership, or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity. For full copyright details, please visit our website at pwc.com/ca.

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Through interviews with prominent PwC tax subject matter professionals, Tax Tracks is an audio podcast series that is designed to bring succinct commentary on tax technical, policy and administrative issues that provides busy tax directors information they require.