TAX NEWS - 2010

Canada HST & GST: Trends in value added taxation and its role in commercial leasing

British Columbia and Ontario are replacing their respective provincial sales taxes and the federal Goods and Services Tax (GST) with a single Harmonized Sales Tax (HST) from July 1, 2010. The federal legislation amending the Excise Tax Act received Royal Assent on December 15, 2009.   


I. Outline

In this article, I provide a brief history of the progression towards value added taxation in Canada. In this context, I consider the tax policy motivations for value added taxes such as the HST.

I discuss the differences between the existing provincial sales taxes of the kind imposed by British Columbia and Ontario, and value added taxes such as the GST and HST. In this context I review the kinds of tenants that are likely to be most affected, both positively and negatively, by the transition from the GST to the HST.

Finally, I discuss in greater detail the most distinguishing feature of the HST, namely the restriction on the recovery of input tax credits for the provincial component of the HST on certain inputs and how this may be dealt with in the context of commercial real property leasing.


II. A Brief History of the Transition to Value Added Taxation in Canada

The federal GST was implemented across Canada on January 1, 1991 at a rate of 7 per cent. Before the introduction of the GST, there had been no value added tax (VAT) imposed at either the federal or provincial level in Canada. The GST replaced the federal manufacturer's sales tax that had been imposed on goods manufactured in Canada.

Shortly thereafter, Québec introduced the Québec Sales Tax (QST) at a rate of 8 per cent. The QST replaced the Quebec retail sales tax and, like the GST, took the form of a VAT. The QST rate was reduced to 6.5 per cent in May 1994, then increased to 7.5 per cent in December 1997. The QST is charged on the GST-included value of the consideration payable for a supply, such that the QST is charged on the GST, resulting in tax on tax.

In transitioning to the GST, it had been planned from the outset that the provinces would have the opportunity to replace their existing provincial sales taxes with a harmonized form of the GST, i.e., with the HST. The first three provinces to replace their provincial sales taxes were New Brunswick, Nova Scotia, and Newfoundland and Labrador, which did so in April 1997.

The federal government has reduced the rates of the GST and HST on two occasions in recent years. On July 1, 2006, the rate of the GST was first reduced from 7 per cent to 6 per cent, and the corresponding HST rate was reduced from 15 per cent to 14 per cent. On January 1, 2008, the GST rate was again reduced from 6 per cent to 5 per cent, and the corresponding HST rate was reduced from 14 per cent to 13 per cent.

In the spring of 2009, Ontario made the surprise announcement that it would replace its 8 per cent retail sales tax (RST) with the HST at single rate of 13 per cent. It is worth noting that the RST will apply to the current scope of taxable insurance premiums after July 1, 2010, which includes most property insurance.

British Columbia followed shortly thereafter with a parallel announcement that it would replace its 7 per cent social services tax with the HST at rate of 12 per cent. This was the first time it became publicly known that the federal government would consider different rates of HST to accommodate the provinces. This principled change makes conceivable the transition of the remaining provincial sales tax provinces to an HST in the future. It also opens the door for a possible a transition by Québec from the QST to the HST.

After July 1, 2010, the VAT and sales tax landscape in Canada will be as follows. The HST will be imposed at a rate of 13 per cent in the provinces of Ontario, New Brunswick and Newfoundland and Labrador. Nova Scotia recently announced that it would increase its HST rate to 15 per cent. The HST will be imposed at a rate of 12 per cent in the province of British Columbia. The GST will apply in the balance of the provinces and territories in Canada at a rate of 5 per cent. Québec will impose the Québec sales tax at a rate of 7.5 per cent, due to be increased to 8.5 per cent from January 1, 2011. In addition to these VAT, the province of Saskatchewan will continue to impose a provincial sales tax at a rate of 5 per cent; Manitoba will impose a provincial sales tax at the rate of 7 per cent; and Prince Edward Island will impose a provincial sales tax at a rate of 10 per cent (which sales tax is imposed on the GST-included value of the consideration).


III. Tax Policy Motivations for Value Added Taxation

There are a number of tax policy reasons for Ontario and British Columbia to replace the GST and their respective provincial sales taxes with a single HST. One clear advantage is that businesses operating in Ontario will only have to comply with a single consumption tax regime, rather than two. In addition, Ontario and British Columbia will be relieved of their respective obligations to administer their provincial sales tax regimes. The administration of the HST will be assumed by the Canada Revenue Agency and the revenues from that tax shared with the provinces according to their respective tax sharing arrangements.

On a more policy orientated level, there is a clear advantage for an export oriented economy such as Ontario, in particular, to move to a VAT. VAT are not, as a rule, borne by businesses that manufacture goods or produce services for export from Canada. Accordingly, the HST, like the GST, does not become an embedded cost of goods and services for export. This is in contrast to the provincial sales taxes in Ontario and British Columbia that are borne by businesses on their purchases of tangible personal property, computer software and a limited range of taxable services. In particular, the transition to the HST should provide a degree of stimulus for the manufacturing sector in Ontario.

More generally, the transition to a consumption tax opens the door for future reductions in the rate of corporate tax by shifting tax obligations from businesses on to the consumer. This is advantageous as corporations are able to undertake tax planning, including changing jurisdictions, which can help them to avoid corporate tax. These strategies do not have obvious parallels in a consumer level tax that is necessarily payable by a local consumer.

Finally, the current fiscal difficulties facing Ontario and British Columbia provide one further advantage of a consumption tax over an income tax, namely that the tax revenues from a consumption tax are, in comparison, more stable than income taxes during a recession.


IV. What are the Differences between Retail Sales Tax and the HST?

One key difference between the RST and the HST is scope of supplies to which these taxes apply. RST applied to the purchase and sale of many goods, computer software, as well as a limited range of taxable services. Critically, there were exemptions for most inputs of energy, including electricity and natural gas. By contrast, the HST applies to almost all goods and services, as well as to the purchase and sale of real property.

A second key difference, however, is that the RST was an unrecoverable tax to the payor. By contrast, the HST is generally recoverable to a person that is GST/HST registered and is paying the GST/HST on an input that is to be consumed, used or supplied in the course of making GST/HST taxable supplies. There are a small group of industries that do not benefit from this exemption, which industries provide GST/HST exempt supplies: health care, financial service providers, residential real estate and charities.

Accordingly, tenants such as banks, insurance companies, doctors, dentists and health clinics will be particularly affected by the transition to the higher HST after July 1, 2010.


V. Restriction on Input Tax Credits to "Large Businesses"

As part of the implementation, British Columbia and Ontario will impose restrictions on input tax credits for HST incurred on energy and a limited range of further business inputs. These restricted input tax credits are to be known as "specified input tax credits" (Specified ITCs). Specified ITCS will eliminate recovery of the provincial component of the HST, i.e., 7 of the 12 per cent HST in British Columbia and 8 of the 13 per cent HST in Ontario.

The restrictions on recoverability for inputs of energy should have the most significant impact as energy inputs are currently fully exempt from RST.


1. Scope of the Restrictions

The restrictions on Specified ITCs for energy will include electricity, gas, combustibles and steam energy. However, the restrictions will not extend to HST incurred on energy used in producing goods for sale, nor for designing or producing equipment for producing goods for sale. Importantly, energy used for air conditioning, lighting, heating or ventilation of a production site will generally be subject to the restrictions.

The restriction on Specified ITCs for energy will not extend to motive fuels acquired to power a propulsion engine. However, restrictions on Specified ITCs will extend to HST on non-diesel fuel to power a vehicle weighing less than 3,000 kg that is required to be registered for use on public highways, as well as such road vehicles, their parts and servicing.

Other restrictions will include Specified ITCs for certain telecommunications services (other than internet access or toll-free numbers), as well as any on food, beverages and entertainment.


2. "Temporary" Restrictions

For now, the restrictions are intended to be temporary. After the first 5 years following implementation, Specified ITCs relating to restricted items are to be phased out over a three-year period. Accordingly, in the sixth year, the restrictions would be limited to 75 per cent of the Specified ITCs; in the seventh year, the restrictions would be limited to 50 per cent of the Specified ITCs; and in the eighth year, the restrictions would be limited 25 per cent of the Specified ITCs before being eliminated in the ninth year.

Only time will tell if these restrictions, in fact, will be lifted by future governments.


3. Definition of "Large Business"

The restrictions are only to apply to "large businesses", though the threshold is fairly low. A person who is registered for GST/HST purposes would be considered to be a "large business" if the total consideration for GST/HST taxable supplies made in Canada by the person, or by associates of the person, that was paid or payable in the previous fiscal year exceeds $10 million.

In calculating the $10 million threshold, amounts attributable to consideration for supplies of zero-rated exports, supplies made outside Canada through a permanent establishment in Canada, and supplies deemed to have been made for nil consideration pursuant to a joint election made by specified members of a qualifying group will be included.

However, amounts attributable to consideration for supplies of financial services, exempt supplies, supplies of real property that is capital property, and supplies of the goodwill of a business in situations where GST/HST is not payable on those supplies need not be included.


4. Application to Leases

Most commercial leases will require that GST and other taxes payable on rent will be in addition to the amount of the rent. It is worth reviewing the definition of terms such as "GST" or "Applicable Taxes" within lease agreements to confirm that these definitions are sufficiently broad to include the HST, whether by defining the HST directly as the "harmonized sales tax" or more generally as in the following example:

"GST" means goods and services taxes, value-added taxes, multi-stage taxes, business transfer taxes however they are characterized.

Commercial leases typically require the tenant to pay the proportionate share of operating costs to the landlord. Landlords should review the definitions of "Operating Costs" or "Operating Expenses" in their leases to ensure that these terms are sufficiently broad to allow the landlord to recover an amount on account of Specified ITCs, as well as RST on insurance.

The following is an example of a definition of "Operating Costs" as found in a typical commercial lease:

"Operating Costs" means the total cost and expense incurred in owning, operating, maintaining, managing and administering the Shopping Centre and the Common Areas, excluding only the original acquisition costs and financing and mortgage charges, but specifically including without limiting the generality of the foregoing, all Taxes not recovered from tenants of the Shopping Centre; any capital or place of ownership taxes levied against the Landlord or any owners of the Shopping Centre on account of their interest in the Shopping Centre, in an amount equitably allocated to the Shopping Centre by the Landlord… [underlining added].

In addition, consideration should be given to including amounts on account of RST on insurance and Specified ITCs in estimates and reconciliations of Additional Rent as may be required from time to time under a commercial lease.

Finally, consideration should be given to the July 1, 2010 transition to ensure that HST is properly invoiced on amounts of rent payable from that day forward.