Canada: Significant changes to harmonized sales tax (HST) rules for financial institutions

The Department of Finance released a backgrounder on 19 May 2010 that outlines changes to the way financial institutions — investment plans in particular — have traditionally accounted for the goods and services tax (GST) / harmonized sales tax (HST). While traditional financial institutions have always been required to pay HST based on their allocation to participating provinces, the backgrounder significantly broadens the scope of those persons required to allocate to the participating provinces by including investment plans.


Application to investment plans

Investment plans include mutual fund trusts and corporations, pension plans, pooled funds and trusts, and segregated funds of insurers, all of which generally have unit-/contract-holders or beneficiaries in multiple jurisdictions. To date, these entities have not been required to account for the harmonized sales tax (HST) applicable in the participating provinces of Nova Scotia, Newfoundland and New Brunswick unless the entity was resident in one of those provinces.

As of 1 July 2010, with the implementation of harmonized sales tax (HST) in Ontario and British Columbia, the rules will change considerably. From that date, most investment plans that have unitholders in multiple jurisdictions will be subject to special attribution rules that will require the entity to account for harmonized sales tax (HST) in each participating province in which it has unitholders. This is a result of new provisions that deem an investment plan to have a permanent establishment in each province in which the plan is qualified to sell or distribute units, shares or contracts. A financial institution subject to these attribution rules is referred to as a "selected listed financial institution" (SLFI).


The special attribution method calculation

As an SLFI, each investment plan will be required to calculate an "attribution percentage" for each series within each fund, based on the value of investments of unitholders in each participating province. As a result, the fund will need to know the location of its unitholders and the value of their investments in each participating province to calculate its harmonized sales tax (HST) payable under the special attribution method (SAM) calculation.

Generally, where the fund has a provincial attribution to multiple provinces, but is located in and incurs expenses in a participating province, it will generally be in a "refund" position as a result of the SAM calculation. Conversely, if the fund is located in and incurs expenses in a non-participating province, it will likely be in a payable position as a result of the SAM calculation.


Example

A mutual fund distributes units in Quebec and Ontario only, with 75% of the value of the units held by unitholders in Quebec and the remaining 25% by unitholders in Ontario. The mutual fund is based in Quebec and incurs all of its expenses in Quebec (assume $1m in taxable expenses subject to GST of $50,000 and recoverable Quebec sales tax of $78,750).

The mutual fund would take the net goods and services tax (GST) of $50,000 and multiply by the percentage attributed to Ontario (the only participating province in this example), to arrive at the goods and services tax (GST) attributable to Ontario of $12,500. This amount is multiplied by the factor 8/5 to arrive at the provincial component of harmonized sales tax (HST) due of $20,000. In this example, there is no provincial component of harmonized sales tax (HST) paid that would otherwise be deductible from the $20,000.


New compliance and administration requirements

Mutual funds typically have unitholders in multiple jurisdictions and will face challenges in calculating the attribution percentage and the SAM calculation for each series within each fund. In addition, an area of particular concern to investment plans is the new requirement to obtain information regarding the residency of the underlying unitholders of the investment plan's institutional investors. Since most investment plans would not have access to underlying unitholder information of their institutional investors, they will have to rely on third parties to provide the required information.

In response to some concerns raised by industry, there are some relieving measures contained in the backgrounder, most of which relate to compliance and administration. Most investment plans and segregated funds will be able to file elections allowing the fund managers/insurers to file the harmonized sales tax returns on behalf of the funds, and eliminate the requirement for each fund to obtain a separate GST number.

In addition, the backgrounder introduces elections allowing the funds/managers to offset the tax liabilities of the funds with the managers, thereby easing the cash flow burden on the funds. Finance has indicated these elections are due before 30 June; however, no election forms have been released to date.

The proposed rules will mean a significant increase in the compliance and administration obligations and unrecoverable tax for most listed financial institutions. Taxpayers are cautioned to consider the proposals carefully and take particular note of due dates of elections and filings.