Harmonization of Canadian Commodity Taxes

by D'Arcy A. Schieman, Esq.*
Osler, Hoskin & Harcourt LLP
Toronto, Canada


* The writer would like to thank Sean Aylward for his contributions to this article.

Across Canada, the federal government and provincial governments (except Alberta) impose some form of sales tax on the purchase of goods and services in Canada. Some provinces have “harmonized” their provincial sales tax (PST) with the federal Goods & Services Tax (GST) — meaning the two commodity taxes are aggregated and administered as one by the federal Canada Revenue Agency (CRA) — and, recently, Ontario (in its March 2009 Budget) and Quebec announced that they will follow suit. This article will provide a background of the GST and the various PSTs, and describe the potential impact of Ontario's harmonization.
Goods & Services Tax

Payment/Collection/Remittance

The GST is a 5% federal tax that is levied, under Canada's Excise Tax Act (ETA), on the supply of goods and services within Canada. Subject to certain exemptions (described below), the GST is imposed at each stage of distribution, but GST credits are generally available to a person engaged in a commercial activity (as defined in the ETA 1 ). Thus, the effect is that only the consumer or other end-user (i.e., a person that is not itself engaged in a “commercial activity”) in each supply chain bears the burden of the GST.

1 “[C]ommercial activity” is defined in subsection 123(1) of the ETA to include, in relevant part, any “… business carried on by the person (other than a business carried on without a reasonable expectation of profit by an individual, a personal trust or a partnership, all of the members of which are individuals), except to the extent to which the business involves the making of exempt supplies ….” A description of an “exempt supply” is provided below.

For taxable supplies made in Canada, vendors generally must collect GST from the recipient (purchaser) at the rate of 5% of the amount payable. For taxable imported goods, the importer of record is required to pay GST at the border. For other taxable imported supplies (generally, supplies made outside Canada not for a Canadian resident's exclusive use: (1) in commercial activities; or (2) outside of Canada), the recipient is required to self-assess GST and remit it directly.

However, as noted above, the vendor or importer, in filing its GST returns may generally — as long as it is engaged in a commercial activity — deduct from the GST collectible on its sales the amount of GST payable or paid on its purchases and retain such amount (which it would otherwise be required to remit to the CRA) as an input tax credit. And if such input tax credits exceed its collectible GST during the relevant reporting period, the vendor may also claim a refund in the amount of such excess.

Certain supplies (e.g., supplies of financial services) are characterized as exempt under the ETA. A supplier of an exempt supply does not collect GST and is not entitled to claim input tax credits on its purchases of inputs to such supplies (in effect, is treated as the end-user of such inputs in that it pays non-creditable GST on them). Other supplies are defined as zero-rated taxable supplies (such as tangible personal property purchased for export from Canada or intellectual property supplied to a nonresident that is not registered for GST), which do not bear GST, but the supplier is nonetheless entitled to claim input tax credits on inputs thereto. (In the result, there is no net GST on the zero-rated supplies or inputs thereto.)

Nonresident Registration

The ETA provisions pertaining to GST registration requirements are often of particular interest to nonresidents. For instance:

• a nonresident person must register under the ETA and charge and collect GST if it is making a taxable supply in Canada;
• a nonresident person with a permanent establishment in Canada is deemed to be a resident of Canada, for GST purposes, with respect to activities carried on by that establishment in Canada; and
• a nonresident GST registrant without a permanent establishment in Canada is required to post security with the CRA.

Provincial Sales Taxes

Provincial retail sales taxes, which vary from province to province, are generally applicable to all goods and limited services purchased by consumers and other end users. Such a PST is collected by the vendor and remitted to the appropriate provincial taxing authority. Unlike with GST, credits are generally not available in respect of PST; instead, a purchaser may be entitled to claim an exemption from the payment of PST (e.g., if the goods are purchased for resale or for use in manufacturing). On importing commercial goods into such provinces, a purchaser must self-assess and remit any PST that is applicable.
Since 1997, in Nova Scotia, New Brunswick, and Newfoundland, PSTs have been harmonized with the GST at an aggregate rate of 13% (the provincial component of which is 8%) and collected by the federal government along with GST and then redistributed to the respective provinces.

Once Ontario (in particular) and Quebec harmonize their PSTs with the GST, it is expected that the remaining provinces in which non-harmonized PST is assessed (i.e., British Columbia, Saskatchewan, Manitoba, and Prince Edward Island) will follow suit, leading to a regime of Harmonized Sales Taxes (HSTs) across Canada.

Ontario Harmonization

As noted above, the Government of Ontario, in its recent 2009 budget, announced that the province will harmonize its existing 8% PST with the federal GST (effective July 1, 2010). The new Ontario HST will be applied at a rate of 13%.

Application of HST

Generally, the new HST will apply to the provision of goods and services in the same manner as GST currently applies. That is, property and services that are currently subject to the 5% GST will now be subject to the 13% HST (subject to full point-of-sale rebates for books, children's apparel, car seats, diapers, and hygiene products). The Ontario HST is expected to be substantially similar to the one introduced in Newfoundland, Nova Scotia, and New Brunswick 12 years ago.

For those businesses that are currently permitted to claim input tax credits in respect of GST paid on their expenses, the HST will represent a significant cost savings over the existing PST, because whereas no credit was available for PST paid on taxable goods and services, now a full input tax credit will be available for HST paid on taxable goods and services, generally as described above in terms of GST and subject to the temporary restrictions discussed below.

Administration

The HST will be administered by the CRA under rules similar to the GST. HST registrants will file a single return for HST (i.e., replacing their GST and PST returns). As is the case with the GST, “small suppliers” will not be required to register for HST. For HST purposes “small suppliers” will be those with annual taxable sales under C$30,000 per year (or C$50,000 for public service bodies).

Temporary Restrictions on Input Tax Credits for Large Businesses/Financial Institutions

Large businesses (with annual taxable sales in excess of $10 million) will be unable to claim input tax credits for five years following the implementation of the HST in respect of:

• energy (except when purchased by farms or used to produce goods for sale);
• telecommunications services (other than Internet access or toll-free numbers);
• road vehicles weighing less than 3,000 kilograms and fuel, parts, and certain services for such vehicles; and
• food, beverages, and entertainment expenses.

Five years after implementation, the above restrictions will be phased out (over the following three years), with full input tax credits to be available starting in 2018.

Exempt Financial Services

Financial services will be considered exempt, as they are now for GST (i.e., such services will not attract HST, but the supplier will not be entitled to claim input tax credits on expenses related thereto). Notwithstanding this, the Budget proposes to continue to impose an 8% sales tax on insurance premiums that are currently subject to Ontario PST (e.g., property insurance). Ontario's exemption of financial services is contrary to the approach adopted by Québec, which treats financial services as zero-rated (i.e., Québec Sales Tax is not applicable to financial services, but QST input tax refunds are allowed for QST paid on inputs to the provision of such services).

Rebates of HST

(1) Residential Real Property
For Ontario buyers of newly constructed primary residences priced up to C$400,000, there is a proposed rebate of 75% of the provincial portion of the tax (i.e., a rebate of 6% (of the 8%) provincial component of the HST). The rebate will gradually diminish moving up in the house price bracket from C$400,000 to C$500,000. Above that price, the full 8% provincial component of the HST will apply.

(2) Public Service Bodies
Similar to the GST, there will be rebates of HST for public service bodies as follows:

• municipalities: 78%;
• universities and colleges: 78%;
• school boards: 93%;
• hospitals: 87%; and
• charities and qualifying not-for-profit organizations: 82%.

Design Issues and Transitional Rules To Be Determined: Concerned Parties Should Provide Comments to Implementation Panel

While the Ontario Budget set forth a basic outline describing the proposed HST, many of the most important details that will affect businesses were not announced. For many businesses, these transitional rules, “place of supply” rules, and other technical design issues will be extremely important.

With that in mind, one paragraph of the budget stands out:

Additional Information

Additional information on technical design issues and transitional rules will be released in the coming months to help taxpayers and businesses prepare for the proposed changes. The government will also establish an implementation panel to assist with the transition to the single sales tax. [Emphasis added.]

For those business sectors that may be adversely affected by the proposed change, the next six to 12 months of system design to be undertaken by the implementation panel may be particularly important. This time period will likely represent the best opportunity for affected businesses to provide input to the Ontario government for the development of implementation rules.

Industries wishing to influence the technical design and transitional rules for the HST should, therefore, prepare to address the implementation panel and other relevant Ontario officials promptly to ensure that their views are known before such issues are finalized.