Implementation of Ontario's harmonized sales tax.

• Author: Spagnuolo, Diana M.

August 24, 2009

On August 24, 2009, Tax Executives Institute submitted the following comments to the Ontario Ministry of Revenue on implementation issues relating to the adoption of a harmonized sales tax in the Province of Ontario. The comments, which took the form of a letter to Steve Orsini, Assistant Deputy Minister in the Minstry's Office of the Budget and Taxation, were prepared under the auspices of TEI's Canadian Commodity Tax Committee and the Toronto Chapter's Ontario Tax Committee, whose chairs are Diana M. Spagnuolo of Imperial Oil Limited and Carol Nixon of Lanxess Inc., respectively. Materially participating in the preparation of the comments were Vincent Alicandri of Hydro One Networks, Inc; Carol Felepchuk of TD Bank Financial Group; Daniel Karvonen and Martina Krummen of FNC Lavalin Inc.; Phil W. Riley of ArcelorMittal Dofasco Inc.; Richard Taylor of Rogers Communications Inc.; Natalie St-Pierre of Bell Canada; and Michael J. Willis of LaFarge Canada Inc. Mary L. Fahey, TEI's General Counsel, served as legal staff liaison on this project. Note: On September 16, TEI submitted comments to members of the Ontario Legislative Assembly, expressing support for the enactment of a Harmonized Sales Tax in the Province.

On March 10, 2009, the Government of Canada and Province of Ontario signed a Memorandum of Agreement (MOA) to use their best efforts to negotiate a new Canada-Ontario Comprehensive Integrated Tax Co-ordination Agreement, whereby Canada Revenue Agency and Canada Border Services Agency would administer an Ontario value-added tax (OVAT). The parties agreed to work toward implementation of the harmonized sales tax regime effective July 1, 2010, when Ontario's current retail sales tax (RST) will be combined with the federal goods and services tax (GST) to create a single sales tax rate of 13 percent (i.e., 8-percent provincial tax and 5-percent federal tax).

TEI commends the Province for moving to simplify tax administration by harmonizing its RST with the GST. This letter responds to your request for TEI's comments on transitional and other issues that may arise as Ontario implements the new taxing regime. We have focused on the issues you believed to be the most pressing and will address other issues in a separate letter later this year. We urge the Province to release draft language promptly to permit time for public comment and for companies to implement the new regime.

Background

Tax Executives Institute is the preeminent association of business tax executives. The Institute's 7,000 professionals manage the tax affairs of 3,200 of the leading companies in Canada, the United States, Asia, and Europe and must contend daily with the planning and compliance aspects of Canada's business tax laws. Canadians make up 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together constitute one of our nine geographic regions. Our non-Canadian members (including those in Europe and Asia) work for companies with substantial activities in Canada. In sum, TEI's membership includes representatives from most major industries including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). TEI concerns itself with issues of tax policy and administration and is dedicated to working with government agencies to reduce the costs and burdens of tax compliance and administration to our common benefit.

Temporary ITC Restrictions

The MOA provides that, during the implementation of the OVAT, large businesses will be temporarily restricted from claiming input tax credits (ITCs) on certain expenses, such as telecommunication services (other than Internet access or toll-free numbers), certain road vehicles, fuel, and energy, which includes electricity, natural gas, combustibles and steam. Further detail about the proposed restriction was provided in chapter 3 of the Ontario Budget, 2009:

Similar to the restricted input tax credit (ITC) system in Quebec, large businesses (those with annual taxable sales in excess of $10 million) and financial institutions would be unable to claim input tax credits in certain areas.

After five years, full ITCs on taxable supplies will be phased in over a three-year period.

The Institute recommends that the Province follow the model of the Maritime Provinces, which did not place temporary restrictions on large corporations for claiming ITCs. The ITC restrictions are especially disappointing in respect of financial institutions that have limited recoveries of tax. In addition, financial services should be treated as zero-rated (rather than exempt) supplies under the federal and provincial systems, just as they are treated under the Quebec sales tax regime. By failing to provide unrestricted ITCs for all supplies to businesses and by failing to zero rate financial services, the harmonization is incomplete and economically inefficient.

a. The Quebec Experience. TEI was asked to comment on the Quebec sales tax (QST) restrictions on input tax refunds (ITRs) as they apply to large businesses. Like the proposed OVAT, the QST legislation contains ITR restrictions. These restrictions are imposed under section 206.1 of the Quebec Sales Tax Act and include telecommunication services, road vehicles, and fuel, as well as certain supplies of electricity, gas combustibles, and steam.

The ITR restrictions imposed by section 206.1 have been repealed for small and medium businesses, but remain in effect for large businesses. Large businesses are defined as registrants whose value of the taxable and non-taxable supplies made in Canada by the registrant, by a person with whom the registrant is associated, or by a person whose business the registrant has continued, exceeds $10,000,000 during the last fiscal period. In this respect, the value of the supplies made in Canada must include the value of all the exports, including those deemed to be made outside Canada, but the amount of the GST, as well as the value attributable either to the sale of immovables that are capital property or to the goodwill of a business sold for which no GST is payable, must be excluded.

The efforts and controls required by large businesses to apply these restrictions are significant. Even after large investments of time and resources, compliance remains challenging. Because of the lack of clarity, companies and auditors have applied these restrictions inconsistently, spawning numerous disputes on audit.

b. Telecommunication Services

1. Application of the QST. Quebec's ITR restrictions apply only with respect to supplies of telephone service and other services of transmitting and receiving telecommunications (e.g., the right to send or receive messages over a private or dedicated line service). They do not apply to supplies of telecommunication equipment (e.g., the lease or sale of telephones, switches, servers, dark fibre, etc.).

   The ITR restrictions were introduced under paragraphs 4 and 5 of section 206.1 of the Quebec Sales Tax Act, which provided that the restrictions applied to (i) telephone service (e.g., local voice service) that was taxable as moveable property under the Quebec Retail Sales Tax Act; and (ii) a telecommunication service or any telecommunication in respect of which the tax prescribed by the Telecommunications Tax Act would apply, but for the repeal of said tax. The Telecommunications Tax Act taxed the service of sending and receiving telecommunications, other than telephone service, but did not tax equipment or other property. In practice, the Quebec Retail Sales Tax applied on the flat monthly rate for local telephone service, and the Telecommunications Tax applied on long distance and other usage-based charges for the service of sending and receiving telecommunications. When the ITR restrictions were introduced, Quebec could have restricted the right to claim ITRs on supplies...