Canadian Indirect Tax News, May 2006
06-4

Rate reduction announced!
As was widely anticipated, the Conservative government announced a general reduction in the rate of the goods and services tax (GST) in its 2006 budget, tabled on May 2, 2006.

Effective July 1, 2006, the GST rate will fall from the current 7% to 6%. At the same time, the current harmonized sales tax (HST) will fall from 15% to 14%. Consequent amendments have also been made to ensure that the GST tax fraction falls from 7/107 to 6/106 (and the HST equivalent from 15/115 to 14/114), as would be expected.

It should be noted that until the budget is passed all of the planned measures are just proposals.

Tax integrity maintained
To protect the integrity of the tax system and to prevent abusive transactions between non-arms-length parties, new anti-avoidance measures have been announced to cover the transition from 7% GST to 6% GST.

Transitional measures
Certain transitional rules have been announced to ensure that the new reduced GST rate applies to all property and services supplied on or after July 1, 2006.

Generally:

• If GST becomes payable on or after July 1, 2006, without having been paid before that day, the new rates will apply.
• If GST is paid on or after July 1, 2006, without having become payable before that day, the new rates will apply.
• If GST becomes payable or is paid before July 1, 2006, the old rates will apply.

The general timing rules to determine when GST is due on supplies (including deemed supplies) are not impacted by the new measures; therefore, the earlier of payment date and invoice date will determine the time of the supply and hence the rate to use.

Residential property
There are a number of specific transitional rules applicable to sales of residential real property. Essentially, GST at 7% will apply to all agreements entered into on or before May 2, 2006*, regardless of when ownership or possession is transferred or when consideration is paid. (However, purchasers of residential properties may claim a transitional rebate in addition to the regular new housing rebate).

Continuous supplies
As the new rate will be applied based on the invoice date, there will be no need to apportion any bills for services (e.g., hydro, cable, etc.) that straddle July 1, 2006. In addition, lease payments made after June 30, 2006, will also reflect the new GST rate.

Financial institutions and imported taxable supplies
Under a proposed measure announced on November 17, 2006, financial institutions are required to apply a new formula to self-assess GST on imported taxable supplies on an annual basis. Under the budget measures, financial institutions with taxation years beginning before July 1, 2006, will be required to determine the number of days before July 1, 2006, to the total days in the taxation year, and must use the 7% rate on this portion and the 6% rate on the remainder.

Taxable benefits/partner rebates
Because these measures come into effect half-way through the benefit year, the GST rate for calculating taxable benefits and partner rebates will be 6.5/106.5 for the 2006 taxation year (14.5/114.5 in the harmonized provinces) and 6/106 (14/114) for subsequent years.

Businesses in general
Most businesses will not be affected by the rate change in the long term; however, in the short term even registrants engaged exclusively in commercial activities may encounter issues in implementing the change. It has been estimated that the actual cost of implementing the rate change is approximately $600 per business.

Retailers will likely face significant pressure to reduce prices now if they want to encourage consumers to purchase items in advance of the rate reduction, particularly big ticket discretionary items.

Revised remittance rates have been proposed for small business that use streamlined accounting. Generally, business using streamlined accounting will lose out slightly.

Businesses engaged mainly in exempt activities will see the benefits of the rate reduction, in that they will be paying less non-recoverable GST overall.

Individuals
The reduction of the GST rate will result in direct savings to consumers; however, as most monthly expenses are not subject to GST (e.g., mortgage repayments, insurance, basic groceries, day care, property tax, etc.) the total savings will likely not be that great. Consumers will only save on taxable expenses (e.g., hydro, gas, telecommunications, car leases and running costs, etc.). More substantial savings will be made by consumers who choose to purchase big ticket items such as cars, new houses and appliances after July 1, 2006. The rate reduction means that consumers will save $100 for every $10,000 spent on taxable purchases. However, if consumers finance the purchase of the big ticket items, the actual monthly savings are likely to be negligible.

New housing and other real property
Purchasers of new houses are eligible for a rebate of approximately 36% of the GST payable to the builder. This percentage rebate is not affected by the budget measures, but due to the lower rate, the total amount of rebate available will drop from $8,750 to $7,560. The fair market value at which rebates are phased out will not change. However, the threshold is raised for purchasers of shares in a housing corporation and for the rebate for building only.

Anyone who is required to self-assess GST on new or substantially renovated real property and who can legitimately delay reaching substantial completion or giving possession to an occupier can likely benefit from the rate reduction in that the 6% rate will apply in place of the 7% rate.

Public sector bodies
The rebate rates available for eligible public service bodies will not change; therefore, as with financial institutions, public sector bodies will benefit from a reduction in the GST rate. For example, a registered charity that currently incurs $50,000 in GST per annum will see an overall annual reduction of non-recoverable tax of approximately $3,500.

Public sector bodies that use the special quick method to calculate their net tax remittance will see a reduction in the remittance rate in line with the rate reduction. For example, the remittance rate for an Ontario hospital authority will be reduced from the current 6.2% to 5.4%. An Ontario hospital authority that makes $100,000 in taxable supplies generates an additional $366 in revenues using the current rates, but this will fall to just $276 using the new rates.

Public sector bodies that revoke the election to tax otherwise exempt real property revenues after May 2, 2006, will no longer base the self-assessment requirement and the resultant GST recapture on the fair market value. Instead, the GST amount will be based on the basic tax content, to reflect the GST rate applicable at the time the election was made. This may, in some cases, increase the cost.

Changes to penalties and interest “Administrative Amendments”
A number of additional measures were announced with the rate reduction, as follows:

• The current 6% penalty for failing to pay or remit GST when required will be removed, but interest will be charged based on Treasury Bill rates, rounded up to the next percentage point, plus 4% instead. Currently, there is little difference in these two rates.
• There will also be a new late filing penalty of 1% of the return balance plus 0.25% for each complete month to a maximum of 12 months (i.e., a maximum of 4%).

None of these amounts will be deductible for income tax purposes. These measures will be implemented in respect of tax years that begin on or after the implementation date, which is the later of April 2007 and Royal Assent. It is not clear how the foregoing changes will impact the voluntary disclosure program.

In addition to the foregoing:

• There is a proposal to restrict the payment or offset of all refunds or credits under all federal tax acts, other than Child Tax benefit payments, until all required returns have been filed.
• The Minister is no longer required to wait 90 days from the date of a Notice of Assessment to commence collection by way of deduction or set-off.
• Where the Minister extends the filing deadline, penalty and interest will not commence until after that extended date.
• The penalty on demands will be standardized at $250.
• Interest repayable to a taxpayer on previously remitted penalty and interest subsequently cancelled under a fairness request now accrues from 30 days after the date of the request.
• The intention is to harmonize interest and penalty provisions across federal tax statutes.
• The existing regime would be substantially phased out by approximately April 2012.

Other taxes and levies
Alongside the GST rate reduction, a number of other measures were announced, including:

• The repeal of excise tax imposed on jewellery was announced effective May 2, 2006.
• Excise levies on tobacco and alcohol have been increased to offset the reduction in the GST. However the levy on alcoholic products produced by small Canadian brewers and vintners has been reduced.

Footnote:
*There appears to be a conflict in the published materials, in that the proposed legislation appears to refer to all real property whereas the accompanying draft legislation appears to restrict these rules to residential properties. We have not yet obtained clarification from Finance on this issue.

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