Harmonization challenges

By Sania Ilahi
Illustration: Gary Clement

As some provinces get ready to introduce harmonization, businesses anxiously await clarifying legislation

With Ontario and British Columbia harmonizing their sales taxes with the federal goods and services tax, businesses are anxiously awaiting the release of the federal legislation to provide much-needed clarity to make their requisite changes to systems and business processes. While bulletins and in-formation notices issued by the Department of Finance, Canada Revenue Agency, BC and Ontario provide some comfort to taxpayers, the uncertainty created by the absence of detailed legislation means many organizations are reluctant to make significant investments in preparation until legislation is available and passed into law. Other businesses had already taken steps to change their information systems based on the existing harmonized sales tax (HST) place of supply rules when sweeping changes were announced on February 25, 2010. The changes to the rules are dramatic and significantly alter the existing rules that have been in place for almost 13 years. While the proposed rules provide more clarity, uncertainty remains because these proposed changes are not yet law and further amendments are not out of the question. This article addresses some of the changes to the proposed place of supply rules, specifically as they relate to the supply of services.

Place of supply rules are used to determine whether, and at what rate, suppliers must charge sales tax on their supplies of property and services. The original place of supply rules vary depending on the type of supply, e.g., tangible personal property, services or intangible personal property (IPP). In the case of sales of tangible personal property, the applicable tax rate depends on where goods are delivered or made available — and if you arrange the freight for those goods to be shipped to another province, the tax rate of the destination province applies — even if legal title of the goods passes where the goods leave a shipping dock in the supplying province.

The prior rules in respect of services and IPP were more complex and largely based on where the services are performed or where the IPP could be used. Most services (with specific rules for transportation services, postage and telecommunication services) are considered to be made in a province (and therefore subject to the GST/HST rate in that province) if 90% of the service is performed in that province. If that condition is not met, one must consider whether 10% of the service is performed in a province and the contract for the supply is negotiated in that province, or failing that, whether at least 50% of the service is performed in that province and the contract is negotiated outside Canada.

These cumbersome rules placed considerable reliance on the jurisdiction in which the services were performed with no need to consider the location of the recipient of the supply. Where services were performed exclusively (or more than 90%) in a single jurisdiction, the rules were relatively straightforward to administer. However, where services were performed in multiple jurisdictions, the place of supply largely rested on where the contract for the supply was negotiated. As a result of these rules, suppliers faced challenges when determining the applicable tax rates, and recipients in nonharmonized provinces often paid HST on services acquired from suppliers in the harmonized provinces. Existing rebate pro-visions provide some relief to recipients of nonharmonized provinces in respect of the provincial component of the HST paid on services to the extent those services are consumed outside the harmonized province. However, the rebate provisions were not well known and could be difficult to administer, with the result that the recoverable provincial component of HST paid by recipients in nonharmonized provinces was often not recovered.

To address some concerns resulting from the different GST/HST rates (12% in BC, 13% in Ontario, New Brunswick and Newfoundland and Labrador, and 5% in the remaining provinces and territories. Nova Scotia has announced a 2% increase, to 15%, as of July 1) and the obligation of suppliers to collect the appropriate amount of tax, the general proposed place of supply rules focus on where the recipient of the service is located rather than where the service is performed. It should be noted that while these general proposed rules apply to most services, the current specific place of supply rules for specific services including transportation, postage and telecommunications are being maintained, and a host of additional specific services will, as noted below, have specific place of supply rules.

The new rules propose that the applicable sales tax rate de-pends on the province in which the address of the recipient of the supply is situated. This eliminates the requirement to determine where the service is actually performed or to track where the contracts were negotiated. In situations where the address of the recipient is unknown, the applicable tax rate shifts to that of the province in which the service is performed. If a service is performed in multiple provinces, the supply will be considered to have been made in the province in which the greatest proportion of the service is performed. The above rules do not apply to specific services, such as a supply of a service in relation to real property, which will be regarded as having been made in the province in which the real property to which the service relates is situated. Similarly, a supply of a service in relation to tangible personal property will be deemed to have been made in a participating province in which the greatest proportion of the tangible personal property is situated. Other services which have specific place of supply rules are:

services rendered in connection with litigation,
services supplied on board conveyances,
customs brokerage services,
repairs, maintenance, alterations and other services relating to goods,
services of a trustee in respect of certain trusts,
certain telephone services,
air-navigation services, and
computer-related services and Internet access.

The proposed changes to the place of supply rules are effective for supplies made as of May 1, 2010, and to supplies made after February 25, 2010, and before May 1, 2010, if the consideration for the supply has not become due and has not been paid be-fore May 1, 2010.

The proposals also include changes to the rules relating to self-assessment requirements and rebates of the provincial component of the HST on property and services brought into or removed from a harmonized province.

The proposed place of supply rules that use the address of the recipient to determine the applicable tax rate will be easier for some businesses to administer. They also create unexpected situations where a service is performed, for example, entirely in Ontario (where the HST rate will be 13%), but because the client has a BC head office mailing address, the 12% BC HST rate will apply. While suppliers generally welcome the clarity and simplification, many are concerned that significant changes continue to be proposed at such a late date and the actual legislation has not yet been implemented. Significant amendments that relate specifically to the financial-services sector (a sector heavily impacted by HST) are still expected. Early release of legislation will notably lessen taxpayers’ concerns and provide the much-needed certainty that will allow taxpayers to finalize their critical business process and systems changes required to accommodate sales tax harmonization and the new place of supply rules.

Sania Ilahi is a senior manager, indirect tax, with Ernst & Young in Toronto

Technical editor: Trent Henry, tax managing partner, Ernst & Young