The long-awaited panacea?

By John Drysdale
Illustration: Blair Kelly

As the CRA challenges offshore trusts, many cases and appeals are working their way through the judicial system

With the introduction of a harmonized sales tax (HST) in Ontario and BC on July 1, 2010, the concept of a national value-added tax in all provinces may someday become a reality. After the goods and services tax (GST) replaced an antiquated and regressive federal sales tax in 1991, Quebec was the first province to mothball its existing retail sales tax system in favour of a GST-like Quebec sales tax (QST). In 1997, New Brunswick, Nova Scotia and Newfoundland and Labrador adopted a value-added tax structure that became known as the HST. Twelve years later, Ontario and BC deemed it the right time to extend the HST to their respective provinces, with some minor differences for political effect.

For the past 18 years, the GST and its provincial look-alikes have been the cause of much political debate. Supporters of a value-added sales tax structure argue that such a tax has numerous advantages, including:

fundamentally, it is the most economy-friendly form of sales taxation. It promotes investment in the manufacturing sector and does not adversely affect the export sector since it generally does not allow for sales tax to be hidden in the cost of inputs to the manufacturing or ex-port process;
since its inception, it has been a constant and consistent source of revenue for the federal government, regardless of the state of the economy;
it is designed to be a simple, broad-based and therefore efficient tax, allowing for a flow-through of taxes payable and taxes recoverable, with any resulting tax refunds being paid quickly. Because it is broad-based, it also allows for reduced collection efforts, resulting in lower collection costs per dollar of tax than other forms of commodity taxation; and
its resulting reduction in the current investment in know-ledge and training that multiple retail sales tax systems require will lead to measurable cost savings.

Those against such a tax structure offer the following opposing arguments:

the tax base is too broad and affects consumers adversely;
the tax structure is flawed and unfairly affects certain industries, such as the financial services sector; and
the nature of the accounting for the tax by registrants, with the potential for inappropriate refund of net tax, has resulted in an increased incidence of fraudulent activity over recent years, which in turn has reduced the inherent efficiencies in the tax as legitimate refund claims are held pending audit.

In spite of the ongoing debate, the current political climate appears to favour the adoption of a commodity tax system that is harmonized with the federal GST. As further evidence of the benefits of such a tax structure, proponents point to actual and well-documented experience in New Brunswick, Nova Scotia and Newfoundland and Labrador, where the shift to HST, though not immediate, resulted in a reduced overall tax and administrative burden. Because the tax in Ontario and BC will be quite similar, there is no reason to believe that the result will be different. If so, is it just a matter of time before we have all provinces jumping on the bandwagon?

Though the theory behind HST strongly supports its adoption by each province in Canada, the reality is that such radical change in sales tax structure is a political uphill battle, as we witnessed in Ontario and, more particularly, in BC. Regardless of the politics, experience suggests the adoption of a true HST across Canada, with as few differences as politically feasible, would result in a sales tax landscape that would be cheaper, easier and more efficient to administer.

The implementation of HST in Ontario and BC will have a significant effect on all GST registrants in Canada and abroad. Because its application will be directly tied to the existing GST, all GST registrants will be required to consider and plan for its application on July 1, 2010.

This includes implementing significant changes to systems and processes and consideration of numerous operational issues, including its effect on current collection and input tax credit mechanisms, budgeting and operational cash flows, sales and purchasing systems (including IT changes), transaction documentation, human resources, education and training and external communication with customers. As CAs, many of us will be called upon to assist in resolving the operational issues in a manner that will ensure the proper implementation and administration of this new tax structure.

The following commentary outlines the more significant issues GST registrants will face in their implementation initiatives. Although not exhaustive, it should raise awareness of the magnitude of the initiative and assist in development of an implementation plan to address individual needs of GST registrants.

Collection and input tax credit (ITC) mechanisms
For GST registrants, the collection and ITC mechanism within the organization should already be well established. What will change with HST is the rate of tax charged and collected on sales (5% federal component plus 8% Ontario provincial component or 7% BC provincial component) and the amount of HST recoverable as an ITC on purchases. Although most HST paid by organizations will be eligible for an ITC, similar to the QST, partial ITC restrictions will apply on the purchase of certain goods and services. The treatment of these tax rate changes and restricted input tax credits within the organization’s accounting and reporting systems will need to be addressed.

Budgeting and operational cash flows
The effect of sales tax harmonization on organizational budgeting and operational cash flows will depend on the nature of the organization’s activities and the extent to which retail sales tax has been a cost to the organization in the past. From a budgeting perspective, it will be necessary to determine to what extent the organization may have paid unrecoverable retail sales tax on purchases made prior to July 1, 2010 versus purchases made with either 100% recoverable or partially recoverable HST paid subsequent to that date. The result of this exercise will likely have some effect on an organization’s product/service pricing after implementation date.

From a cash flow perspective, a higher rate of tax collected on sales will have an adverse effect on cash flow to the extent that the tax is remitted to the Canada Revenue Agency prior to being collected from the customer. There may, however, be certain mitigating strategies where ITCs can be claimed for HST paid on purchases prior to the payment of supplier invoices.

Sales and purchasing systems
Determining when and where a sale takes place dictates whether tax is applicable and at what rate. It will be critical to the implementation process to familiarize yourself with new transitional and place of supply rules in Ontario and BC to be able to properly apply the correct rate of tax both during the transition period and subsequent to June 30, 2010.

From a purchasing perspective, the timing of purchases will become critical because of an organization’s ability to recover HST versus a current unrecoverable retail sales tax. The decision to defer otherwise taxable purchases for retail sales tax purposes may have a material effect on operations.

From an IT perspective, significant changes will be required to the billing and accounts receivable systems and the purchasing and accounts payable systems. Tax tables, point-of-sale equipment and tax status of products and services will need to be addressed, as will tracking of various rates of tax and the federal/provincial components of HST to enable the capturing of restricted ITCs.

Transaction documentation
Documentation requirements are quite strict under the existing GST/HST legislation. In order to comply with these requirements, sales invoices, purchase invoices, purchase orders, ex-pense reports, etc. will require alteration. Existing contracts that straddle the implementation date will require review to determine the impact of HST and whether there is a need for amending or clarifying wording. Any new contracts should be drafted to properly consider the HST.

Human resources
For most organizations, human resources will be involved in the implementation process on a number of levels. In the short-term, there will be a need to determine whether additional staff is required to ensure that implementation deadlines are met. It will also be necessary to review internal policies to determine whether any changes are necessary, particularly in the areas of expense and taxable benefit reporting. Training materials will also be needed to enable all staff to understand and apply the new tax structure in the various departments. In the longer-term, staffing needs may be reduced because of the efficiency of the tax structure.

Education and training
Because all facets of an organization are affected by sales taxes, the benefit of proper organization-wide education and training for sales tax harmonization is a reduction in costly errors, surprises for overlooked issues and potential future audit exposures. Assembling the right individuals to develop and deliver the training programs will ensure that errors and surprises are minimized down the road.

External communication
A shift in sales tax structure of this magnitude will create confusion for customers. To minimize this, clear messages will be necessary to ensure they understand what sales tax changes will result from harmonization. As a general rule, customers will be expecting price reductions from their suppliers since suppliers will no longer be paying unrecoverable retail sales tax on purchases that would otherwise have been incorporated in their sale price. Communicating price reductions or lack thereof with timely explanations will mitigate any potential damage to customer relationships.

In summary, the above commentary outlines the more significant issues that all GST registrants will face in their implementation initiatives. There are, however, many other issues to consider before an organization is harmonization ready. These will vary by organization and will only be identified if the proper effort is put forth in the implementation planning process.

Admittedly, it will take some time before sales tax harmonization is proven to be the cure-all for the illnesses in the current federal and provincial sales tax regimes in Canada. In the next six to 12 months, many of us will wonder whether the ultimate destination will in fact be worth the journey. Further complicating the issue are a number of provinces sitting on the fence and leaning the other way, suggesting that a national value-added-tax may not be as imminent as we think. We are, however, two provinces closer than we were just a year ago.

John Drysdale, CA, is a principal with Brendan Moore & Associates, a sales tax consulting and recovery firm in Oakville, Ont. He can be reached at jdrysdale@brendanmoore.com

Technical editor: Brigitte Alepin, M.Fisc., MPA, CA, president of AGORA