Canada: Real Property And The Harmonized Sales Tax In Ontario

The Ontario government announced in its March 26, 2009 budget that it plans to harmonize the 8% Ontario retail sales tax (RST) with the 5% federal goods and services tax (GST) to form a 13% harmonized sales tax (HST), effective July 1, 2010 (the "Implementation Date"). The HST will generally apply in the same manner as the GST to goods and services provided in Ontario, including to supplies of real property.

THE CURRENT REGIME

Currently, the sale of real property in Ontario is subject to GST but is not subject to RST. Thus, while builders must pay unrecoverable RST on building materials used in the construction process, and many other supplies (which the Ontario government estimates to account for approximately 2 to 3% of the final sale price of a new home), builders do not charge RST on the sale of the property.

THE NEW REGIME

New Residential Properties

New homes sold for more than $400,000 will generally be subject to an increase in tax under the harmonized sales tax, with homes sold for more than $500,000 being subject to a significant increase in tax. Under the HST regime, the cost to build a new home will decrease, since builders will now be able to claim credits for all of the sales tax they pay on their inputs, however, the sale of these new homes will now be subject to an additional 8% tax. Ontario has proposed a rebate of 75% of the Ontario portion of the HST (i.e. 6%) for new homes sold for under $400,000. This, combined with the decrease in the building costs, which Ontario assumes will be passed on to purchasers, means that new homes sold for under $400,000 should be effectively taxed at the same rate under the HST as they were under the RST regime.  However, the Ontario rebate begins to be phased out at $400,000, and disappears entirely at $500,000. Thus, assuming again that the builder passes the 2% savings on to the purchaser, under the new regime new homes sold for more than $500,000 will effectively be subject to an additional tax of almost 6%.

Federal statistics from 2008 indicate that roughly 23% of new homes in Ontario sold for between $400,000 and $500,000, while roughly another 23% sold for over $500,000. Thus, almost 46% of new homes in Ontario will be subject to a tax increase. These numbers will be even higher in the Toronto market.

  • EXAMPLE 1: NEW HOME - $400,000

    A new home with a price tag of $400,000 will benefit from an HST rebate that should operate in the same way as the current GST new housing rebate. If, as the government predicts, the builder passes on the 2% savings to the purchaser, the $400,000 home will sell for $392,000. HST will be payable on the new home at the rate of 13%, for a total of $50,960 of HST.  The Ontario component of the HST on the home will be $31,360. Under the proposed rebate program, the purchaser will receive a rebate of $23,520 (75% of $31,360) for the provincial component, and a GST new housing rebate of $3,654. Thus, the purchase price of the home which previously would have sold for $416,850 ($400,000 plus $20,000 of GST minus a GST rebate of $3,150) will be $415,786 ($392,000 plus $50,960 of HST minus $23,520 of Ontario rebate, minus $3,654 for the GST new housing rebate). If we assume that builders will pass all of their cost savings to purchasers, a $400,000 home will actually cost slightly less under the new regime.
  • EXAMPLE 2: $1,000,000 NEW HOME

    A new home with a selling price of $1,000,000 will be subject to an additional 8% of tax under the HST regime. If, as the government predicts, the builder passes on the 2% savings ($20,000) to the purchaser, the purchaser will pay $1,107,400 ($980,000 plus $127,400 of HST) for a home which previously would have cost $1,050,000 ($1,000,000 plus $50,000 of GST). The net effect under the above assumptions is an increase in the price of the house of $57,400.

    As most builders want to sell residential properties inclusive GST or HST and after providing for the GST/HST rebates, which are generally assigned to the builder, it is imperative that builders review their agreements to make sure that if title and possession of the new home transfer after July 1, 2010, the agreement is clear that the HST has properly been worked into the purchase price. The agreements will also need to be reviewed to ensure that the vendor can obtain all of the relevant rebates, and not merely the GST new housing rebate.

Commercial Properties

Both the purchase and rental of commercial property will also be subject to an increase in tax under the HST regime. When a GST registrant purchases commercial property, we expect that they should be able to self-assess the HST in the same manner as currently applicable for GST. Businesses that can claim input tax credits should be able to recover the full 13% HST, and could end up saving money in the new regime if vendors pass on their RST savings to the purchaser. However, the additional tax is a significant issue for businesses engaged in GST exempt activities such as banks and insurance companies. Since these businesses are generally unable to claim full input tax credits, the rental or purchase of commercial property by these parties will result in up to an additional 8% of tax applying to the price.

HST TRANSITIONAL RULES

While the Ontario government's announcement of the HST included broad information on the general structure of the tax, the government has yet to specify many of the details, including any transitional rules it will implement in order to transition between the RST and the HST regimes. For instance, we do not know how the government plans to treat real estate transactions that straddle the July 1, 2010 date of implementation of the HST. We understand that Ontario is currently consulting with taxpayers, and that it will likely implement transition rules in the near future.

Transition rules are necessary to make sure the new system works, as absent transition rules, tax harmonization could yield unfair results in some situations. For example, absent any transitional rules, a builder who completes a project prior to July 1, 2010, but sells the project after July 1, 2010, will have paid unrecoverable RST on its building materials yet will have to charge the purchaser the full HST. Double taxation will also arise, though to a lesser degree, in situations where construction is partially completed prior to, but the property is sold after, July 1, 2010. 

Transfer Of Ownership Or Possession before July 1, 2010

GST is generally payable on a taxable sale of real property on the earlier of the day possession or ownership transfers to the recipient. When the HST was first implemented in Nova Scotia, New Brunswick and Newfoundland (the "Harmonized Provinces") a transition rule was implemented which provided that the provincial component of HST was not payable where either ownership or possession transferred prior to the date of implementation. Although it is not certain, we would expect that the same time of liability rule should apply to the implementation of the HST in Ontario such that HST should only apply where ownership and possession of a property transfer after July 1, 2010.

Possible Transition Rules And Rebates

When the HST was implemented in the Harmonized Provinces on April 1, 1997, these provinces offered a partial rebate in certain cases where a residential property was partially built by April 1, 1997 but where ownership and possession transferred after this date. The purpose of the rebate was to avoid the double taxation of residential units where the builder had paid unrecoverable provincial sales tax, but the purchase paid HST. Builders were eligible for rebates based on an estimate of the RST content  of the property and the percentage of completion by April 1, 1997. The builders had to claim the transitional new housing rebate before January 1, 1998.  These rebates only applied to residential and not commercial properties.

A grandfathering provision was also created when the HST was implemented in the Harmonized Provinces under which sales of residential units and condos to individuals were not subject to the provincial component of the HST if the individual and the supplier entered into a written agreement to sell the property on or before the "announcement date" of the technical changes to the HST. This date was not the date when the provinces announced that they were harmonizing their sales taxes with the GST, but rather was approximately 6 months later when the technical changes to the legislation were finally announced. It should be noted that where this grandfathering rule applied, the builder was not able to claim any input tax credits for the provincial portion of any HST paid on construction costs.

If Ontario creates similar transition rules to the Harmonized Provinces it is not certain when they would become effective, although it is very likely they would be effective on or after March 26, 2009, and on or before the future date when the technical changes are released. While there is no guarantee that Ontario will offer the same rebate for residential properties, or that the same or a similar grandfathering rule will apply, these rules and rebates give us insight as to what was done in the past, and an indication of what Ontario may choose to do in the future.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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