Canada: Ontario’s New Harmonized Sales Tax: Practical Considerations for Landlords and Tenants

Copyright 2010, Blake, Cassels & Graydon LLP

Originally published in Blakes Bulletin on Real Estate, April 2010

Introduction

In March 2009, the Ontario government announced the harmonization of the provincial sales tax of 8% (the PST) with the federal goods and services tax of 5% (the GST) to create a harmonized consumption tax of 13% (the HST). Generally, the HST will apply to goods and services in the same manner that GST currently does. In other words, most goods and services on which the GST was levied will become subject to the HST. It is expected that Ontario's HST will be substantially similar to the 1997 introduction of HST in Newfoundland, Nova Scotia and New Brunswick. In anticipation of the HST's effective date of July 1, 2010, this article highlights some issues of relevance to landlords and tenants.

Input Tax Credits and the Effect of HST on Businesses

Under the current tax regime, with the exception of GST-exempt businesses, GST that is paid by a business is credited against GST that the business collects from its customers, which credit is termed an "Input Tax Credit" or "ITC." A GST-exempt business does not collect GST from its customers, and as such, claims no ITCs. GST-exempt businesses include (but are not limited to) businesses providing the following: health care and dental services; educational services; legal aid services; educational services; and child and personal care services. In addition, supplies provided by public bodies, financial services organizations (such as banks and credit unions) and charities are GST-exempt.

Generally speaking, once the HST is effective, the operating expenses of GST-exempt businesses will increase, as these businesses will be required to pay HST on their rent (and other expenses), but will continue to be ineligible to claim ITCs. On the other hand, those businesses that are currently permitted to claim ITCs (i.e., non-exempt businesses) will experience a cost savings as currently no credit is available for these businesses on PST paid on goods and services, whereas a full ITC will now be available for HST.

Practical Effect on Leases

Large businesses, defined as those with taxable sales in excess of C$10-million per annum, will be restricted from claiming ITCs on particular transactions. Specifically, until June 30, 2015 (or five years after the date of HST implementation), large businesses will not be able to claim ITCs on the 8% of the HST (i.e., what would have been the PST) that they paid for the following: food and beverages; entertainment; vehicles weighing less than 3,000 kilograms (and fuel associated with the same); telecommunications services (but not including toll-free numbers and Internet services); and energy. Instead, the ITCs for the foregoing services will be phased in during the period from July 1, 2015, to June 30, 2018, with full ITCs becoming available in 2018. In short, during the first five years following the introduction of the HST, the new ITC rules will effectively increase the cost of the foregoing products and services for commercial property owners and managers who are deemed to be large businesses. Therefore, where no ITC is available to a landlord for a portion of operating costs because the landlord qualifies as a large business, the definition of operating costs in leasing documentation should be revised to allow for the recovery of HST not available for ITCs. As a result, the HST regime will adversely affect tenants, since landlords will be reimbursed for their increased operating costs by passing the same onto their tenants.

Landlords should also ensure that all offers to lease, letters of intent, leases and other ancillary lease documentation (such as lease amending agreements) are worded such that the HST to be paid by a tenant is adequately captured. References to GST should be removed from all such documents, and definitions recrafted so that taxes are defined broadly enough to include the HST. A failure to make the foregoing changes to one's documentation is not fatal, as legislation codifies that sales taxes (including HST) must be collected on taxable items, and as such, even where a lease is silent with respect to sales tax, it is deemed to apply. However, specific references to taxes in leases are for the landlord's benefit, for if the tenant fails to pay the same, a lease default is triggered.

HST and Rent Payments – Transitional Rules

Under the new HST regime, the 13% HST will generally apply to commercial lease rent payments due on or after July 1, 2010. However, landlords and tenants should also be aware that certain transitional rules apply to rent payments made prior to July 1. In this regard, it should be noted that as a general rule of thumb, HST will also apply to rent payments made on or after May 1, 2010, if part of the rent payment relates to a lease period that begins on or after July 1, 2010. For example, a tenant who makes a semi-annual rent payment for the period May 1, 2010, to October 31, 2010, would have to pay HST for the months of July, August, September and October but not for May and June. This rule does not apply, however, if the lease period ends before July 31, 2010. For example, a tenant who makes a lease payment for the lease interval from May 15, 2010, to July 14, 2010, would not have to pay HST on any portion of the payment as the lease interval ends before July 31.

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.