The Ontario and British Columbia versions of the "harmonized" sales tax have adopted a feature of the Quebec Sales Tax ("QST") by limiting the right to input-tax credits for large businesses with annual sales of $10 million or more as well as financial institutions. In the '90s, when Quebec introduced this idea, it was motivated partly by the fear of loss of revenue from the replacement of a single incidence retail sales tax by a value-added tax. At the time 40% of Quebec's revenue from its retail sales tax was generated by sales of gasoline and fuels. The government feared a possible temporary loss of revenue if registrants could recover as input-tax credits all the tax paid on their purchases of fuels.
Accordingly, a "temporary" ban on ITCs was introduced for purchases of motor-vehicles (other than those exceeding 3 000kg), fuels for vehicles ( other than diesel), energy products such as oil, gas, steam and electricity (other than that used in the production of goods for sale), telecommunication services (other than toll-free services and Internet access) by large businesses. The limitation also extends to "meals and entertainment" expenses (with the exception of those not subject to the 50% income tax "clawback"). In Quebec this "temporary" limit on ITCs became permanent. It is worth remembering that most taxes including income and sales taxes were generally introduced as temporary measures; they tend however to become permanent..... The Ontario and BC versions of the HST follow Quebec's lead and also implemented these "temporary" restrictions on ITCs for large businesses. Apparently, theses restrictions will be phased out over a five-year period. We will see if history repeats itself.
Administrative nightmare
This limitation to input-tax credits greatly complicates administration of sales taxes by the subjected "large enterprises" as it is becomes necessary to code all purchases to determine whether or not the tax paid on the purchases is recoverable or not. Analysis and proration often becomes necessary; for example manufacturers must segregate the portion of electricity used in production activities (but not including lighting and heating of production areas) from their total purchases to accurately compute their ITCs on admissible electricity purchases.
In Quebec, large businesses simply do not claim ITCs on purchases of goods covered by ITC restrictions under the QST legislation. However, Ontario and BC HST further complicates the matter. Indeed, it is not allowed to simply not claim back the tax on restricted purchases. Large businesses must initially declare ( or claim) ALL their input-tax credits and "RECAPTURE" or identify and deduct the amount of ITC subject to the restriction in another section of their mandatory electronic declaration and return. While this has the same effect as not claiming the tax at all it is seemingly necessary in order to allow CRA to determine the accurate portion of the HST to pay to the Ontario and BC governments. Failure to follow the correct procedure will result in interests and penalties.
Moreover while businesses are allowed four years to claim their ITCs (and are therefore not required to claim them in the first period when they become available), this is not the case for "recaptured" ITCs; such recaptured ITCs MUST be declared in the actual period where they first become available or penalties and interests will apply. These requirements significantly increase the administrative burden for businesses subjected to ITC restrictions.
We would also add that businesses with operations across the country and centralized accounting centers will need to modify their accounting systems to tract provinces where purchases are actually made in order to be able to correctly "recapture" BC and Ontario restricted ITCs.
Planning in advance
HST becomes effective on July 1. That's only four months away. It leaves little time to determine what has to be done in terms of system modifications, personnel training ect... This is a challenge for all GST/HST registrants but much more true for large businesses subject to ITC restrictions since they must not only address tax collection issues but also modify purchases systems and sales tax accounting procedures. For instance, it becomes necessary for manufacturers to monitor and segregate energy consumption. Different sales tax codes must apply to gasoline and diesel purchases. Telecommunication costs must be closely monitored to determine which expenses are subject to recapture. If goods are subject to ITC restrictions it also becomes necessary to determine actual province of purchase.
Where proration is necessary, the law allow uses of "proxies" or predetermined rates by industry; it is also possible to administratively use constant "factors" ( for example X % of electricity purchases) in each declaration or return to calculate "recaptured" ITCs as long as the amount of "recaptured" ITC by use of the factors is reconciled at year-end with actual expenses. Accordingly, it may not be necessary to determine electricity actually used in production activities on a MONTHLY basis. From the information provided to date, it is important to note that use of such "proxies" or "factors" appears to be only permitted if an ELECTION to that effect is made before the subject period which statutorily runs from July1 to June 30. Do note also, that "reconciliation at year-end", means the subject period, i.e. the July 1 to June 30th interval and not the fiscal or calendar year-end. Accordingly it appears that use of these simplified method may require an election to be made before July 1. While CRA has released little information on these matters, The Ottawa Tax Examiner will keep you posted on further developments.
GST and HST are not simple matters. ITCs restrictions significantly renders the system even more cumbersome. The existence of different rules for Ontario, BC, Quebec and the maritime provinces also further fogs the issue. PLEASE consult your friendly sales tax adviser before implementation date or the new HST may indeed cost your business dearly.
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