2006 Federal Budget Update: Transitional Issues to Consider for the Reduction
May 2006
Release No: 06-03
As we’ve all heard by now, the GST rate will be reduced from 7% to 6% effective July 1, 2006. Although such a change to an income tax rate is generally straight forward to implement, many more complications arise from a change in a sales tax rate. In this Fast Fact, we’ve addressed some common implementation and transitional considerations that you’ll need to deal with in respect of the GST rate reduction as a supplier of goods or services or as a recipient of such supplies. For more detailed information, the Canada Revenue Agency (CRA) has released a lengthy question and answer summary on their website at http://www.cra-arc.gc.ca.
In this summary, any reference to GST includes the federal component of the HST unless noted, and we will refer to the HST specifically where needed. Consequently, a reference to a 6% or 7% GST rate can be read as a reference to a corresponding 14% or 15% HST rate. In addition, for the sake of brevity, any reference to June 30th and July 1st is a reference to June 30, 2006 and July 1, 2006 unless otherwise noted.
General Transitional Considerations
The general transition rule is fairly straight forward, and is as follows:
- If GST becomes payable on or after July 1st, without having been paid before that day, the 6% GST rate will apply.
- If GST is paid on or after July 1st, without having become payable before that day, the 6% GST rate will apply.
- If GST becomes payable or is paid before July 1st, the 7% GST rate will apply.
Clearly, the critical time frame for most transactions is when the GST becomes payable on a transaction or event. Having said that, the rules that determine when GST becomes payable have not changed. The following is a brief summary of these rules:
- GST related to a supply is usually payable on the earlier of the date payment is made for the supply or the date the supplier issues an invoice.
- If there is an undue delay in issuing an invoice, GST becomes payable when the invoice would have been issued if there had been no delay.
- If a transaction is governed by a written agreement, GST will be due at the earlier of the date of an invoice or the payment date under the written agreement.
- For taxable leases, licences or similar arrangements under a written agreement, GST is payable on the earlier of the date the payment is made or the date it is required to be made under the agreement (assuming no invoices are issued).
- For imports, GST is payable on the date the good was imported, or the date the good was released from customs control, if later.
- Where the GST rules deem a supply to have been made, the date of the payment or other triggering event giving rise to the deemed GST will be the relevant date for determining when GST becomes payable.
In addition, if GST is not otherwise payable by the last day of the calendar month after the calendar month in which any of the following events takes place, it becomes payable on that day:
- in the case of a sale of tangible personal property, other than a sale referred to below, the buyer acquires ownership or possession of the property;
- in the case of a sale of tangible personal property on approval, consignment, sale-or-return basis or similar terms, the buyer acquires ownership of the property or re-supplies it to someone other than the seller; and
- in the case of a supply under a written agreement for construction, renovation, alteration or repair of real property, or of a ship or other marine vessel when the work is reasonably expected to last more than three months, the work is substantially completed.
If you are unsure of the date GST becomes payable for a particular transaction, contact your BDO advisor.
As mentioned, it does appear that the period to which a good or service actually relates will not always be relevant. For example, if an organization charges a taxable fee to customers on June 1st for services rendered from July to December 2006, the charge will still be subject to the current 7% rate even though the service is rendered after the effective date. Here are some additional observations on common transactions:
- Where a customer takes possession of goods before July 1st (say June 1, 2006) under a promotion that defers payments to a future period (say January 2007), GST will be due on June 1, 2006 at 7%.
- Where goods are purchased under a layaway plan, and payments are made before and after July 1st, the payments made after June 30th will be subject to GST at 6% while the payments made before July 1st will be subject to GST at 7%. The consequences of a conditional sale contract will be similar.
- For coin-operated vending machines, the critical date will be when the coins are removed from the machine. Deferring (where feasible) that event until after June 30th will result in that supply being subject to GST remittable at 6%.
- Where services are invoiced after June 30th for work done prior to July 1st, the 6% rate will apply. The 6% rate will also apply where the services are invoiced after June 30th and are in respect of services performed both before and after July 1st. As mentioned, rules do apply where there is an undue delay in invoicing.
- Where a non-refundable retainer is collected before July 1st for services to be provided after June 30th, the retainer payment will be subject to GST at 7%. The same conclusion applies to ticket sales, prepaid magazine subscriptions and other prepaid goods or services.
- Deposits are not considered to be a supply until they are applied, and therefore, where a deposit is made before July 1st for a sale after June 30th, the entire supply will be subject to GST at 6%.
- For equal billings arrangements, payments made or due before July 1st will be subject to GST at 7%, and subsequent payments will be subject to GST at 6%. Note that the rules will vary where reconciliations are done, and reference should be made to the CRA summary mentioned earlier.
Treatment of Coupons, Price Adjustments and Returns
The underlying principles just discussed are consistent with the treatment of goods returned by customers, in that the GST rate will be governed by the original sale date. For example, if a customer returns a good after June 30th that was purchased before July 1st and exchanges that good for an identical product, there will be two transactions:
- the refund of the purchase price of the returned good will include the 7% GST that the consumer paid, and
- the new good taken will be a post-June sale, taxable at 6%.
For retail operators, these transactions may be difficult to deal with given that the rates in question differ.
Similarly, for price adjustments after June 30th, the GST consequences will depend on when the actual sale took place and the GST rate that applied to the sale.
With respect to coupons, when a supplier redeems coupons that were accepted by a retailer on or after July 1st, the rate of GST will be reduced from 7% to 6%, and therefore the tax fraction of the coupon value will be reduced from 7/107 to 6/106 (for HST, the fraction will decrease from 15/115 to 14/114). For coupons issued by retailers, this reduces the amount on which GST is calculated. The coupon will not have an impact on the GST rate determination. That is, when you treat a non-reimbursable coupon as reducing the value of the consideration before the GST is calculated, you do not have to deal with tax fractions.
GST Included Supplies
Some goods and services are provided on a GST-inclusive basis. For example, taxi fares are charged at a rate that includes GST. The date the amount for the supply was charged will be the critical time frame. For instance:
- For amounts charged before July 1st, 7/107ths of the total charge must be remitted (15/115ths for HST) by the supplier.
- For amounts charged after June 30th, 6/106ths of the total charge must be remitted (14/114ths for HST) by the supplier.
Input Tax Credit and Bad Debts
Except where special rules apply, input tax credits (ITCs) will remain equal to the amount of GST that was paid on an invoice – either 6% or 7% of the supply. If you use the simplified method for calculating ITCs (which is generally only available for purchases used to generate taxable supplies), you will have to track purchases before July 1st and purchases after June 30th to ensure the correct ITC is claimed. ITCs can be claimed on supplies as follows:
- Subject to GST before July 1st – 7/107ths of the total cost.
- Subject to HST before July 1st – 15/115ths of the total cost.
- Subject to GST after June 30th – 6/106ths of the total cost.
- Subject to HST after June 30th – 14/114ths of the total cost.
In the case of bad debts, where an amount is written off, the amount of GST you can deduct from your next remittance will be calculated in the usual manner – basically the tax in respect of the supply, prorated to the extent that the entire receivable is not being written off. With respect to future bad debt write-offs, you’ll need to determine how much of the debt arose before July 1st and how much arose after June 30th and the amount of tax related to both parts. Where a bad debt is recovered after write-off, you will again have to track when the original debt arose and the amount of tax that was recovered so that it can be repaid to the government.
Changes to Quick Methods of Accounting
The Quick Method rates will be changed to reflect the reduced rates of GST and HST. The new rates will apply for reporting periods beginning on or after July 1st. For reporting periods that straddle July 1st, you will need to separate consideration that became due before July 1st or after June 30th and apply the appropriate rate to each total. The rates to be used are listed below (note that we have just listed the main quick methods – the qualification rules for each method have not changed):
Remittance Rates - Businesses that purchase goods for resale:
Location of permanent establishment |
Before July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-Only province |
2.5% |
2.2% |
HST province |
0% (and 2.1% credit) |
0% (and 2.5% credit) |
Supplies made in a HST province |
GST-Only province |
9.3% |
9.0% |
HST province |
5% |
4.7% |
Remittance Rates - Businesses that provide services:
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-Only province |
5% |
4.3% |
HST province |
3.2% |
2.6% |
Supplies made in a HST province |
GST-Only province |
11.6% |
11% |
HST province |
10% |
9.4% |
For public services bodies, the required remittance rates are set out in the appendix to the Fast Fact.
Employee Reimbursements
Under current rules for calculating the tax deemed paid or payable on reimbursements paid to employees, the CRA has allowed the use of a factor of 6/106 of the reimbursed expense amount (14/114 for HST purposes) rather than the factors of 7/107 or 15/115 of the taxable supply. These factors recognize the fact that the expenses may include tips, gratuities and provincial sales tax, which are not subject to the GST or HST. Effective for reimbursements paid on or after July 1, 2006, new factors of 5/105 and 13/113 have been introduced.
Use of Passenger Vehicles by Sole Proprietors
Where a sole proprietor uses a passenger vehicle less than exclusively in commercial activities, ITCs are based on capital cost allowance (CCA) claims made for income tax purposes, including a proration for personal use. Before the GST reduction, the fraction was 7/107ths of the net CCA claim (15/115ths for HST purposes). With the GST rate reduction, these tax fractions will now be 6/106 for GST and 14/114 for HST in respect of a passenger vehicle acquired in a taxation year that begins and ends after June 30th. Where the taxation year including the acquisition date straddles July 1st, these tax fractions will be 6.5/106.5 and 14.5/114.5 respectively.
Considerations for Annual Filers
Some registrants are eligible to file GST returns on an annual basis, and the qualification rules will not change. However, one logical question you might have is whether your instalments required under the annual method can be reduced in the 3rd and 4th quarters of 2006 due to the GST reduction. The answer to this question is no from a legal perspective. However, if you are sure the amount of tax you will owe at year end will be lower with the GST reduction, you can pay a lesser amount. However, if your estimate turns out to be too low, a penalty and interest will apply on the difference between the instalments you paid and the required amount.
Employee Benefit Changes
Under current rules, where an employer who is a registrant provides certain benefits to an employee, GST is remittable on the provision of the benefit. Given that these rules generally operate on a calendar year basis, the factors will be adjusted as follows:
- Automobile operating cost benefit – For 2006, the employer will be deemed to have collected GST equal to 4.5%, or HST equal to 10.5%, on the value of the benefit reported for income tax purposes and on any reimbursements. For 2007 and subsequent years, the rates of tax are 4% and 10%, respectively.
- Automobile standby charge benefit and other benefits – For 2006, the employer will be deemed to have collected GST equal to 5.5/105.5, or HST equal to 13.5/113.5, of the value of the taxable benefit reported for income tax purposes, and if the taxable benefit is for a standby charge, on the amount of any reimbursement. For 2007 and subsequent years, the rates of tax are 5/105 or 13/113, respectively.
Rules for Rebates
Eligible employees and partners can claim a rebate on their personal income tax returns and the rates for this rebate will be adjusted:
- For expenses paid in 2006 – You can claim a rebate on eligible expenses equal to 6.5/106.5 for expenses subject to GST and 14.5/114.5 for expenses subject to HST.
- For expenses paid in 2007 and subsequent years – You can claim a rebate on eligible expenses of 6/106, and 14/114 respectively.
The rules for other rebates, such as the non-resident business traveller rebate or the visitor rebate won’t change (other than where the rebate is based on a specific amount of GST, which will obviously change).
Rules for Real Estate
One area where the GST rate reduction causes added complication is in the real estate sector, and specifically, the rules for new homes. The general transition concept applies, but is modified slightly for real estate in general:
- Ownership or Possession Transferred before July 1st – The 7% rate will apply to all of the consideration for a supply by way of sale of real property if ownership of the property, or possession of it under the agreement of purchase and sale, is transferred to the buyer before July 1st.
- Ownership and Possession Transferred after June 30th – The 6% rate will apply to all of the consideration for a supply by way of sale of real property, if under an agreement of purchase and sale entered into after May 2, 2006, both ownership of the property, and possession of it under the agreement, are transferred to the buyer on or after July 1.
For sales of residential real property, a special rule applies where the agreement was entered into before May 3, 2006 but closes after June 30th – the purchaser will pay the higher tax rate on closing but will be entitled to a 1% Transitional Rebate. To claim a Transitional Rebate, a person must complete an application form and file it with the CRA. If a new housing rebate is available in respect of the purchase, the individual who claims the new housing rebate is the individual who claims this 1% Transitional Rebate. When the application form becomes available, you will be able to obtain it on the CRA Web site or by calling 1-800-959-2221 (or by contacting your BDO advisor). Note that the Transitional Rebate is not dependant on being eligible for the new housing rebate.
New Home Rebate Changes
The rules for new home rebates will also change. There will be a reduction of the maximum rebate amount from $8,750 to $7,560 to account for the reduction in the GST rate. Under the current GST rate of 7%, the maximum rebate amount is equal to the lesser of 36% of the GST paid and $8,750. When the rate is reduced to 6%, the maximum rebate amount will be equal to the lesser of 36% of the GST paid and $7,560. For example, where ownership and possession of a new home worth $320,000 is transferred after June 30th, the rebate will be $6,912 (i.e., the lesser of $7,560 and 36% of the 6% tax payable on the purchase price of $320,000). Both the new and old rebate caps equate to a home costing approximately $350,000, so the lower and upper phase-out thresholds of $350,000 and $450,000 respectively, will not change as a result of the rate reduction.
The rebate rules will also change in the same manner for owner-built homes. Given the period of construction could straddle July 1st, owners will need to accumulate all costs and GST paid. If the bulk of the GST was paid at 7%, the current limit of $8,750 will apply for the rebate. If most of the GST is paid at the 6% rate, the $7,560 limit will apply.
The cooperative housing rebate will also be changed. The maximum amount of a cooperative housing rebate will be reduced from the lesser of $8,750 and 2.34% of the total consideration payable to the lesser of $7,560 and 2.04% of the total consideration payable for a share of or interest in the corporation, complex or unit. The thresholds for the total consideration will be reduced from $481,500 to $477,000 and the amount at which the phase-out applies will be reduced from $374,500 to $371,000.
Transitional Anti-Avoidance Rule
The proposed amendments include a provision to eliminate the tax saving to any party as a result of the rate reduction in circumstances where an agreement entered before May 3, 2006 between related parties is amended primarily to obtain the benefit of the tax reduction. Another rule will eliminate the tax saving to any party as a result of the rate reduction in circumstances where transactions between related parties are undertaken primarily to obtain the benefit of the tax reduction.
General Business Considerations
Businesses will need to adjust their systems to account for the rate reduction effective July 1st. These system changes could include changes to accounting records, purchase order systems, sales systems, payroll systems (for benefit calculations etc.) and any other systems relying on or referring to the 7% rate. Though it hits retailers especially, businesses of all kinds will have to make substantial changes to their systems. For example:
- Cash registers/sales systems will have to account for the GST rate reduction. (Keep in mind that sales taxes in Quebec and PEI are dependent upon the GST-included price.).
- If you sell supplies with a GST-included price, some customers (especially consumers) will be looking for a price reduction on July 1st.
- Journal entries automatically programmed to journalize GST plus a standard amount will have to be changed.
- New leases quoting a GST rate will have to refer to the new rate, or better still, should perhaps just refer to the amount of GST in general, as another cut to the rate in the future was promised during the election.
- Accounting software will need to be updated for the GST rate reduction. Pre-packaged software should have the possibility of a rate change built into the software, and the supplier may be able to provide specific transitional instructions. Changes to custom software may be more complicated, and you will want to consult with your software developer as soon as possible.
- Electronic and paper purchase order systems will have to refer to the new rate, as will signage and web sites.
- Systems will have to be altered to key off of the date when GST is paid or payable for the tax change.
- Automatic GST reconciling systems will have to be adjusted to refer to the new rate.
- For the purposes of payables and receivables, June 30th will have to be treated as a more formal cut-off date. Although ensuring GST is paid to the government on all sales to the end of a reporting period is important, the importance obviously increases when the rate of tax changes.
- For items that arise without an invoice, care will be required to ensure the transaction is entered with the appropriate date where the GST became payable.
If you have any questions or need help in implementing the GST rate reduction and the associated transitional changes, consult your BDO advisor.
Appendix: Streamlined Method Remittance Rates for Public Service Bodies
The charts below set out the remittance rates for using the streamlined method for various public services entities.
School Authority
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-only province |
6% |
5.2% |
Nova Scotia |
5.4% |
4.6% |
Newfoundland and Labrador or New Brunswick |
4.1% |
3.2% |
Supplies made in a HST province |
GST-only province |
12.5% |
11.8% |
Nova Scotia |
12% |
11.3% |
Newfoundland and Labrador or New Brunswick |
10.7% |
10% |
Municipalities
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-only province |
6.5% |
5.7% |
Nova Scotia or New Brunswick |
5.7% |
4.8% |
Newfoundland and Labrador |
4.6% |
3.7% |
Supplies made in a HST province |
GST-only province |
13% |
12.3% |
Nova Scotia or New Brunswick |
12.3% |
11.5% |
Newfoundland and Labrador |
11.2% |
10.5% |
Hospitals, External Suppliers or Facility Operators
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-only province |
6.2% |
5.4% |
Nova Scotia |
5.8% |
5% |
Newfoundland and Labrador or New Brunswick |
3.9% |
3% |
Supplies made in a HST province |
GST-only province |
12.7% |
12% |
Nova Scotia |
12.4% |
11.6% |
Newfoundland and Labrador or New Brunswick |
10.6% |
9.8% |
Universities or Public Colleges (if supplies through vending machines account for at least 25% of total supplies)
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-only province |
5.6% |
4.8% |
Nova Scotia |
4.5% |
3.8% |
Newfoundland and Labrador or New Brunswick |
2.3% |
1.6% |
Supplies made in a HST province |
GST-only province |
12.2% |
11.5% |
Nova Scotia |
11.2% |
10.5% |
Newfoundland and Labrador or New Brunswick |
9.1% |
8.5% |
Universities or Public Colleges (if supplies through vending machines account for less than 25% of total supplies)
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-only province |
6% |
5.2% |
Nova Scotia |
5.4% |
4.6% |
Newfoundland and Labrador or New Brunswick |
4.1% |
3.3% |
Supplies made in a HST province |
GST-only province |
12.5% |
11.8% |
Nova Scotia |
12.0% |
11.3% |
Newfoundland and Labrador or New Brunswick |
10.8% |
10.1% |
Specified Facility Operator, Qualifying Non-Profit Organization or Designated Charity
Location of permanent establishment |
Before
July 1st |
After
June 30th |
Supplies made in a GST-only province |
GST-only province |
5% |
4.3% |
HST province |
3.2% |
2.5% |
Supplies made in a HST province |
GST-only province |
11.6% |
11.0% |
HST province |
10% |
9.4% |
Please note: this material is general in nature and should not be relied upon
to replace the requirement for specific professional advice. © May 2006, BDO Dunwoody LLP
