Ken Garth:
For a lot of builders, that unrecovered HST cost is really the difference between their project being profitable and not. Particularly, if you think about today's market with such high interest rates, the builders are really struggling to make these projects profitable.
Thomas Kontogianis:
Welcome everyone to the latest episode of the Cross-Border Tax podcast series. I'm Thomas Kontogianis, a Montreal partner at BDOs BSO department. I specialize in real estate and construction clients and I'm part of the National Real Estate and Construction leadership team.
In today's podcast, I have the pleasure of discussing GST HST recovery opportunities for builders of residential rental properties. Joining me to help break down these issues, I have Ken Garth, a partner in our Indirect Tax Practice here at BDO, and George Tadross, a Senior Manager also in the Indirect Tax Practice. Ken and George, welcome today.
George Tadross:
Thank you.
Ken Garth:
Thanks, Thomas.
Thomas Kontogianis:
I guess to start, we'll just have a quick discussion point on the current overview of the real estate industry, where we're at and some recent relevant changes.
Ken Garth:
I guess everyone knows that right now we're in the middle of a very serious housing crisis. I mean, there's a lack of affordable rental housing. People just can't find places to live. I think one of the things we need to start with to frame this is a lot of people aren't familiar with exactly how the GST works on a residential rental construction.
If you have a person who's a builder and a landlord, so they're constructing a large property and when it's completed, they're going to rent it out. What a lot of people don't realize is when that building is completed and rented, the builder has to pay GST or HST depending on where you're living to Canada Revenue Agency based on the value of the property when it's completed.
Just using an example, some very common numbers that we see, if you have 120-unit apartment building in Ontario that's worth about $30 million let's say on completion. When that unit becomes occupied by the first tenant, the landlord actually has to pay an additional $3.9 million of HST on the completion. Obviously, that's a pretty significant cost.
Now in a lot of residential properties, there is a GST new Residential Rental Property Rebate that's available, but it doesn't fully offset the tax that's charged on this construction. That rebate came into effect around the year 2000. There was a period of time since the introduction to GST when there was no rental rebate at all, and then about 24 years ago they brought in this rental rebate.
Again, the rebate doesn't fully recover all the tax. If you look at the 5% GST component, it only gives you 36% of that 5% GST that you have to pay. In addition, they actually start to claw back that rebate as soon as the value of each unit hits 350,000. When the units hit 450,000, the rebates fully clawed back, the federal one.
Now, there's obviously a lot of provinces that have either a provincial, like the Quebec sales tax, or a harmonized sales tax like Ontario and the Maritime provinces. Ontario is the only one of those provinces that currently provides a rebate of the provincial component, and that's 75% of the 8% Ontario HST. Again, that's capped up to a value of 24,000.
George Tadross:
To add to that, the federal claw back thresholds haven't been updated since the introduction of GST in 1991. If you think about property values back then versus where they are now, obviously property values are several times higher now than they were in 1991.
Just using that same example of 120-unit apartment, rental property rebate would be around $2.3 million in Ontario, and it would only be about $540,000 other provinces. That means in Ontario there'd be approximately $1.6 million not recovered. In other HST provinces, it could be upwards of $4 million of unrecovered HST.
Ken Garth:
Yeah, and for a lot of builders that unrecovered HST cost is really the difference between their project being profitable and not. Particularly, if you think about today's market with such high interest rates, the builders are really struggling to make these projects profitable. Builders are only going to construct these projects if they can make money on it.
We've actually got a number of rental property builder clients that we work with, and those large HST assessments put their properties or the projects into the red, and a lot of them are not looking to take on new construction projects, which is an issue.
Thomas Kontogianis:
We could see the relevance of this new rebate we'll be discussing today on future development and why the government is taking this position as it is clearly limiting the supply of new projects because it is a costly element. Let's get a little bit further into what these changes means and what they mean for developers. To start, what is it they do to enhance GST rebate to begin with?
George Tadross:
That's a good question, Thomas. It's referred to as the Purpose-Built Rental Housing Rebate, and it's basically an enhanced version of the existing new rental rebates. It's designed to effectively eliminate GST and possibly HST, especially in Ontario, on certain new housing construction projects.
Thomas Kontogianis:
Very interesting. What type of projects does it apply to?
George Tadross:
It would generally apply to the construction of new units of purpose-built housing, which would either be for apartment-like units where there's a kitchen and a bedroom, or in the case of residential complexes, like long-term care facilities where each unit may not have a separate kitchen facility, 10 or more of such units.
It would apply to entirely to new buildings, additions to existing residential complexes where you're adding four or more units or the conversion of existing commercial property. These would be on properties where construction began after September 13, 2023.
Thomas Kontogianis:
It seems like it's impacting a lot of projects. Seems like a wide range of projects would be included in this, so that's very interesting. You've mentioned that this rebate pertains to construction projects that began after September 13th. How is this date of 'construction beginning' defined?
Ken Garth:
Initially, CRA didn't really provide any clarity on this, and that left a lot of people in limbo. They have since clarified that by the term 'construction began', they mean actually shovels in the ground. When you start to excavate for the foundation of the new building, that's the date that construction began.
If you're in this phase where you're applying for permits and you're doing engineering drawings and architecture and all that, that would all be before the 'construction beginning' date. It's the date that you actually had started excavating the foundation.
Thomas Kontogianis:
What would you say the government is aiming to achieve with this new rebate now?
Ken Garth:
Well, really they're looking to, number one, they're looking to reduce the cost of housing across the country because we all know housing has just become unaffordable for people, including for renters, not just owners. The second thing they're trying to do is they really want to increase the supply of these large multi-unit residential properties because people need a place to live and we just don't have enough supply these kinds of units right now.
They're hoping that by removing that non-recovered GST cost that we discussed a minute ago, they're hoping that's going to incentivize the construction of these rental buildings and apartments by basically removing the goods and services tax and in some cases the HST or harmonized tax on the construction cost.
In conjunction with the federal announcement, they're also asking provinces that currently apply a provincial sales tax component like Ontario or the Maritimes to basically reflect a similar rebate on the provincial component.
Thomas Kontogianis:
Great. To dive a little bit deeper, are there any adverse effects to the real estate industry that are unforeseen because of this rebate?
George Tadross:
Well, Thomas, there's actually a number of them. Using that September 13th date, projects that don't begin after that currently do not qualify, and that puts those projects at a disadvantage to projects that begin after September 13th. Whether or not they could change the project at a later point to qualify, we're not sure of yet.
The other thing is how CRA's going to approach auditing these rebates. Currently, there is a lot of focus on the actual fair market value of a project, and the CRA's values come in at 10 to 15% higher than what was filed, and that can cost millions of dollars in additional tax. Fair market appraisals probably don't mean as much with this enhanced rebate, so there's probably going to be a less focus on that aspect, but they might be focusing on the actual buildings and auditing the actual nature of the buildings and whether or not those qualify as purpose-built housing.
Ken Garth:
Yeah, there's also, because the new rebate doesn't apply to condominium units, there's going to be an inconsistent treatment of rental condominiums versus apartment buildings. If you built a multi-unit residential apartment, you'll be eligible for the new rebate. Whereas if you build a condominium tower with a number of condo units, you won't qualify.
We were actually recently discussing the new rebate rules with a client who had intended on building a new condo development, but because of the new rebate rules and the significant tax advantage it gave them, they're actually changing the plan to have it as a large multiunit apartment building so that they can qualify for the rebate. You can see that the new rules are already having an impact at this early stage.
The other thing to consider is municipal zoning issues. Obviously, that's not a tax issue, but still something that has to be considered. I think municipal zoning rules are going to have to be updated because currently a lot of municipalities, their rules are going to restrict the ability to build these properties that would qualify for the enhanced rebate.
Remember that you need to have at least four units in a building in order to qualify for the rebate. If you're building a duplex or a triplex, that's not going to be eligible. In some cases, the municipal rules don't allow for housing of that density in a regular residential neighborhood. I mean, everybody realizes that we need more rental units. They're supportive of the concept, they just don't want them to be next door to their house because it's not my backyard thing going on.
I think the municipalities are going to have to update the rules and become a little bit more flexible and allow this higher density residential rentals type of building to occur in regular neighborhoods.
Thomas Kontogianis:
It seems like it's important for a good first step by the federal government taken, but it seems like the municipalities will have to get on board. They've also placed a call to action to the provincial government. How would we say the other provinces are lining up and aligning with these changes that have been made already for the GST?
George Tadross:
Well, with respect to other HST provinces or the HST provinces, obviously Ontario is the biggest driver of this change given the population. I would say Ontario probably more than other provinces, have the most drastic need for housing at the moment.
They have already indicated that they will harmonize their own provincial portion of the HST rules, so that purpose-built housing would effectively be on the entire HST and not just the federal portion. Other provinces that implement HST such as PEI and Newfoundland have also said they join in on the rebates. However, we don't expect this to be as significant in those provinces.
In the case of Newfoundland, they've already capped how much that they would provide an enhanced rebate. British Columbia initially announced they were going to go a similar route, but it's a little bit more complicated there with PST. It looks as if they're going the route of a property transfer tax exemption. Quebec initially said aligning QST to match GST is not currently in their plans.
Thomas Kontogianis:
Okay, understood. Not all the provinces are aligned and necessarily on board at this moment. I guess to go a little bit further into the context, it seems like this is a great thing for developers, but how do we see it impacting the rest of the supply chain, such as construction companies, material providers, architects? How do we see the rest of the industry being impacted by this? Is there anything they should be adjusting in their way of operating and doing business?
George Tadross:
It's business as usual, I would say, but there is a bit of confusion, and I'll explain why. When this initiative was first announced, the media reported it as the government will announce that they're removing the cost of GST on construction for purpose-built housing. That caused a lot of confusion in the indirect tax group because that's not necessarily how GST works.
GST is a value added tax, it's charged on most supplies. There really isn't a mechanism to just exempt certain construction costs, but that's not what the case is. Obviously, the legislation surrounding it is far more complicated than that. It's an enhanced rebate that effectively removes the cost of GST from construction costs because a builder's ITCs would not be clawed back by that fair market valuation self-supply.
However, we have heard already from some builders that certain vendors aren't charging them the GST or HST because the project they're working on qualifies for the enhanced rebate. Obviously, the vendors are misunderstanding what the actual enhanced rebate is, and they're misunderstanding the actual rules. That could expose them.
For anyone in the development game, contractors, suppliers of building equipment, tools and lumber and construction materials, you would still have to charge the GST. What would end up happening is that the builder would be eligible for an enhanced rebate.
Thomas Kontogianis:
Oh, great. I think that's very useful to know. I guess there's still a lot of confusion in the marketplace, a newer rule in place. Is there anything else we should know about this topic or the rebate in general?
George Tadross:
So there is one interesting thing about this new rebate, and it's how you file it. CRA has not updated the paper copy or the PDF copy of the existing rental rebate form which is GST 524. However, the have updated the electronic return that you file online. So it's basically a web-form where you input the information directly in the browser. It's currently available with CRA My Business account.
Interestingly enough, because of a unique relationship that Revenue Quebec has with the CRA, where they administer GST on behalf of the CRA for Quebec residents, they have updated the PDF copy of the form to reflect the new enhanced rebate.
Thomas Kontogianis:
I just wanted to take this opportunity to thank both Ken and George for joining me today as we walk through the impacts and opportunities that the GST HST recovery presents for builders of residential rental properties.
We could see that this is a significant win for large apartment builders because it'll definitely impact the profitability of their projects and over time hopefully increase the supply of rental units and apartments. It was mentioned earlier in today's show that we're already hearing from builders who are changing the plan construction to qualify for these new rebates, whether they're building in apartments instead of condos or increasing the number of units to meet the four-unit minimum threshold.
We see that the marketplace is already adapting, and development will start increasing based on these new measures. In the end, the individuals, the renters will likely see a benefit in the long term as an increase in supply will evidently result in a more affordable housing market.
If your business is looking for advice on how to understand this rebate, how it impacts them, please reach out to Ken and his team. We have a large, experienced team on this matter and have experience on dealing with it in the past.
We thank you for tuning into the latest episode of the Cross-Border Tax Podcast. We'll be back soon, but for now, this is your host Thomas signing off. Thanks.