Benjamin Dachis – November 3, 2009

As economic troubles appear to fade worldwide, many Canadian businesses and consumers have more reason to look optimistically at 2010. One reason stands out in Ontario and British Columbia, where governments have announced firm intentions to replace their antiquated retail sales taxes with smarter harmonized sales taxes, the HST.

By eliminating most provincial tax on the cost of things that businesses have to buy to carry out their business, the HST will dramatically lower the taxes on new business investment. That means new machinery, facilities, and business-to-business services get cheaper, and that means more investment and new jobs for Canadians.

Small businesses gain as their tax compliance burden shrinks. And consumers gain too. For instance, after the introduction of the HST in the Atlantic Provinces last decade, consumer prices on many items, like furniture and health care services, were significantly lower, and prices overall were about the same. The business and consumer case for the HST is clear, and few economists would say otherwise.

Yet implementation and transition issues can be big sticking points for major tax reforms. Ontario and BC just released transition rules covering prepaid services.

Contracts for many services delivered over time or in the future, like magazine subscriptions or funerals, are subject to HST if they are paid for after June 2010; if they are paid for before that the provincial portion of the HST does not apply. The date of delivery doesn’t matter so long as the purchase is made before the HST’s implementation date.

Back in the summer, Ontario published revised rebate rules for the biggest minefield: new homes and condominium sales.

First, some background. Under the current provincial retail sales taxes (RST), new homes and condominiums are not directly taxed. However, the cost of sales taxes on construction inputs is embedded in the price of a new home. These costs, estimated at two to three percent of the price of a new home or condominium, are invisibly passed to consumers. Construction tools, materials and other inputs are all taxed under the RST, but not under the HST.

The HST directly taxes housing, making an invisible tax visible. Rebates to buyers of new homes under $400,000 make the tax change effectively neutral for them by keeping the effective tax rate on new housing at two percent, the effective tax rate as with embedded RST.

For new home purchases made after the government announced the transition rules back in June, the HST is applicable if the property ownership is transferred after July 1, 2010. Unlike magazine subscriptions or funerals, HST on new housing depends on when the actual possession is delivered, not when the deal is struck.

Builders of new homes that will be subject to the HST, but built before the HST came into effect, will get a rebate for the estimated RST embedded in the cost of the home. This will allow builders to reap some of the benefits of the input tax credits available under the HST, even though costs were incurred under the old retail sales tax.

In the original Ontario HST proposal from the 2009 Budget, buyers of new homes priced between $400,000 and $500,000 would have been required to pay back the rebates on the value of the house under $400,000. This would have resulted in an effective marginal tax rate of 47.3% in this price range. In other words, for every dollar spent on a new house, buyers would have paid ¢47 to governments of all three levels through the combined HST and land transfer taxes. The very high effective tax rate on new housing would have created a major disincentive to purchase new houses in the $400,000 to $500,000 price range and distorted the housing market.

Such a large tax bill out of every dollar of new housing resulted in significant industry protest. In response, the Ontario government announced a new policy in June — which British Columbia also adopted — that reduced the HST burden on new homes over $400,000 so that buyers don’t need to pay back rebates once their purchase price goes over $400,000. The revised HST plan, by lowering the effective tax rate on new housing in this price range, is a significant improvement over the original proposal, with lower economic cost and less impact on buyer decisions.

An HST will be good for businesses and consumers and is fair to new home buyers. The other provinces that continue to levy retail sales taxes ­— Saskatchewan, Manitoba and Prince Edward Island — should carefully consider the enormous economic benefits that they will obtain from harmonizing their provincial sales taxes with the GST. The path to tax reform, and the pitfalls along it, is now well marked by Ontario and British Columbia.

[National Post]