Ontario introduces recaptured input tax credit rules March 17, 2010 When the new HST rules were first introduced, it was noted that large businesses generally, those making taxable supplies of more than $10 million annually, and certain financial institutions would be temporarily restricted in their ability to claim the provincial portion of certain input tax credits (ITCs). The supplies that will be affected by this restriction are telecommunication services other than internet access or toll-free numbers; energy except where purchased by farms or used to produce goods for sale; road vehicles weighing less than 3,000 kg, parts, certain services and fuel to power those vehicles; and food, beverages and entertainment. As noted in our previous release New Filing Requirements for GST/HST Returns, restricted ITCs will be recaptured rather than denied. Businesses subject to this recaptured input tax credit (RITC) restriction will have to separately identify recaptured ITCs in their GST/HST NETFILE returns for the reporting period when the ITCs first became available. They will not be able to simply forego claiming input tax credits on a specific good or service. Failure to recapture input tax credits in the appropriate reporting period may expose large businesses to interest and penalties. The rate of ITC recapture will be 100% for the first five years that the HST is in effect, and will be gradually phased out during the next three years as follows: About Grant Thornton in Canada Grant Thornton LLP is a leading Canadian accounting and advisory firm providing audit, tax and advisory services to private and public organizations. Together with the Quebec firm Raymond Chabot Grant Thornton LLP, Grant Thornton in Canada has more than 3,100 people in offices across Canada. Grant Thornton LLP is a Canadian member of Grant Thornton International Ltd, whose member and correspondent firms operate in over 100 countries worldwide. 100% for the period from July 1, 2010 to June 30, 2015 75% for the period from July 1, 2015 to June 30, 2016 50% for the period from July 1, 2016 to June 30, 2017 25% for the period from July 1, 2017 to June 30, 2018 0% on or after July 1, 2018
Who is subject to the RITC requirement? As noted, large businesses and certain financial institutions are subject to these rules. Ontario s latest release 1 provides additional details on the types of businesses that will be impacted by these new rules. A large business is defined as one whose RITC threshold exceeds $10 million for the recapture period. 2 The $10 million threshold calculation will include, among other amounts, taxable (including zero-rated) supplies made in Canada and supplies made outside Canada through a permanent establishment in Canada, by the person and its associates. Also, although the definition of a financial institution can be very broad, for the purposes of the new RITC rules, Ontario has proposed that only the following financial institutions will automatically be subject to the recaptured input tax credits: banks, trust companies, credit unions, insurers, segregated funds of insurers and investment plans. Ontario notes that the RITC requirements for selected listed financial institutions (i.e., listed financial institutions that allocate revenues to harmonized and non-harmonized provinces) will be described in a separate information notice. The following entities are not subject to the RITC rules: persons who are not large businesses, persons who are not HST registrants, public service bodies, and persons whose chief source of income for income tax purposes is farming. New proxy methods To simplify compliance, optional proxy methods are proposed for specified energy, specified energy used directly in activities that are eligible scientific research and experimental development (SR&ED) activities in Ontario, and specified telecommunication services where a supply includes telecommunication services and other services and/or goods. 1 Harmonized Sales Tax Information Notice 5 (February 2010) 2 The recapture period generally means a one-year period that begins immediately after June 30 and end immediately before July 1 of the following calendar year. Special rules address other changes during a recapture period e.g., the acquisition of a small business by a large business, exceeding the threshold during a recapture period, etc.
Proxies for specified energy Ontario s latest release includes new optional proxy percentages for determining the portion of certain expenses that will not be subject to the above input tax credit restrictions. For example, businesses producing goods for sale (and carrying on such production primarily in Ontario) are not subject to the input tax credit restrictions. Such businesses will be able to elect to use a proxy amount to determine what portion of the specified energy it acquires for use in Ontario is considered to be used directly in the production of goods for sale. Ontario proposes production proxies for large businesses whose most significant business activities fall into one of 24 specific categories. 3 Under these proxies, an eligible large business may elect to use a prescribed percentage (i.e., 96%, 87% or 70% depending on the category) to determine what portion of the energy it acquires is considered to be used directly in the production of goods for sale and hence not subject to the recaptured input tax credit. If the most significant business activity of a large business does not fall into one of the specific categories, no proxy will be available and the business will have to use another approach to calculate its ITCs. The election to use the production proxy will have to be filed with the CRA before the beginning of a particular recapture period (i.e., one-year period from July 1 of a particular year to June 30 of the following year) and would generally apply for the entire recapture period (i.e., 12 months). Proxy for SR&ED activities Instead of tracking the actual amount of specified energy used directly in qualifying SR&ED activities, Ontario also proposes a SR&ED proxy formula (A = B/C), where A = the percentage of specified energy used directly in qualifying SR&ED activities in Ontario; B = the total amount of the portion of the salaries and wages of employees of the large business directly engaged in SR&ED activities in Canada; and C = the total amount of salaries and wages of employees of the large business in Ontario. Example: For purposes of the RITC requirement, the most significant business activity of a large business (LB) is food manufacturing. It can therefore use the 87% production proxy. It is also using a 25% SR&ED proxy (i.e., 25% of the total amount of the salaries and wages of its employees is attributable to SR&ED activities in Ontario). In its August 2012 reporting period, LB has $2,500 in available ITCs that are attributable to the provincial component of the HST payable in respect of specified energy it acquired for use in Ontario during that reporting period. LB would first apply the SR&ED proxy ($2,500 25% = $625) and then apply the production proxy to the residual amount ($1,875 87% = $1,631). It would therefore, have to recapture $244 in ITCs. If a large business is using both the SR&ED proxy and the production proxy, the rules provide for an ordered application of the proxies. The SR&ED proxy formula (A = B/C) is first applied to the specified energy acquired for use in Ontario. After that, the production proxy percentage is applied to the residual. 3 The proxy percentages are based on the North American Industry Classification System (NAICS) for 2007.
Proxy for specified telecommunication services The proxies for specified telecommunication services are available where a single supply includes telecommunication services and other services and/or goods that are not subject to the RITC requirement. Where the large business cannot readily ascertain which portion of the provincial component of the HST is attributable to the unrestricted services and/or goods, the large business will be allowed to use the following proxies to make that determination. 1 If the supply covered by the invoice includes specified telecommunication services, other services and goods (e.g., telecom equipment rental), then 14% of the consideration for the supply will be deemed to be attributable to the other services and goods (RITC applies to the remaining 86%). 2 If the supply covered by the invoice includes specified telecommunication services and other services (but no goods), then 4% of the consideration for the supply will be deemed to be attributable to the other services (RITC applies to the remaining 96%). 3 If the supply covered by the invoice includes specified telecommunication services and goods (but no other services), then 11% of the consideration for the supply will be deemed to be attributable to the goods (RITC applies to the remaining 89%). Other issues Use of specified road vehicles before resupply The RITC requirements will not apply to specified goods and services acquired solely for resupply. However, if a large business acquires a specified road vehicle for the purpose of resupplying it but uses that vehicle before resupplying it, the large business will generally be required to recapture a portion of the ITCs that it claimed in respect of the acquisition. Example: In April 2011, a car dealership that is a large business acquires, for the purpose of resale, a vehicle that costs $30,000 and claims ITCs in respect of that acquisition (i.e., with no recapture). The dealership subsequently uses the car as a demo vehicle for two months before selling it. The dealership would recapture $96 of the ITCs claimed in respect of the acquisition of that vehicle: $30,000 (cost) 2% 8% (provincial component of HST) 2 months = $96. Option to use an Estimation/Installment Approach To help simplify compliance with the RITC requirements, a large business will be allowed to elect to use an estimation, installment and reconciliation approach to account for the recaptured input tax credits during the year (Estimation/Installment Approach). The election will be filed with the CRA after the end of a large business' fiscal year and will apply for at least one year. Large businesses that want to start using this approach as soon as the HST is introduced would likely be required to elect before July 1, 2010.
Under the Estimation/Installment Approach, for each province that has an RITC requirement, a large business would estimate the amount of ITCs it would be required to recapture during a fiscal year; based on this estimate, make equal installment payments of recaptured ITCs in each reporting period during a one-year period; and at the end of the fiscal year, determine the actual amount of ITCs it should have recaptured during that year and reconcile any differences between the estimated and actual amounts. The RITC rules will impact costs, systems and compliance obligations for large businesses. Our sales tax professionals can help you get ready for the introduction of these new rules, as well as with the various other issues that need to be addressed in preparing your business for the HST. The information contained herein is prepared by Grant Thornton LLP for information only and is not intended to be either a complete description of any tax issue or the opinion of our firm. Changes in tax laws or other factors could affect, on a prospective or retroactive basis, the information contained herein. You should consult your Grant Thornton LLP adviser to obtain additional details and to discuss whether the information in this article applies to your specific situation. A listing of Grant Thornton offices and contact information can be found on our Web site at: www.grantthornton.ca