Toronto - In its March 26, 2009 provincial budget, Ontario announced the intention to proceed with a value added tax. Effective July 1, 2010, provincial sales tax will be harmonized with the federal goods and services tax (GST), resulting in a federally administered 13% tax, of which the Ontario portion will be 8%. Details are expected to be released later in 2009.

At this point, indications are that the proposed harmonization should save manufacturers significant tax dollars but will certainly require considerable effort to prepare for the required changes on a number of fronts. With just over one year before implementation, now is the time for manufacturers to consider the implications of harmonization on their operations, processes, systems and dealings with customers as well as suppliers.

Manufacturers will save on purchases

Currently manufacturers incur a significant Ontario retail sales tax (ORST) expense on goods for own use, promotional materials, as well as furniture, fixtures and equipment including non-custom software and hardware, delivery vehicles, etc. Given that the 13% Ontario harmonized sales tax (OHST) will be recoverable on such input costs, with limited exceptions, the tax savings could be significant. This savings should make Ontario manufacturers more competitive in the domestic and global market. Further, manufacturers will no longer have to deal with the challenges that exist in determining the type of machinery and equipment that qualifies for the current ORST exemption applicable for manufacturing machinery and equipment.

However, unlike under the current ORST regime, manufacturers will not be able to purchase raw materials and manufacturing inputs free from the application of the 8% component of the OHST. This may lead to some cash flow challenges that will need to be considered, including strategizing on ways to deal with suppliers to minimize the impact. This potential cash flow impact will be further dependent on whether raw materials and other inputs, including machinery and equipment, are sourced within Canada or are imported. To the extent that commercial imports are treated the same under the proposed OHST as they are for the current harmonized sales tax in New Brunswick, Nova Scotia and Newfoundland, commercial imports will be relieved from the provincial component of the OHST upon import. However, it is not clear at this point whether commercial goods will be subject to the full 13% OHST upon import.

As noted above, the OHST generally will be recoverable by most manufacturers. However, for the first eight years post-harmonization, large businesses (i.e., with annual taxable sales in excess of $10 million) will be restricted from recovering the provincial component of the OHST in respect of costs incurred for energy, except where purchased by farms or used to produce goods for sale; telecommunication services other than internet access or toll-free numbers; road vehicles weighing less than 3,000 kilograms (and parts and certain services) and fuel to power those vehicles; and food, beverages and entertainment.

A couple of points to consider with respect to the above OHST recovery restrictions. The first is that from a tax cost perspective, most of the particular expenses subject to the restrictions are currently taxable for RST purposes and therefore this restriction will not, for the most part, result in an increased tax cost. The second point is that the restriction regarding energy will add certain complexity because Ontario manufacturers will be required to track their energy costs related to manufacturing and non-manufacturing use in order to be able to recover the full provincial component of the OHST on the portion used for manufacturing.

Impact on sales

For goods sold in Ontario, the provincial component of the OHST is to be collected in the same manner as the GST, with some exceptions that only apply on sales to end consumers. Therefore, a significant factor will be ensuring that the current tax codes used for GST purposes are correct.

For manufacturers selling to customers outside of Ontario, the yet-to-be-determined special place of supply rules and the existing zero-rating rules will be important to take into consideration to ensure proper compliance on when to collect the additional 8%. Additionally, manufacturers involved in specific GST drop-shipment arrangements with customers outside of Ontario will want to review the applicable rules and ensure the correct process is in place to deal with such transactions post-harmonization.

Impact on systems

A significant implication for manufacturers with the introduction of the OHST is the required systems changes. Such changes will impact the accounts receivable and billing systems as well as the accounts payable systems in numerous ways. It will be necessary to identify the priorities for IT departments related to the specific system requirements for the OHST and ensure the requisite testing and implementation procedures are executed.