The GST reduction: a dream for consumers, a potential nightmare for businesses.

On May 2, 2006, the Conservative Party led by Stephen Harper presented its first budget. In the budget, the Conservatives followed through with their promise to reduce the Goods and Services Tax (GST) from 7% to 6%. There was no indication as to if and when we would see the rate reduced to 5% as promised. Many question why the Conservatives have chosen this strategy as it will be very costly to implement and could wipe out the surplus entirely. The cost is estimated to be as high as $8.5 billion over two years with Canada's national surplus currently about $8 billion. The provincial governments are also watching closely as the rate reduction will not only impact the federal government's coffers. The sales tax revenue of both Quebec and Prince Edward Island will be reduced by the GST rate reduction as their sales taxes are calculated on the GST included cost of the good or service being provided. Given that Canada currently has a minority government, the Conservative government gambled that it would receive the support required to get the change through both Parliament and the Senate or face another election. It was unlikely though that the opposition parties would have opposed the proposed change, as it is so popular with the voters.

The implementation date was July 1, 2006; the Saturday of a long weekend. This choice of date caused problems for business as employees and service providers had to forgo part or all of their holiday to implement the changes to cash registers and other recording systems. There were and are many other challenges that businesses were not prepared for, as this is the first GST rate change since the introduction of the GST in 1991. Businesses generally found that it was not as simple to implement as many believed.

Benefits of the Rate Decrease

Consumers will be the big beneficiaries of the change; however, the amount saved will depend on the amount spent. Basic groceries are tax-flee but GST is added to items such as detergents and most other consumer goods. Educational, medical and financial services are not subject to GST so there are no savings there. However, these businesses pay GST on their costs so the service providers will benefit from the rate reduction. It is unlikely, however, that the savings will flow through to their customers. Most other services are subject to GST so consumers of accounting and legal services, for example, will pay less GST. You won't save on your residential rent, as it is not subject to GST. The landlord will see a tax savings, but again there is no compunction to pass this along to you.

New homebuyers taking ownership and possession on or after July 1, 2006 will save substantially. The purchase of used houses is exempt from GST, but because they share the same market as new homes, the impact of the rate reduction could also be reflected in resale house prices. Because there is a GST New Housing Rebate available for homes priced under $450,000, consumers of "cheaper" houses will not obtain the full benefit from the rate reduction as the method of calculating the rebate has not changed.

For example, if you bought a $300,000 new house prior to July 1, 2006, it would have cost $313,440 with GST and Rebate and at 6% it will cost $311,520 with GST and Rebate, a savings of only $1,920. For a new house costing $400,000, the previous cost with Rebate was $422,960 and at 6% GST it will be $419,680, which is a savings of $3,280. For those buying a new home for $500,000 you will save $5,000 (your cost will be $530,000 with the GST included as compared with $535,000 now). The Canadian Home Builders Association suggests that the GST New Housing Rebate should be changed to a flat rate of 2.52% of the sale price and further suggests that the rebate threshold needs to be indexed in order for housing affordability to be sustained over time. There were no such changes announced in this budget. In addition, the amount of tax you will pay to the builder for your new home will depend on when you entered into the contract to purchase the new house. If you entered into the contract on or before May 2, 2006 you will still pay the 7% GST even if you take ownership and possession on or after July 1, 2006; however, you will be able to apply for a transitional rebate of 1% which will be adjusted downward by a proportionate amount of the GST New Housing Rebate you are entitled to claim.

Most businesses won't directly benefit because they already get a credit for the GST they pay, although their sales should increase as a result of consumers' increase in buying power. Anyone making exempt supplies, like schools, universities, hospitals, charities and not-for-profit organizations will benefit from the tax rate change, but the benefit will be diluted because they qualify for a partial rebate of the GST they pay.

On the other hand, businesses should avoid being "tax stabbed" or bearing the cost of the GST rate reduction. Businesses need to ensure the rate change has been implemented properly, that the correct GST is being collected and reported, and that the amount of GST paid matches the amount of input tax credit or rebate claimed. We know of one retailer that implemented a 1% rate reduction for PST at midnight and the next morning discovered that the cash registers were charging 0% as a result. It took two hours to correct the error; meanwhile consumers were buying without paying tax (and the retailer had to cover it).

In 1991, a credit was paid to compensate business for the system changes required to implement the GST. The government has chosen not to assist businesses with their cost of implementation this time and it is likely businesses will pass this cost on to the consumers.

Businesses must get the rate correct. It sounds simple but is not always obvious. Different timing rules apply depending on what the business supplies and when the product was ordered, paid for and delivered. Generally the retailer collects GST at the rate effective on that date of "purchase". If selling over time, it is the date when the payment is due under the contract that dictates what rate should be charged. If more than one payment is required--the GST charged depends on the date each payment becomes due. For example, if you enter into a lease that straddles the effective date of the change, the payment will drop by 1% on payments due after the change. The same applies to progress billings.

Deposits will be another issue as they are not taxable necessarily when received. Therefore, it is important for businesses to differentiate between a deposit and a prepayment. Tax on deposits is created when the deposit is applied to a supply. When non-refundable prepayments are received, the tax may be collectible at the time of payment. For example, when you sell a computer for cash and the consumer takes it home that day, you will charge at the GST at the rate in effect on that day. If you take a deposit, it is not taxed until the consumer purchases the computer (i.e., you close the deal). If you sell the computer and finance it (i.e., buy now, pay later), the GST is charged on the full amount at the rate in effect on the day the customer takes the computer home and not when you get paid.

We will also need to be vigilant when claiming Input Tax Credits (ITCs) and Rebates in the period beginning before and after the change, to ensure the correct rate is used. (ITC is the term for the GST a business

pays and claims back as a credit.) For example, supplier's invoices may come in on the same day that are subject to different rates of tax depending on the date that the invoice was actually issued and when the "supply" occurred. Data entry will be slower as the clerk will need to ensure the proper amount is input. Most accounts payable software calculates GST automatically and these systems will require tax code and other system changes to match the date with the tax rate to ensure the proper amount of GST is recorded.

Certain factors are used to claim ITCs and Rebates for allowances and reimbursements to employees, volunteers and partners. Smaller businesses may be using the Quick Method of accounting for GST or the Simplified Method for calculating GST or Net Tax. These factors have been changed to reflect the rate reduction and businesses need to ensure they have made these changes in their systems.

Barry Nabatian, general manager of Market Research Corp., predicted on December 2, 2005 that lowering the GST would have a positive psychological effect on consumers. Items like cars or appliances would be more affordable, allowing some purchasers to make the leap or upgrade to a higher model, he said. However, consumers must believe that the reduction will be passed on and not absorbed by retailers for there to be a positive impact.

Businesses may have been tempted to be creative to counter consumers' reluctance to purchase big-ticket items before the rate is reduced. There is a provision in the proposed legislation to prevent restructuring of transactions to merely benefit from the tax reduction; note that, it only applies to persons who are not operating at arm's length. However, the general anti-avoidance rules should be considered if you have restructured transactions where the only purpose was to get a benefit from the tax rate reduction.

The GST rate reduction is very popular with consumers and the opposition parties had to think about the impact on the voters if they chose to vote against this popular change. Businesses were happy that the opposition parties did not hold up the legislation and the change became law on July 1, 2006. It will be interesting to see if there is a significant rise in consumer spending on big-ticket items now that the GST rate has been lowered.

Beverly J Gilbert is a Chartered Accountant with the law firm of Borden Ladner Gervais LLP in Calgary Alberta.