Canada: Restricted Input Tax Credits

The Harmonized Sales Tax (HST) was introduced in Ontario on July 1, 2010, bringing about changes for many businesses. Most notably, it introduced a requirement that "large businesses" be required to repay or "recapture" the portion of any available input tax credits (ITCs) attributable to the provincial portion of the HST that becomes payable, or is paid without having become payable, in respect of a specified property or service that is acquired. 

At the time of introduction, many businesses were able to identify themselves as meeting the criteria of a "large business." But since that time, how many more have possibly grown their businesses, expanded their sales, made acquisitions, or changed their corporate structures such that their associated group structures now meet the definition? How many other businesses have expanded their operations into Ontario?

For purposes of the Restricted Input Tax Credits (RITC) requirement, a person is considered to be a large business during a particular recapture period if the person is a GST/HST registrant and the person's RITC threshold amount for that recapture period is greater than $10 million, or the person is a financial institution.

The definition of the threshold amount is quite long and convoluted. Simply put, it is the total of all consideration for taxable supplies made in or outside of Canada in the last recapture period, as well as the supplies of all associated corporations, including any inter-company transactions, with rules in place to account for short years. 

What is restricted?

In general, specified property and services include:

• qualifying motor vehicles, including certain vehicle parts and services, and in Ontario, motive fuel (other than diesel fuel) for use in motor vehicles;
• specified energy;
• specified telecommunication services; and
• specified meals and entertainment that are currently subject to an ITC repayment requirement of 50 per cent under the Excise Tax Act.

However, the RITC requirement generally would not apply to the following specified property and services:

• specified property acquired by a large business for the sole purpose of being resupplied by that large business (i.e., by way of sale, or by way of lease, license or similar arrangement);
• specified property acquired by a large business for the sole purpose of it becoming a component part of other tangible personal property that is to be supplied by the large business; or
• a specified service that is acquired by a large business for the sole purpose of being resupplied by that business.

Persons subject to the RITC requirement may not simply forgo claiming these recaptured ITCs in their calculation of net tax, but are required to separately identify any recaptured ITCs in their GST/HST NETFILE returns. Large businesses that fail to account for RITCs in the proper manner will be subject to penalties.

"Recapture period" means a one year period that (a) begins immediately after June 30 of a particular calendar year and ends immediately before July 1 of the following calendar year, and (b) occurs during the period that the RITC requirement is in effect (i.e., during the period on or after July 1, 2010, and before July 1, 2018).

The rates of recapture will be 100 per cent for the first five years that the HST is in effect, and will be phased out by reducing the rate of recapture in equal increments over the following three years. The ITC recapture rates will be as follows:

If a person that is not a large business at the beginning of a particular recapture period has a fiscal year-end during that recapture period, and its threshold amount exceeds $10 million at that point, the person generally will not be considered a large business until the beginning of the next recapture period. 

Conversely, if a person that is a large business at the beginning of a particular recapture period has a fiscal year-end during that recapture period, and its threshold amount is below $10 million at that point, the person generally will continue to be considered a large business until the end of that recapture period. It is important to revisit these criteria annually during tax filings to ensure compliance, particularly for businesses near the threshold amount.

Accounting for RITCs

Where a large business purchases specified property or services and pays HST in a province with ITC restrictions, it must ensure that it has a system in place to account for the required recapture of the provincial component of the HST paid on those purchases. The amount of the recaptured HST input tax credits must be reported separately. 

As a first step, a large business should use different general ledger accounts for tracking the provincial portion of the HST paid in the province that must be recaptured. The business is required to account for RITCs in its GST/HST return for the reporting period in which the ITCs first become available – that is, in the first reporting period in which the provincial component of the HST to which the input tax credits relate becomes payable or is paid without having become payable.

Penalties

Significant penalties may apply for failing to properly account for recaptured ITCs in the proper reporting period. Under Regulation SOR /2010-150 Electronic Filing and Provisions of Information (GST/HST) Regulations – section 7, any failure to correctly report the required recapture amount in a particular reporting period may result in a base penalty equal to five per cent of the difference between the amount that was required to be reported and the misstated amount. In addition, a further one per cent penalty may be applied for every complete month that the recapture amount remains misreported, to a maximum of five months, prior to the error being brought to the attention of the Canada Revenue Agency (CRA) or the misreported amount being included in an assessment of net tax for the reporting period in question. Essentially, within six months, any failure to report a recapture amount in the proper reporting period, or an error that misstates the amount of recapture in a particular reporting period, could result in a penalty equal to ten per cent of the under-reported amount.

Further, once a particular recapture error or omission has been identified for a particular reporting period, similar errors in subsequent periods could conceivably be eligible for the gross negligence penalty.

The CRA has indicated that a large business may correct any improperly reported recaptured ITCs for a particular reporting period by sending a letter to its local tax centre requesting that its GST/HST return for the period in question be adjusted to report the correct recapture amount.

The province of Ontario has been under the HST regime for more than four years now. The intricacies of dealing with restricted supplies and understanding what is and what isn't included in the definition, including methodologies to minimize the tax impact of these restrictions, require the assistance of specialists in the area of the HST.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.