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How will HST impact Ontarians?

Author: Investor Education Fund
Date: 3/25/2010

woman-calculating-taxes-largeWhy HST and what will it mean?

Once the harmonized sales tax (HST) comes into effect July 1, 2010, in Ontario, many fees for services in this province will be more costly for the consumer. That’s because many services will be subject to higher taxes. Internet access fees will be subject to higher taxes. So will getting a massage, writing a will, having an accountant prepare your income taxes, and investing in certain types of funds.

Many consumers regard the HST as a tax grab, as they did the federal goods and services tax (GST), introduced in 1991. But it's not so simple. HST replaces the retail sales tax (RST), and like the GST that replaced the manufacturer's sales tax, it is meant to level the playing field between different types of businesses.

Traditionally, it was easier to tax tangible goods rather than intangible services. Thus, the parts that went into making a television were taxed before they went to the assembler, and wholesalers paid tax on the assembled TVs they bought from the manufacturers, and retailers paid tax on what they bought from wholesalers. Then the consumer paid a retail sales tax at the point of purchase. While labour – or the value added – was taxed at each step along the way to getting the goods to the consumer, so were the taxes.

With the introduction of HST, these intermediate taxes effectively disappear. This is because under the HST system the parts makers, manufacturers, wholesalers and retailers are eligible for tax rebates, called input credits, on the intermediate taxes they have paid. This system, called value-added taxation, avoids what economists characterize as “tax cascading” – taxes levied on taxes.

Consumer impact

The prices of goods that are currently subject to RST will likely remain the same under HST. Some prices may even fall. This has been the experience of consumers in the three Atlantic provinces that signed up for HST in 1997, according to academic studies. The provincial government estimates that once HST takes effect, 83% of the purchases Ontarians make will remain unchanged.

However, prices of the many personal and professional services that were previously exempt from Ontario's RST probably will go up, and they represent 17% of consumption. On these purchases, Ontarians should be ready to pay more.

Overall impact

The HST consolidates tax collectors, thus lowering overheads. By going from two tax agencies – one federal and one provincial -- to one, Ontario businesses are expected to save $500 million in paperwork and administrative costs.

Consumers newly subjected to HST can expect to see roughly a 7.6% increase on goods and services that were previously exempt from provincial sales taxes, TD Bank estimates.

Over time, some of these service providers should be able to reduce their costs, by claiming the input tax credit for the goods and services they used to pay tax on, such as office equipment.

But these cost reductions probably won't happen soon enough for many consumers. The key question will be how willing or able businesses will be to pass on their own tax savings. Consumers should be ready to comparison-shop, and the Internet (HST included) could well be a useful tool.

Items and services for which there will be no change in the amount of tax you will pay under HST:
  • Admissions to Sporting Events
  • Adult Incontinence Products
  • Auto Insurance
  • Auto Rentals
  • Basic Groceries
  • Books
  • Cable TV Service
  • Cell Phone Charges
  • Certain Medical Devices
  • Child Car Seats and Car Booster Seats
  • Child Care Services
  • Children’s Clothing
  • Children’s Footwear
  • Cleaning Products (e.g., Soaps, Detergents)
  • Clothing
  • Crafting Supplies (Scissors, Yarn)
  • Diapers
  • Feminine Hygiene Products
  • Furniture
  • Home Insurance
  • Home Maintenance Equipment (Lawnmowers, Snow Blowers, Sprinklers)
  • Home Phone Services
  • Luggage, Briefcases, Bags, etc.
  • Mortgage Interest Costs
  • Most Educational Services
  • Most Health Care Services
  • Movie Tickets
  • Municipal Public Transportation
  • Municipal Water
  • Music Lessons
  • Newspapers
  • Over-the-Counter Medication
  • Pharmacist Dispensing Fees
  • Prepackaged Computer Software
  • Prepared Foods Sold for $4 or Less
  • Prescription Drugs
  • Radios, Stereos, CD Equipment and Accessories
  • Refrigerators and Freezers
  • Residential Rent
  • Re-sale of Homes
  • Restaurant Meals
  • Tailoring
  • Toys
  • TVs, DVDs and Accessories

Source: Ontario Ministry of Revenue

What will be subject to HST in Ontario:
  • Electricity
  • Gasoline
  • Heating Fuels
  • Internet Access Fees
  • Personal Services (e.g., Hairstyling)
  • Professional Services (e.g., Legal, Accounting and Real Estate Fees and Commissions)
  • Tobacco
  • New Homes and New Residential Rental Properties (offset by government rebates)

Source: Ontario Ministry of Revenue

What is the impact of HST on investing going to be?

One thing Ontarians will pay more for, once HST takes effect, is investment funds – mutual funds, segregated funds and ETFs . This may induce consumers to steer away from money market and short-term bond funds. Here’s why.

Investment funds, are currently “exempt” from GST. That doesn't mean they don't pay GST. It just means they can't charge GST to investors. As a result, they cannot claim rebates on the GST they have paid. They have to absorb it.

Ultimately, the investor does pay, but not directly. Instead, GST is an expense payable by the fund – like management fees. It becomes a hidden or embedded cost. Those embedded costs are summarized in management expense ratios (MERs) – the total of management fees, marketing costs, administrative charges and taxes. MERs – since they are charged directly to the fund -- reduce annual returns to investors, by between 0.5% and 2.5% or more depending on the type of fund.

Trading and professional advice

HST could make other financial vehicles – such as GICs and individual bonds and stocks -- more attractive than investment funds. Of course, there is still HST to be paid by the bank, insurance company or investment dealer. It's an embedded cost, like an MER. But the embedded cost is lower because trading in financial vehicles is only a transfer of ownership. Holding a money-market fund, by contrast, involves receiving taxable advice. When consumers buy and sell stocks or bonds, they may receive advice from financial advisors and brokers. But, in tax terms, that doesn't count as advice: it's a one-time transaction. What counts as advice, according to the Canada Revenue Agency is:

  • researching, analyzing and advising;
  • determining and directing which assets or liabilities of an investment portfolio are to be acquired or disposed of; and
  • acting to realize performance targets in respect of an investment portfolio

In other words, ongoing portfolio management by a professional investment counsellor – already a taxable service for GST – will now be a taxable service for HST. That will cause taxes on investment funds to more than double – from 5% to 13%.

As a result, the Investment Funds Institute of Canada estimates that Ontarians will be paying four to five times the taxes on investing in a mutual fund then they would pay for a GIC because, in a mutual fund, manager skill or research in choosing and structuring investments is being deployed and taxed.

Tax impact on investments

GST already applies to investment fund management fees. A typical mutual fund, with a 2% management fee, will see its management expense ratio (MER) bumped up to almost 2.1%, thanks to the application of GST. With HST, the MER will rise to roughly 2.26%.

In a portfolio of $500,000, that's an $800 annual drag on returns ($1300, if existing GST is included). That additional drag may not be evident in an MER, because MERs are required, by securities regulations, to be all-in ratios. But fund companies will break it out as an expense in their annual and interim financial statements. Go to the Statement of Operations; under expenses, you will find a line item for GST paid.

If investment fund companies operate in any of the HST provinces, there are additional complications. Quebec and the three Atlantic provinces that currently participate in HST have given investment funds rebates on HST up to now. So far, there's no indication the same treatment will apply to fund companies domiciled in Ontario and British Columbia.

What is the impact of HST on other expenditures going to be?

On Housing?

Buying a home is a significant expense. Some new homes in Ontario will cost more because of higher taxes resulting from the introduction of HST. Others will not. It will depend on the value of the home.

HST will apply to the sales price of all new homes in Ontario when it takes effect. But for homes that are priced up to $400,000, 75% of the provincial portion of the HST will be rebated to the builders, lowering the provincial portion of the HST to 2%. As a result, new homes valued at $400,000 or less will not be subject to higher taxes under HST.

However, buyers of higher priced new homes will be paying more in taxes. This is because there will be no change to the GST portion of the HST. Currently the GST is rebated in full on homes costing less than $350,000 and then partially rebated in decreasing amounts on homes selling for up to $400,000. But buyers of new homes valued at $400,000 currently pay the full 5% GST and will continue to once HST comes into effect.

So what does this mean for buyers of homes costing more than $400,000 once HST comes in? They will be charged provincial tax at two rates: 2% on the first $400,000 they pay for a new home and 8% on any amount above that.

There will be no HST on the resale of existing homes; but renovations will be taxable. The HST will also increase the cost of moving house and of living in a condominium. It will apply to monthly maintenance fees for condos, as well as to the cost of services tapped when buying and selling a home, such as legal advice, packing and moving household items, home inspection and professional real estate services (including closing costs and real estate agent commissions).

Buyers of new homes will receive a rebate of up to $24,000 regardless of the price of the new home.
  • Buyers of new residential rental properties will receive a similar rebate
  • The HST will not apply to purchases of resale homes

On household maintenance costs?

Consumers should also be prepared to budget more for the natural gas and fuel oil they use to heat their homes, as well as the gasoline they use to drive their cars. These were previously exempt from the retail sales tax (but subject to the excise tax). The same tax increase will also apply to tobacco, but not to alcohol.

And there will be a new tax on taking a taxi.

On personal services?

Consumes will take an HST trim on their haircuts, manicures and hotels. However, some taxes can be avoided by buying now. For example, you can prepay your magazine subscriptions and funeral services before July 1, 2010, and not pay HST on them.

On household cash flow, tax credits and the economy?

The HST also represents a modest shift from taxing income to taxing consumption. That is the preferred option in economic debates, since income taxes discourage saving that could be used for investments that foster economic growth. Consumption taxes, by contrast, encourage saving, according to the pundits.

As a result, the Ontario government has already lowered the income tax rate applied to the first $37,000 of income, by 1 percentage point, from 6.05%. to 5.05%. This will reduce income taxes for 93% of Ontario taxpayers, the province estimates.

In addition, Ontario has beefed up the sales and property tax credit system, with singles making under $80,000 receiving three $100 tax credits in 2010 and 2011. Families making under $160,000 will receive a one-time $1,000 credit. After that, there will be a continuing annual $260 credit per person, similar to the GST credits that are already paid to lower-income earners.

Check out this chart for more information summarizing what's taxable under the HST and what's not.