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HST and Commercial Landlords

The upcoming introduction of Harmonized Sales Tax (HST) in Ontario will have broad-ranging repercussions among industries and businesses of all types, including real estate and leasing.  This article will examine the specific impact that the HST will have on commercial property owners and managers who are designated as “large businesses” as part of the new tax changes.
 
As most are aware by now, the HST comes into force on July 1, 2010, and represents a blending of the 8% provincial sales tax (PST) and the 5% federal goods and services tax (GST) for a total of 13% in tax.  It will generally apply to all goods and services which are currently subject to the GST.   
 
Under the current system, the GST paid by businesses is credited against the GST collected from the business’s customers, the result being “input tax credits” (ITCs).  
 
Once HST is implemented, most businesses will experience a cost savings because the full ITC will be available for HST paid (in contrast to the current situation, which does not allow a credit for PST paid). However, the effect will be the opposite for GST-exempt businesses, of which there is a broad array.  
 
(These include businesses which provide health and dental services, educational services; legal aid services; and child and personal care services. Certain supplies provided by public bodies, charities, and financial services organizations – such as banks and credit unions – are also GST-exempt.)  This is because once the HST is implemented, operating expenses for these kinds of businesses will increase since they will be subject to paying HST on rent and other expenses, but will still be ineligible to claim ITCs.
 
Which brings us to commercial landlords:  under the new HST regime, “large businesses” (which are defined by legislation as being those with taxable sales in excess of $10 million per year) will similarly be restricted from claiming ITCs on the 8% of the HST (i.e. the portion formerly representing PST) on specific transactions, including amounts paid for:

In other words, for those commercial landlords and property managers whose operations fall within the definition of “large businesses”, this means that the overall costs of these items and services will increase, because no ITC will be available on that  portion of their operating costs.  
 
(And by extension, the introduction of HST will also adversely affect tenants, since commercial landlords will aim to be reimbursed for their increased operating costs by passing these increases on to their tenants).
 
These restrictions remain in place for five years after HST comes into force, i.e. until June 30, 2015.  However, the ITCs for these items will be phased in over three years starting July 1, 2015, with full ITCs becoming available after June 30, 2018.
 
So what are the practical repercussions for commercial landlords, once the HST is in force?  For one thing, commercial landlords should ensure that all Offers to Lease, Letters of Intent, Leases, Amending Agreements, and related lease documentation are worded to reflect the HST payable by tenants.   References to GST should be removed from all of these documents.
 
Also, the definition of “operating costs” in all Leases should be revised to allow recovery of the HST which is not available to count towards the ITCs.
 
Note that from a commercial landlord’s perspective the existence of obsolete references to GST, or inaccurate references to sales tax will not render a Lease void or the tax uncollectible. (This is because tax legislation expressly designates that they are nonetheless payable on all taxable items, even if the Lease agreement is silent).  Still, this kind of post-HST “tidying” of Lease documentation ultimately benefits the commercial landlord, because a tenant’s failure to pay the necessary taxes can trigger a default in the Lease. It is therefore to the commercial landlord’s advantage to make the lease terms as clear, specific, and accurate as possible.