Reminder: ITR restrictions for large businesses and others to be phased out
Most of the time, our articles on taxation deal with topics or new developments that translate into either additional costs for real property owners and/or their tenants, or new tax compliance obligations, which translate into…additional costs as well.
Therefore, it gives us great pleasure to announce today some good news: a reduction in the cost of the Quebec Sales Tax (QST) resulting, this time, in substantial savings for owners, tenants and property managers.
In 2012, the Quebec government announced it was harmonizing the rules for applying the QST with those of the Goods and Services Tax (GST) after signing a harmonization agreement with the federal government. Among other things, this agreement provided for input tax refund (ITR) restrictions for large businesses to be phased out. In 2015, the Quebec government’s budget provided for the phase-out of the ITR restrictions for large businesses. This gradual elimination began on January 1, 2018, and will continue until January 1, 2021.
For GST/QST purposes, a large business is defined as a business with total taxable supplies in Canada exceeding $10 million annually. The income from the taxable supplies of associated entities must also be included in this calculation. This analysis must be carried out for each fiscal year.
Below is a list of the items to which this restriction applies.
- Road vehicles weighing less than 3,000 kg registered in Quebec, and related goods and services acquired in Quebec or brought into Quebec within 12 months following the date on which the vehicle was acquired in, or brought into, Quebec
- Fuel, other than fuel oil, used to supply the engines of road vehicles weighing less than 3,000 kg registered in Quebec
- Electricity, gas, steam or combustibles, unless exempted under the law
- Telephone and other telecommunication services, except for Internet services and toll-free numbers (i.e. 1‑800 and 1‑888)
- Food, beverages and entertainment that are only 50% deductible under the Taxation Act
In real estate, the restriction affecting electricity, gas, steam or combustibles is extremely relevant.
Phasing out of restrictions
The gradual elimination referred to above has resulted in a drop in the percentage of ITR restrictions from 100% to 75% since January 1, 2018. As such, large businesses have been able to claim 25% of the QST paid or payable on a limited number of goods and services since that date.
On January 1, 2019, this percentage will drop to 50%, then to 75% on January 1, 2020. January 1, 2021 will mark the complete elimination of the ITR restrictions for large businesses. From that point forward, large businesses will be entitled to claim 100% of the QST paid or payable on these items if they are purchased in the course of their commercial activities.
Nonetheless, it is important to note that the 50% general restriction applicable to meals and entertainment will remain in effect in all provinces, whether the taxpayer qualifies as a large business or not.
In 2010, the Ontario government announced it was harmonizing its provincial sales tax with the federal GST, thereby becoming a province in which the Harmonized Sales Tax (HST) applies. The HST rate in Ontario is currently set at 13% (i.e. 5% GST and 8% PST). At that time, Ontario introduced restrictions similar to the ITR restrictions described above. These restrictions only applied to the provincial sales tax component of the HST (i.e. 8%). However, Ontario had committed to phasing out these restrictions. Which is why, beginning on July 1, 2015, the recapture rate (i.e. the amount subject to restriction) was lowered to 75%. A 25% reduction in the recapture rate was applied on July 1 in each subsequent year. As of July 1, 2018, this restriction was completely eliminated. Since then, a business in Ontario that qualifies as a large business can claim all of its ITCs on the full amount of the HST.
Still, as is the case with the ITR restrictions and the QST, it is important to note that the general restriction of 50% applicable to meals and entertainment will remain in effect, whether the taxpayer qualifies as a large business or not.
Electricity charged back to the tenant by the owner
We would like to take this opportunity to remind you about some specific rules applicable in applying the GST/QST when owners charge electricity costs back to their tenants.
Landlords who invoice their tenants for the electricity
In the case of landlords who invoice their tenants some of the costs relating to a commercial lease, such as the expenses incurred for electricity, charging back this expense must not be treated as an extension of the service or good originally received by the landlords. The tax authorities will consider costs invoiced in this way as additional consideration for the rent. This additional consideration is taxable in the same way as the base rent.
Therefore, landlords must determine whether they qualify as large businesses for the purposes of the QST and, if applicable, restrict the amount of the ITRs they can claim, regardless of their tenants’ status. Tenants would treat this additional expense in the same way as the base rent: they would be able to recover the entire amount of QST paid relating to this expense if the other conditions for claiming an ITR are met (e.g. an expense incurred in in the course of their commercial activities and proper supporting documentation). The same principle applies when the electricity is included in the rent.
Electricity used to produce goods intended for sale
There is one exception to the ITR restriction that affects the purchase of electricity used to produce goods intended for sale. This exemption is determined based on the portion of energy used to produce the goods intended for sale compared to the other activities of the business that do not meet the conditions for the exemption. The portion of the electricity not used for production remains subject to the ITR restriction described above. A person wanting to take advantage of this exception will have to be able to provide proof of the production-related percentage used to claim the ITRs. It is possible to do this by providing, for example, an expertise report prepared attesting to the electricity consumed by the different types of production equipment used.
In the case of a lease for a commercial or an industrial building, it is important to stress that, when a tenant uses part of the electricity being charged back by the landlord to produce goods intended for sale, it is the landlord who can benefit from this exemption and who, as a result, would have the right to claim an ITR on the portion of the electricity used for that purpose.
The gradual elimination of the ITR restrictions and of ITC the recapture has an impact on the real estate industry in general, and on tenants and landlords in particular, in terms of the expenses relating to the electricity used for commercial activities.
Reminder: Triple net leases and other similar leases
In the case of triple net leases, tenants pay all of the expenses relating to the building in question.
In such instances, when the landlord receives a municipal tax bill from the municipality relating to the building, and the landlord charges this expense back to the tenant, the landlord must also charge GST/QST on the amount, as it is an additional consideration for the rent.
However, the landlord will sometimes forward to the tenant certain invoices that have been addressed to the landlord, since the tenant is required to pay these costs in accordance with the lease. One frequent example of this is when the municipal or school tax bill is addressed to the owner but is often payable by the tenant under the terms of the triple net lease. In this event, landlords will ask tenants to make the payment on their behalf. It is important to note that, under these circumstances, the amount of the municipal or school tax also constitutes an additional consideration for the rent, to which the GST/QST must be applied. Therefore, the owner of the building will still have to invoice the GST/QST on this amount even if no invoice was initially issued to the tenant. Tax authorities often verify this item during audits.