
HST Self-Supply on new apartment
buildings has been around for a long time. We were first introduced to the
world of HST (or GST as it was then known) back in 1990 at a seminar put on by
one of the leading accounting companies to help the appraisal profession adjust
to the new rules. GST was officially
launched in January 1991 and the world of Self-Supply was unleashed. For the
first 35 years or so it lay relatively dormant with scarcely a call to our
offices from new apartment builders, who are the most affected by the new rules.
Rarely were we consulted on Self-Supply valuations. Everyone was seemingly happy in apartment
land. But the last 5 years has erupted with calls coming in on a regular basis from
clients old and new, anxious to escape the inevitable battle with CRA’s
auditors and appraisers. (For those looking for a tutorial, see our blog post
of August 24th, 2016, “HST Self-Supply Rules: Is CRA on the Warpath”. And feel the pain).
Undoubtedly the biggest practical
problem for apartment builders is the uncertainty it leaves after the building
has been completed. HST on new buildings is based on “Fair Market Value”, not
on the cost of construction. The latter
is easily calculated because ITC’s (Input Tax Credits) will have been filed
with CRA throughout the construction process. The former – “Fair Market Value”
- cannot be calculated until the building is completed and it is, like any market
value figure, just an opinion. But CRA’s
opinion increasingly is at odds with the builder’s opinion. To make matters
worse, CRA’s review will come along well after the building has been finished,
and therefore well after the mortgage financing has been committed, and
occasionally even after the building has been sold. In jurisdictions with regulatory rent
controls, rents too will have been committed. In short, the final HST tax bill
comes in well after all the dust has (literally) settled. Too bad that it can’t
be agreed in advance, or based on something more predictable than “Fair Market Value”.
"Just levelling the playing field..."
The reasoning behind the Self-Supply rules is
succinctly laid out in an official CRA
publication (GST/HST Memoranda series 19.2.3, paragraph 5) which begins
“Purpose of self-supply rules: level playing field”. In essence, it is an
attempt to put the builder who wants to keep the building on the same footing
as an investor who wants to buy it. The selling price will (fingers crossed)
include a profit component for the builder and that’s what CRA wants a piece
of. It’s difficult to argue with the
principle, but what it overlooks is that HST is just another construction cost to
be recovered through the eventual selling price. If HST is charged on the
elusive profit component, it simply adds to the cost of the building and hence
adds to the selling price. The builder pays tax on the profit and recovers it
from the purchaser as part of the selling price. The playing field is level.
But if no tax is charged on the elusive profit component, the cost of the
building is marginally lower and, assuming a balanced market, the selling price
will be marginally lower. The playing
field remains level, just slightly smaller. CRA’s concern is that the tax on
the builder’s profit will simply end up in the builder’s pocket, but a
competitive market will address that. Viewed from that angle, the pain, anguish
and sleepless nights endured by the builder waiting to settle the tax bill with
CRA is more to do with the size of the playing field than its degree of tilt. All
of that pain and anguish could be removed if the tax on profit were a
predictable formula, agreed in advance, rather than an elusive opinion coming
after the show is over.
HST on Apartment Rents
So, what if the profit – or rather the tax thereon – is
occasionally underestimated? Eventually
it is the end user who pays the HST on goods and services anyway. That’s how
value-added taxes work. For apartment buildings that means the tenant
ultimately bears the cost of the builder’s HST, even though residential rental
property is, for the most part, officially exempt from HST. Rents must be
sufficient to recover all of the costs or else buildings don’t get built. So
that troublesome tax on the builder’s profit ultimately shuffles through to the
tenants. Is it a bad thing to give
tenants a break these days? And for more
on THAT debate, check out our recent June 21st blog, “Affordable,
Attainable, Available”.
Lee Weatherby is the Vice President of our Counselling Division. If you'd like more information about our counselling services, feel free to contact Lee at (902) 429-1811 or lweatherby@turnerdrake.com.