In July of 2010, the Ontario government will introduce the most significant tax change in years with the implementation of the HST. We are only just beginning to grasp its affect on the business community.
Specifically, we're talking about its impact on your electric bill.
Unlike the current GST program, where most businesses can claim sales tax credits for costs, under the HST costs such as electricity will be restricted from receiving full credits. In the case of your business's hydro bill, the eight-per-cent provincial component will not be creditable unless electricity is acquired by a farm or is used to produce goods for sale.
These credit restrictions will apply to large businesses whose annual taxable sales exceed $10 million and financial institutions, and will be in place for five years, with credits expected to be phased in over the subsequent three years.
Most office tenants in Ontario have a net lease contract for space, in which their proportionate share of a building's common expenses (including electricity) is a straight pass through by the landlord, usually lumped together under the label of "additional rent." How will the electricity restrictions affect these arrangements? If we look to Quebec, where sales tax credit restrictions are of a similar nature, Revenue Quebec considers that the electricity credit restriction rests with the landlord and not the tenant in the case of a net lease. It is not certain if Ontario's HST rules will follow Quebec's lead but at this stage it seems likely.
In Quebec, if the landlord is either a large business or a financial institution, the credit restriction applies even if the tenant is neither. Conversely, if the landlord is neither a large business nor a financial institution, no credit restriction applies even though the tenant may be either. The restriction depends on which party has the liability to pay the bill with the utility company.
In fact, a tenant paying a bill directly to the utility to satisfy a landlord's legal obligation would not change the fact that the landlord has the liability for the supply of the electricity, and thus Quebec considers the credit restriction as resting with the landlord.
So if the landlord is a large business or financial institution, the credit restriction applies even if the tenant pays the bill directly to the utility and the tenant is neither. Interestingly enough, based on Quebec, to the extent that the tenant uses the electricity to produce goods for sale no landlord credit restriction applies.
The potential cost impact on tenants can be further exacerbated when the lease arrangements include a management fee payable to the landlord for property care, a common part of a net lease. The management fee is usually calculated on the base rent plus operating expenses.
In this case, any Ontario HST credit restriction on electricity incurred by the landlord increases the management fee payable by the tenant to the landlord in respect of the property. This can be a significant increase for large tenancies.
For perspective, a 10,000-square-foot office tenant in Ottawa might expect electricity bills of about $2.50 per square foot every year, or about $25,000. This may include a 10- to 15-per-cent management fee collected by the landlord, or $2,500 to $3,750.
As a small business I may expect to get that eight-per-cent component of the Ontario HST back, as I am not subject to direct credit restrictions. But if the landlord is liable for electricity costs and is a large business or a financial institution, the credit restriction will likely apply and a $25,000 cost of electricity becomes $27,000 ($25,000 x 1.08).
The management fee will also proportionately increase, resulting in a potential $2,200 to $2,300 annual impact. Over a five-year lease, that's an additional $11,000 to $11,500 of additional costs to be considered in the provincial component of the Ontario HST alone.
To a tenant occupying 100,000 square feet or more, the impact could be measured in six figures.
Should the magnitude of the costs be in the range described above, we will likely see larger anchor tenants further insist on separate electrical meters to limit their exposure to this increase on the management fees.
And for small and medium businesses for whom this isn't an option, just remember to turn out the lights when you leave at night. You might be saving more money than you think.
By Darren Fleming and Lloyd McMaster
Special to the OBJ
Darren Fleming is managing principal and broker of record for CresaPartners, and Lloyd McMaster is a senior manager specializing in indirect tax for PricewaterhouseCoopers LLP.
