Recommendations to Reduce Significant Internal Trade Barriers (Sales Tax Harmonization)

Dear Ministers:

Re: Recommendations to Reduce Significant Internal Trade Barriers (Sales Tax Harmonization)

The Commodity Tax, Customs, and Trade Section of the Canadian Bar Association (“CBA Section”) understands that Canada and the provinces wish to reduce barriers to internal trade and to strengthen our economy, particularly in light of ongoing trade tensions with the United States. The CBA Section would like to take this opportunity to recommend eliminating one of Canada’s most significant internal trade barriers: the provincial sales tax (“PST”) regimes in British Columbia, Saskatchewan, and Manitoba (the “PST Provinces”).

The Canadian Bar Association is a national association representing over 40,000 legal professionals, including lawyers, notaries, law professors, and students across Canada. Our mandate includes promoting the rule of law, improving access to justice, advocating for effective law reform, and providing expertise on how legislation impacts Canadians’ daily lives. The CBA Section comprises approximately 40 members and works to enhance awareness and understanding of legal and policy issues related to commodity tax, customs, and trade.

The CBA Section appreciates the federal and provincial interest in reducing barriers to business trade in Canada and is pleased to provide the recommendations herein.

1. Background

The existence of PST in the PST Provinces is an unnecessary internal trade barrier that does not exist in provinces that only have the goods and services tax / harmonized sales tax (“GST/HST”). There are three main reasons why PST is a significant internal trade barrier:

• Compliance Complexity: Canada has multiple, yet distinct, sales tax regimes. While GST/HST applies federally, with different rates of GST/HST in Ontario and the Atlantic provinces, distinct PST systems with different rules, returns, and compliance deadlines apply in the PST Provinces. Instead of complying with a single sales tax (GST/HST) with a single set of rules, businesses operating in Canada are required to comply with multiple sets of different rules due to the various sales tax regimes in place. The existence of three separate PST systems results in increased administrative costs for both businesses and the respective provincial governments. It discourages businesses not located in the PST provinces from providing goods and services to persons residing in the PST provinces.
• Embedded Tax Costs: While participating provinces have harmonized their sales tax regimes with the GST, British Columbia, Manitoba, and Saskatchewan have legacy PST systems that operate on outdated retail sales tax concepts that result in businesses that operate in the PST Provinces having to pay PST on property and services that they consume in the provinces; whereas, businesses with operations in the “participating provinces” generally recover the GST/HST that they pay on property and services that they consume in operating their respective businesses. This distinction results in businesses that are located in the PST provinces being at a competitive disadvantage vis-à-vis businesses with operations in the “participating provinces”.
• Discouraging Investment in the Infrastructure Necessary to Make Canada’s Economy Strong: PST is an upfront tax imposed on capital investment—a tax imposed before any revenue is earned by the business. GST/HST as a value-added tax (“VAT”) operates on the principle that while a business will pay GST/HST on purchases, if the purchase was made to produce another taxable supply, the initial tax will be fully refunded as an input tax credit (“ITC”). The underlying theory is that a business should not be taxed while investing in itself, and instead, the earned income for value consumed in Canada is, in effect, taxed. This approach facilitates new ventures and other investments without sacrificing government revenues.

These attributes of PST significantly increase the cost of doing business in the PST Provinces and make Canada less competitive compared to its trading partners.

2. Submission

The CBA Section recommends that British Columbia, Saskatchewan, and Manitoba replace their PST regimes by each becoming a ‘participating province’ in the GST/HST system. This change would significantly improve competitiveness in the PST Provinces and across Canada, and would reduce one of the most significant trade barriers between provinces for business.

3. Discussion

Looming Trade Threats

Canada’s prosperity depends on its ability to compete and thrive in a global economy. Canada’s trading relationship with the United States, its most significant trading partner, faces challenges not seen since before NAFTA, and productivity growth has remained persistently weak.¹ One of the most significant barriers to doing business in Canada is the existence of the PST in British Columbia, Saskatchewan,
and Manitoba.

From its inception, the GST was designed to enhance Canada’s economic competitiveness by modernizing the tax system and eliminating the hidden federal sales tax.² GST eliminates the hidden taxes imposed on business expenses by allowing commercial businesses to claim a refund of the tax incurred on purchases and imports as an ITC. In contrast, under the PST regimes in the PST Provinces, businesses incur unrecoverable sales taxes on their inputs because they do not have access to ITCs. This significantly increases the cost of doing business in the PST Provinces. Businesses must either pass on the cost to consumers through higher prices or reduce their profits and investments in new technology. This is a significant issue at a time of low productivity growth and underlies the reason PSTs have been referred to as “antiquated, distorting and unfair”.³

Published research highlights examples of the shortcomings of the PSTs, with just a few examples as follows:

• Elimination of the hard cost of British Columbia's PST on machinery and equipment alone would increase the per-worker stock of capital by 6.5%. The resulting increase in labour productivity would increase average hourly earnings by between 1.1% and 2.7%, and increase annual income per worker by between $700 and $1,700.⁴

• Adoption of the HST instead of the Ontario PST was expected to have the following impacts:

• a decrease in the effective tax rate on business investment from 4.1% to 0.9%;
• $294 increase in GDP per capita and $0.37/hour labour productivity increase; and
• $63 increase in disposable income per capita.⁵

• The OECD recognizes that PSTs have "significant disadvantages" compared to VAT systems, partly due to the audit and invoice trail generated by GST/HST-like systems.⁶

To further illustrate the issue, we have highlighted a few industry-specific examples of the difficulties we see in practice with PST systems.

Hidden Tax Cost Examples

Take the Liquified Natural Gas (LNG) projects on British Columbia’s Northern Coast as an example. Canada and British Columbia have only managed to complete one such project in the past decade and a half. LNG Canada proceeded only after British Columbia provided a temporary exemption from the PST for the construction of the first two production trains. The CBA Section is advised that each train costs $10 billion; therefore, without a PST exemption, it requires an additional upfront payment of $700 million in British Columbia PST before a single drop of LNG has been produced and sold. Such significant upfront PST costs discourage investment in British Columbia and the other PST provinces, and yet Canada must attract investment to build the infrastructure projects necessary to make their collective economies strong.

The same applies to the wires, the pipes, and the rails that are required to build and develop the transmission and energy corridors for transportation of crude oil, gas, and potash from other locations in British Columbia, Alberta, and Saskatchewan to tide water, and for transportation of British Columbia's and Manitoba’s hydroelectric power across Canada into other provinces.

PST regimes impose tax on these projects at the beginning, at the time of initial investment, when the projects are least certain. In this way, PST discourages the investments that are necessary to grow Canada’s economy before any project has earned any revenue. In contrast, with GST/HST, the government is, in a sense, a partner of industry and investors, encouraging them to invest, which empowers the government to share in the wealth created through the income tax imposed on the profits and revenues earned by these projects. The income tax is paid by the wealth passed down to the contractors, subcontractors, workers, and employees who profit from these investments going forward. In addition, the government retains GST/HST revenue when the end product is purchased by consumers at the end of the supply chain in Canada.

As a further example, the PST on software is a significant cost to payment processing and artificial intelligence (AI) companies. Since the PST is not recoverable by these businesses, it discourages them from operating in the PST Provinces.

This issue can also arise for “selected listed financial institutions” (e.g., banks, credit unions, insurers, etc.) (“SLFIs”) that operate in multiple provinces. SLFIs are discouraged from operating in British Columbia, Manitoba, and Saskatchewan due to PST, but they are indifferent between the GST/HST rates in different provinces. Under the GST/HST rules for financial services, SLFIs are sensitive to incurring unrecoverable GST/HST (just like PST). However, these rules also determine an SLFI’s overall GST/HST burden in a way that is disconnected from the province-specific GST/HST rate it pays. If a PST province harmonizes with the GST/HST, that province removes a significant barrier to SLFIs operating in that province.

These are merely illustrative examples — CBA Section members encounter PST inefficiencies on a regular basis. The problem of unrecoverable PST applies to all industries and is particularly burdensome to new businesses and businesses expanding from elsewhere in Canada. These businesses regularly question whether it is worthwhile to operate in the PST Provinces and, in some instances, have chosen to minimize the cost of doing business by relocating to Alberta or to a “participating province” with only the GST/HST regime. If the PST Provinces harmonize their sales taxes with the GST/HST, commercial businesses would be able to recover all the sales taxes paid on their inputs in all provinces, while collecting GST/HST on their sales, which reduces the cost of doing business in Canada without threatening government revenues. This measure, along with other measures that support growth, would enable Canada to become more competitive internationally.

Internal Trade Barriers

A strong economy is the foundation of national security and resilience. Yet, businesses — both domestic and international — continue to express concern about the complexity of operating across provincial lines, particularly in the PST Provinces.

In the PST Provinces, businesses must file a unique return to each province, interpret a unique sales tax statute in each province, and interact with each province’s tax authority. In contrast, Alberta and the participating provinces⁷ offer a streamlined and predictable environment for investment and growth that allows businesses to, across all of those provinces simultaneously, file only one return, interpret only one statute, and interact with a single tax authority.

The fragmentation of Canada’s sales tax landscape is itself akin to a tax that raises no revenue. Compared to countries like Australia, which has a single federal VAT system, Canada’s compliance costs are significantly higher. Even the European Union (“EU”), with over 448 million inhabitants and 27 member states,⁸ has a single EU VAT Directive that harmonizes the structure and principles for EU VAT.⁹ In this competitive global environment, Canada should lead, not lag, in harmonization. Tax advisors and tax lawyers regularly hear from their international clients about the complexity of the Canadian sales tax landscape compared to other jurisdictions of a similar economic size.

It should also be noted that complying with PST is a lot harder than complying with the GST/HST. For example, suppose a company acquires a piece of machinery for a gas plant in British Columbia. In that case, it must spend a significant amount of time determining whether the PST applies to that equipment. This determination generally requires the tax team and advisors to consult with the engineers and the operations teams supporting the business. Depending on whether the equipment is located within the plant, at the end of the plant, or outside the plant, the PST application may vary. Under the GST/HST regime, the business pays GST/HST and then claims an ITC to recover the tax (as occurs with all of its other inputs). Neither the business's enterprise resource planning (ERP) system nor the tax advisors need to determine compliance options for the purchase.

Moreover, the complexity of the PST regimes makes them more susceptible to tax disputes and contrasting interpretations. The increased dispute risk is itself a deterrent to investment, which in turn increases internal trade barriers.

Harmonizing Canada’s tax systems and administration would reduce the compliance burden imposed on businesses by eliminating inconsistent rules, multiple audits, and multiple return filings, as well as by simplifying interactions with tax authorities.

Notably, several expert commentators have recently flagged the PSTs as interprovincial trade barriers - CBA Section is by no means alone in this regard.¹⁰

HST and Local Priorities

Among the six provinces that previously considered harmonization with the GST/HST,¹¹ British Columbia is the only province that returned to PST. We believe that differences in implementation can partly explain the difference in outcome. When combined with the current political climate, lessons from prior harmonization attempts permit a successful harmonization effort today.

One important example is the possibility of replacing select PST exemptions with point-of-sale rebates. Many PST exemptions are politically popular and, if necessary, can be maintained with point-of-sale rebates that effectively eliminate the tax on certain sales to consumers. In Ontario, point-of-sale rebates are available for books, children’s clothing, diapers, and newspapers.¹² In this way, point-of-sale rebates can incorporate local priorities to generate support for harmonization with only minimal compliance difficulties.

4. Concluding Comments

No tax system is perfect. However, across Canada, the patchwork of multiple consumer-facing PST and VAT systems has led to unnecessary complexity and compliance costs — costs that don’t serve any clear policy goal and ultimately hinder the economy. By harmonizing Canada’s PST systems with the GST/HST, Canada can reduce duplication, lower unnecessary costs for businesses, and make life more affordable for Canadians. PST is a significant internal trade barrier between provinces and must be addressed.

Thank you for the opportunity to provide our comments. Please do not hesitate to contact us if you require any additional information or wish to discuss any aspect of our submission further.

(original letter signed by Noel Corriveau for Brent F. Murray)

Brent F. Murray
Chair, Commodity Tax, Customs and Trade Law Section

End Notes