June 13th, 2023
What are the main GST/QST points to know regarding the change in use of a building owned by a public service body?
Please note that unless otherwise indicated in the text, we refer only to the Excise Tax Act[1] (hereinafter the “ETA”), since the Act respecting the Québec Sales Tax[2] (hereinafter “QSTA”) is harmonized in its application. Our comments are based on the provisions of the ETA and QSTA, or on the current positions or administrative practices of the Canada Revenue Agency (hereinafter the “CRA”) or the Agence du Revenu du Québec (hereinafter the “ARQ”) in effect to date. In the event of legislative amendments or changes to the current positions or administrative practices of the tax authorities referred to in this document, these comments should be revised.
What are the GST rules for determining whether there has been a change in use of a building owned by a public service body?
Public service bodies (school service centres, CÉGEPs, universities, hospital authority, municipalities, paramunicipal organizations, non-profit organizations and charitable organizations) (PSBs) are subject to specific rules regarding the change in use of their buildings.
General rules for PSBs
The real property of a PSB is treated according to the rules applicable to capital assets (movable property), namely the rules on principal use (50%+). If the real property is used primarily in “commercial activities”, as defined in the ETA, of the PSB, then all of the GST payable for its acquisition and improvements is refundable as an input tax credit (ITC). Conversely, if the real property is not used primarily in “commercial activities”, no ITC can be claimed. A rebate of the GST paid can however generally be claimed by the PSB based on the applicable PSB rebate rate.
The rule on insignificant changes in use does not apply to the capital assets (buildings) of a PSB on which the election of section 211 ETA and 272 QSTA has not been filed. For instance, if a 2% change in use means that a PSB’s capital asset (real property) is no longer used primarily in “commercial activities”, the change is significant for purposes of the change in use rules, as ITCs claimed may have to be remitted to tax authorities. Similarly, if a 25% change in use does not change the principal use of the building, the change is not significant for purposes of the change in use rules.
Rules applicable to PSB real property that is subject to sections 211 ETA and 272 QSTA elections
A PSB’s real property for which a section 211 ETA election has been filed is treated under the general change in use rules for real property. Under these rules, the PSB may claim ITCs for the GST paid on the acquisition of capital assets (real property), when the property is used more than 10 % in «commercial activities».
At the time of the section 211 ETA election:
The PSB is deemed to have paid GST equal to the GST content of the real property. The PSB may claim ITCs on the deemed GST paid for the real property if the real property is used in “commercial activities” at a ratio of more than 10%.
Upon an increase of 10%+ of commercial activity use (less than 90%)
An increase of 10% or more in “commercial” use of capital asset (real property) is deemed to be the same as receiving a supply of the part of the real property matching the increase. The PSB is deemed to have paid GST on the deemed acquisition of the part of the real property whose use changes from non-commercial to commercial. The PSB may claim an ITC equivalent to the amount of the deemed tax.
Upon an increase to 90 % or more commercial activity use
If the “commercial activity” rate increases to 90 % or more, the PSB will be deemed to use the real property at 100 % in “commercial activity” and should be able to claim an ITC on the remaining tax content that has not already been claimed as ITC.
Upon a decrease of 10%+ of commercial activity use which does not completely cease
If the PSB reduces, by 10% or more, the extent to which the capital asset (real property) is used in commercial activities ― without ceasing commercial use ― the PSB is deemed to have sold a portion of the capital asset (real property) to match the reduction and to have collected GST on the portion of the real property that is no longer in commercial use.
Upon termination, reduction to less than 10% of commercial activity use
When the PSB ceases commercial use of a capital asset (real property) or reduces its commercial use to less than 10% and begins to use the real property for other purposes, the entire real property is deemed to have been sold and reacquired, including the collection and/or remittance of deemed tax. The resulting tax liability results in the recapture by the tax authorities of ITCs previously claimed and takes into account the current fair market value (FMV) of the real property, if its value has decreased.
How is the tax content of real property calculated?
The tax content of real property is determined by a formula. In simple terms, the tax content is calculated as follows: (A-B) x C, where:
Element A:
- total all amounts of tax payable at the time the property was last acquired or imported;
- add all amounts of tax payable at any time in respect to improvements (goods and services) acquired, imported, or brought in after the last acquisition or importation;
Element B:
- deduct all amounts of tax recoverable by way of rebate or remittance (other than an ITC);
Element C:
- multiply the net amount by the factor that takes into account the depreciation in the FMV of the property since the property was last acquired. For the purposes of this exercise, we will use the lesser of 1 and the value of FMV divided by cost plus capital improvements.
Increase in commercial use of real property owned by a PSB that has been subject to a section 211 ETA election
A PSB that currently uses a capital asset (real property) in “commercial activities” and that increases the extent to which the real property is used in commercial activities by 10% or more is deemed to have paid tax in respect of the supply. The PSB may claim an ITC equal to the amount of deemed tax paid on the deemed supply.
The amount of tax that the PSB is deemed to have paid at the time of the deemed supply is determined by the following formula: A × B, where:
A is the basic tax content of the real property immediately before the time of the deemed supply,
B is the extent (percentage) to which the registrant has increased its use of the real property in “commercial activities” of the registrant relative to its total use of the real property at the time of the deemed supply.
Summary example #1
Calculation of recapture at the time of the section 211 ETA election, then after an increase in commercial activity use
A PSB that receives a 50% GST rebate for its exempt activities purchased an office building for $200,000, plus $10,000 GST. The building was then used exclusively in exempt activities until August 2020, when the PSB spent $8,000, plus $400 GST, to improve the building for use in part in its “commercial activities”. The PSB then elected to apply Section 211 ETA on the building.
At the time of the deemed acquisition following the section 211 ETA election, the FMV of the property had decreased to $180,000. At this time, 40% of the building was used for “commercial activities”. The PSB is entitled to an ITC equal to the deemed tax paid, which is the proportion of the basic tax content of the real property reflecting the extent of its activity use at the time of the deemed acquisition. The ITC to be claimed is equal to the deemed tax paid (basic tax content) × 40%.
The basic tax content of the real property at the time of the deemed supply is as follows: (A – B) × C, where:
A = $10,000 + $400 = $10,400
B = $10,400 x 50% GST rebate = $5,200
So (A-B) = $5,200
C = the lesser of 1 and the FMV divided by cost + capital improvements, i.e.: $180,000/($200,000 + $8,000) = 0.865
Therefore, $5,200 × 0.865, for a basic tax content of $4,498. Therefore, the PSB may claim an ITC of $1,779.20 ($4,498 × 40%).
The PSB then increased its use of the building “commercial activities”, going from 40% to 75% in 2022. The FMV of the building had increased from $180,000 to $225,000 at the time of the change in use. Therefore, the deemed tax paid by the PSB as a result of the increased use of the real property in “commercial activities” is 35%” of the basic tax content of the real property at the time of the deemed acquisition. The ITC to be claimed at the time of the deemed supply is therefore equal to:
(A – B) × C, or:
A = $10,000 + $400 = $10,400
B = $10,400 x 50% GST rebate = $5,200
So (A-B) = $5,200
C = the lesser of 1 and the FMV divided by cost + capital improvements, i.e.: $225,000/($200,000 + $8,000) = 1.082
Therefore, $5,200 × the lesser of 1 and 1.082. The PSB can then claim an ITC of $1,820 ($5,200 × 35%).
Is it important to track the commercial activity percentage of a real property?
With the two examples below, we will demonstrate the importance of tracking the rate of “commercial activity”, as well as understanding the rules of change in use in GST.
Summary example #2 – Real property with a section 211 ETA election
A PSB elected to apply section 211 ETA on real property it owned with a value of $20 million and a GST content of $500,000, following a GST rebate of 50%. The percentage of “commercial activity” at the time of the section 211 ETA election, in January 1, 2014, was 30%. As a result, the PSB claimed an ITC of $150,000.
Following a review of the building’s percentage of “commercial activity” at the end of 2020, the PSB found that the percentage of commercial activity for 2020 was 45%. The FMV of the building had increased since then, without the PSB making any improvements to the building. A 15% change in use has occurred. The PSB could potentially claim an additional $75,000 ITC as a result of this change in use.
The PSB’s manager contacts a commodity tax advisor to find out how to claim the amount in question. The advisor informs the manager that the PSB must first determine when the change in use occurred, since the PSB has a maximum of 4 years to claim the ITC after the date of change in use. Thus, if the change in use occurred more than 4 years ago, for example in 2015, it would be too late to claim the $75,000 ITC.
The manager then calculates the building’s commercial activity rate for each year since 2014 and finds that the 15% change in use occurred in 2015. It is too late to claim the $75,000 ITC, as it has been over 4 years.
Summary example #3 – Building used primarily in the PSB’s commercial activities
A PSB acquired real property in 2010 with a value of $20 million and a GST content of $500,000, following a partial rebate of 50%. The rate of commercial activity at the time of the building’s acquisition in 2010 was 52%. The following year, the rate of commercial activity was 55%. From 2010 to 2021, the building’s percentage of commercial activity varied between 50.2% and 57%. In 2022 and 2023, the building’s percentage of commercial activity was 47%, due to a decrease in traffic from a taxable activity.
Since the percentage varies annually depending on the different activities carried out by the PSB in the building and is very close to the 50% limit, the PSB managers decided, all throughout the ownership of the building, not to claim ITCs on the tax content of the building, even though over 50% of the building was used in commercial activities and the PSB could claim 100% of the tax content, thinking that they would not have to remit the tax if the commercial activity rate dropped under 50%. However, they claimed the tax payable on the operating expenses of the building based on the “commercial activity” rate in effect for each year, since this tax is not refundable on operating expenses if the “commercial activity” rate decreases.
In 2023, the PSB was audited by the tax authorities and one of the elements of the draft assessment was an amount of $500,000 of GST to be paid in 2022 following the change in use of the building from primarily commercial to primarily non-commercial. In fact, based on the calculations of the “commercial activity” rate of the building in each of the years, the auditor could confirm a significant change in use in 2022. In addition, it is now too late for the PSB to claim the ITCs that could be claimed in 2010, as the time limit has now expired.
Could the PSB be required to remit GST on a reduction in commercial use of a building, even if it did not claim ITCs on the acquisition or following an upward change in use?
In Example #2 above, the PSB manager who made the January 1, 2014 section 211 ETA election mentions to his commodity tax advisor (hereinafter the “consultant”) that he anticipates that the building’s “commercial activity” rate will decline 15% in 2022 anyway, and that he believes he will not have to remit the ITCs since he has not claimed an ITC’s on the 15 % rate increase in 2015.
The consultant informs him that, unfortunately, if there is a change in use of more than 10%, the PSB would have to remit tax, even if it has not claimed any ITCs, since the formula for calculating the tax to be remitted when there is a reduction in commercial use of 10% or more in the ETA is based on the basic tax content of the building. It does not consider ITCs claimed. For example, if a downward change in use of 15% occurred and the value of the building has not decreased since January 1, 2014, the PSB must remit $75,000 in GST for the reporting period in which the change in use occurred.
In Example #3 above, the PSB would be required to remit the basic tax content of $500,000 (if the FMV of the real property has not decreased since acquisition), even though it did not claim an ITC. This is because the formula prescribed in the ETA to calculate the tax to be remitted (when a reduction in commercial activities is such that the real property is then used primarily for the PSB’s non-commercial activities) is based on the basic tax content of the real property. It does not consider the ITCs claimed. However, the PSB could elect to apply section 211 ETA to its property and claim 47% of the GST content of the property paid as a result of the change in use, in order to reduce the amount to be remitted.
In both cases, the PSB could also make representations to the tax authorities to reduce its tax liability, since it has not claimed ITCs on the GST it owes. However, since the change in use rules are provided for in the ETA, the taxing authorities have the privilege of granting or refusing a reduction of the PSB’s tax obligations.
Important Points to Remember
- A “significant” change in use for a building that has not been subject to a Section 211 ETA election is the percentage of change in use required to change from primarily commercial to primarily non-commercial activities, and vice versa.
- A “significant” change in use for a building that has been subject to the section 211 ETA election is 10% or more and a change of use that would result in a “commercial activity” rate of 10 % or less, and of 90 % or more.
- Tracking the “commercial activity” percentage of a PSB-owned capital asset must be done annually or before if there is a significant change in use;
- For PSBs, the applicable rule, in GST, to claim ITCs ― or not ― upon acquiring and after improving a capital asset (unless the real property is subject to section 211 ETA) is the rule of primary use (+50%);
- A PSB may get out of the primary use rule by making electing to apply section 211 ETA for each of the real property assets owned by the PSB;
- If the PSB is eligible to claim ITCs for the GST payable on the acquisition, improvement, or “significant” upward change in use of real property, ITCs should be claimed as soon as possible;
- GST payable on a “significant” downward change in use of a real property asset should be remitted as soon as possible to avoid penalties and interest;
- Even if a PSB has not claimed ITCs on the acquisition, improvements, and “significant” upward change in use of real property, there may be GST remittable on a “significant” downward change in use (subject to the fair market value of the property), since the calculation of the tax remittable is based on the tax content of the property and the percentage of change in use, not the ITCs claimed.
The information presented in this article is intended to provide information to Consultaxe clients and others whom the topic interests. The information presented herein is general. Before making a decision, readers should consult a professional advisor.
[1] Excise Tax Act, RSC 1985, c. E-15 [hereinafter the “ETA”].
[2] Act respecting the Québec sales tax, L.R.Q., c. T-0.1 [hereinafter the “QSTA”].
