Ontario retail sales tax on software: August 30, 2002

Tax Executive, The, Sept-Oct, 2002

On August 30, 2002, TEI's Toronto Chapter sent the following letter to Brenda Kershaw of the Ontario Ministry of Finance concerning the Province's draft legislation and administrative rules for software and related services. The letter was prepared under the auspices of the Institute's Canadian Commodity Tax Committee, whose chair is Martina Krummen of Air Canada, and was reviewed by TEI's Executive Committee in accordance with longstanding procedures. Carol Felepchuck of IBM Canada Limited contributed materially to the preparation of the submission.

**********

On behalf of Tax Executives Institute, I want to thank you for the opportunity to provide comments on the draft legislation and administrative rules in respect bf Ontario's Retail Sales Tax (ORST) for software and related services. The Ministry of Finance has been very generous in the opportunities it has presented TEI to provide input on this important subject.

Background

Tax Executives Institute is an international organization of more than 5,300 professionals who are responsible--in an executive, administrative, or managerial capacity--for the tax affairs of the corporations and other businesses by which they are employed. TEI's members represent more than 2,800 of the leading corporations with 53 chapters in Canada, the United States, and Europe.

Canadians make up approximately 10 percent of TEI's membership, with our Canadian members belonging to chapters in Calgary, Montreal, Toronto, and Vancouver, which together constitute one of our eight geographic regions. In addition, a substantial number of our U.S. members work for companies with significant Canadian operations. In sum, TEI's membership includes representatives from most major industries, including manufacturing, distributing, wholesaling, and retailing; real estate; transportation; financial services; telecommunications; and natural resources (including timber and integrated oil companies). The comments set forth in this submission reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency.

Ontario's Retail Sales Tax Act (ORSTA) currently treats tangible personal property--and the labour provided to "install, assemble, dismantle, adjust, repair or maintain" that property--as taxable. The definition of tangible personal property under the ORSTA includes computer programs. An exemption from tax is provided under ORSTA [section] 7(1) 62 for a "custom" computer program, which is defined as one that is "designed and developed to solely meet the specific requirements of, and that is intended for the exclusive use of, a particular person." ORST Guide #650--Computer Programs and Related Services, at 3 (February 2001).

On July 19, 2002, Finance Minister Janet Ecker announced proposed changes to the retail sales tax treatment of software and related services. The proposed amendments take some important first steps to clarify the treatment of these programs for ORST purposes. Recognizing the administrative and conceptual challenges in this are, TEI urges the Province to examine whether software and related services should be taxed when used as business inputs. Nonetheless, we commend the Ministry for its efforts to clarify the law and are pleased to provide the following comments on the proposed changes, as well as recommendations for additional amendments.

Adoption of a De Minimis Rule

In its December 19, 2001, comments, TEI recommended the adoption of a de minimis rule for software-related services where vendors generally provide non-taxable services with an incidental supply of taxable services. The Institute commends Ontario for proposing the adoption of such a rule, specifying that where taxable and non-taxable services are sold together for a single price, ORST would not apply if:

* the vendor's cost of the taxable services is 10 percent or less of the vendor's cost of the nontaxable service, or

* in the case of a vendor charging for time spent (e.g., hourly or daily rate) for services rendered, the time spent to provide the taxable services is 10 percent or less of the time spent to provide the non-taxable services.

The de minimis rule will help those vendors (and purchasers of these services) who supply what is for the most part a non-taxable service, but includes a nominal component of taxable services. We foresee a problem, however, with the use of the word "cost" in the regulations describing the application of this rule. The draft rule permits services to be provided on a non-taxable basis if the vendor's "cost" of taxable services is 10 percent or less of the "cost" of the non-taxable services provided. If the purchaser of these services is audited concerning the make-up of the services provided, the vendor will be called upon to disclose its costs. This request would not normally be fulfilled in every-day business practice, because vendors are generally very protective of their cost information.

To address this problem, TEI recommends that the term "cost to the vendor" in the description of the de minimis calculation be replaced with the word "value." Value could be substantiated by providing supporting pricing documents or by utilizing cost records and uplifting these by a common profit margin. Such. an approach would protect the confidentiality of the vendor's pricing information, while ensuring that the taxable component of the services is nominal. It would also accord with the July 19, 2002, Backgrounder issued with the draft legislation, which contemplates the appropriateness of using values in respect of the de minimis rule by stating (at page 4) that "the fair value of the taxable services must be reasonable in relation to the total fair value."