The big little complicated tax cut

If you have a client selling a house anytime soon, you might want to tell them to push their closing date to July 1. As expected the Conservatives cut the GST to 6% in Tuesday’s federal budget.

The reduction to the GST represents 33% of the tax relief from the $26.2 billion in cuts across the 2005-’06 to 2007-’08 tax years. It is by far the largest new tax measure announced in Tuesday’s budget. The impact of the GST cut will not be felt equally across all sectors, however. Rather than cut the GST on alcohol and tobacco, the government increased the excise levies to on those products by 1% to offset the reduction.

The Conservatives were mum on when they plan to further reduce the GST to 5% as announced during the election campaign. The budget only says that the government plans to reduce the "GST by a further point in a future budget."

Homebuyers stand to benefit from the cut — provided their close dates are after Canada Day. According to the budget, a suburban family purchasing a new home for $350,000 will save $2,310, while a family purchasing a new $200,000 home will save $1,280 in GST. (The $1,280 savings takes into account the GST new housing rebate, which is equal to 36% of the gross GST payable on the price of a new home valued at less than $350,000).

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The government has structured the tax cut in a way that after July 1st, homeowners will still pay 7% tax, but they will have to apply for their 1% reduction, says Bruce Goudy, a tax partner with Ernst & Young. "What they’ve done is they have taken the opportunity away from the developers to capture that [tax cut], by saying that the dollars were already embedded in the original price and put it in the hands of the consumer."

Savings from the GST reduction will amount to approximately $3.5 billion in 2006-07 and about $5.2 billion in 2007-08. The Conservatives also plan to channel extra relief to low and modest-income Canadians by maintaining the GST credit at current levels even though the GST rate will be reduced.

By delaying the cut until July 1, the Conservative government gives companies time to adjust their accounting systems. "For the next couple of months there will be significant transition costs," warns Goudy. It’s expected to be an administrative challenge.

But as Goudy points out, don’t expect the parking lot attendant to lower his prices from $10 as a result of the GST cut. Likewise, financial institutions, perhaps even more than consumers, stand to benefit from the reduction of GST rate, he says, since banks, insurance companies and mutual funds recover such a small portion of their GST. "With the banks, it is not expected that those additional savings would be passed on to the consumer in terms of reduced service charges, instead that will more likely go to the bottom line," he says.

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While Darcy Briggs, a portfolio manager and fixed income analyst at Bissett Investment Management in Calgary, favours an income tax break versus a consumption tax break, he says the GST reduction will have only a slight impact.

"It was estimated it would be deflationary because it’s factored into the CPI," he says. "The Bank of Canada has predicted it would bring down the inflation rate but not change their outlook on monetary policy. So it’s been factored in by the bond markets."

Briggs expects there will be a drop in CPI once the GST reduction comes into effect, adding this shouldn’t impact effect the bank’s stance. "A lot of stuff had already been telegraphed."

As for the impact the GST has on investments, the cut will have an impact but it’s expected to be more on the margins. "It will encourage more purchases in mutual funds than would otherwise happen, but it will be very incremental," says Ian Russell, the president of the IDA’s new trade association.

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Capital gains exemption promise side-stepped

The Conservative’s bold capital gains exemption promised during the last election was noticeably absent from the budget. While few expected the issue would be a provision in the budget, some had hoped the Tories would have at least taken the opportunity to layout a framework for their proposal.

Russell was particularly disappointed that Finance Minister Jim Flaherty avoided the topic, considering the issue was prominent in the recent Throne Speech.

"We had anticipated based on the throne speech that we would have at least seen reference to it and a call for consultations," he said. "It creates a bit of uncertainty."

Still, Russell is confident that consultations on this measure will take place. It’s a complex issue, he says, so he believes the Conservatives want to come up with a proposal that addresses some of the inherent challenges before proceeding.

Liberal stance on trusts and dividends upheld

The former Liberal government’s decision back in November to lower the tax on corporate dividends and leave trusts alone was upheld by the Conservative government. The decision, which levels the playing field between investors in income trusts and corporations, was widely expected.

George Kesteven, president of the Canadian Association of Income Funds, applauded the government’s restraint. "We’re very pleased that the Conservative government will maintain the decision to lower taxes on dividends tabled last fall," he said "This approach should provide greater parity between the way that investors in income trusts and corporations are handled in the tax system."

Filed by Mark Brown, Advisor’s Edge Report, mark.brown@advisor.rogers.com.

(05/02/06)

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Mark Brown