GST/HST Implications for Transportation Consortia of Ontario District School Boards June 22, 2011

Table of Contents

Executive Summary 1

Introduction 5

Consortium Overview 9

The Sales Tax Landscape 11

Application of GST/HST 16

Rules for Public Institutions 19

Rules for Non-Profit Organizations 24

Special Concepts 27

Current Structures 32

Glossary 49

Appendix 1 Listing of Existing Consortia 53

Appendix 2 List of Reference Documents 566

Appendix 3 Copies of Selected Reference Documents 588

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Executive Summary Introduction and Background

In 2006, the Ministry of Education (Ministry) introduced reforms related to the funding and administration of student transportation services in Ontario. The Ministry had proposed the development of a consortium structure, whereby coterminous school boards would coordinate and manage the delivery of student transportation services in an effective and efficient manner. Currently, almost all of Ontarios elementary and secondary school boards are participating in one of the 33 student transportation consortia now in operation.

These consortia have been set-up, and are operated, in an appropriate business-like manner, and an important element of this business approach is the treatment of sales taxes.

Issues

Whether the consortia are unincorporated associations of the member boards, or whether they are incorporated as separate legal entities, they represent an added link in the supply chain between the third-party transportation suppliers, and the students that are receiving the transportation services. In particular, these consortia are now in the middle of this supply chain, and the nature of the consortium entity and its relationships and transactions with the boards on one hand, and with the transportation providers on the other, give rise to the sales tax considerations.

For several reasons, the consortia are at differing stages of development and sophistication. Most of them have a number of common characteristics, including the creation of the consortium entity, which is likely to have a tax status different than that of the member boards. Accordingly, sales tax may apply to a supply differently, depending on whether that supply was made from a board to the consortium, or whether it was made from the consortium to the board. Overall, the development of these structures has resulted in added sales tax complexities that members of the Governance Committees and consortia managers may not be aware of. Our findings bear this out - some consortia are achieving appropriate (overall tax-cost) results using appropriate procedures, while others are achieving appropriate results consequentially. Still others are likely achieving mixed results, and could be open to greater audit risk if the CRA determines that the procedures are not consistent with the legislative requirements.

Because commercial businesses are generally able to fully recover the GST (now HST) paid on their inputs, many of them dont make sales tax management a high-enough priority. This may create a false sense of security because compliance deficiencies can still be costly in terms of time and resources, as well as interest and penalties. In the case of non-commercial organizations such as school boards, the HST paid on inputs is generally not fully recoverable. As such, some management of sales taxes is necessary for effective and efficient operations, even without the potential added costs of an assessment.

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Consortia Review

In 2010, KPMG LLP was engaged to review the provision of student transportation services from a sales tax perspective. We were tasked with conducting a study of the transportation consortia, and with developing a comprehensive resource guide for the application of sales taxes to their operations.

The timing of this review was favourable not only have the last few years seen the introduction and evolution of the Ministrys reforms, but there have been simultaneous, and significant, changes to the sales tax landscape in which these consortia operate.

These changes have culminated in the recent implementation of the Harmonized Sales Tax (HST), in Ontario. The HST merges the Ontario Retail Sales Tax (ORST) with the Federal Goods and Services Tax (GST), into a single consumption tax that applies to most goods and services.

Our mandate included a review of the existing structures to identify the transactions and relationships within them, and to determine the various ways in which GST/HST applied to those structures, relationships and transactions. We considered different business forms for the consortia, and have commented on the tax implications of each. In addition to providing a summary of the straightforward application of the tax rules, we have also addressed a few, more specific provisions that may be used to improve the tax effectiveness and efficiency of the consortia structure.

We are not aware of any specific focus on the elementary and secondary educational sector, by the tax authorities. In preparing this report, we learned of one consortium that has been the subject of a compliance review by the Canada Revenue Agency (CRA), and that there were no significant adverse findings. These points are good news, and an opportunity to consider these issues, and where necessary, to make adjustments before the issues are raised in less favourable circumstances.

We also note, that based on our observations, many of the structural or procedural adjustments that may be required by member boards or consortia, can be implemented without significant cost or effort.

We recognize that there may be few resources within the consortia system with a detailed understanding of sales tax issues and rules. Accordingly, we have compiled this report to help guide the decision-making of those individuals responsible for the financial management of the transportation consortia. The report includes a basic introduction to the sales tax environment, as well as more detailed discussions and examples of the application of those provisions that are most relevant to school boards, and student transportation consortia.

Findings/Conclusions

The creation of the consortia structure has made the application of sales tax a much more important consideration for the delivery of student transportation services than it may have been prior to the reforms initiated by the Ministry. This is partially because of the variety and complexity of the transactions and relationships that have resulted, and it is also partially the result of the legislative changes that have been occurring in the sales tax environment, particularly in Ontario.

Our look at the consortia that are in place leads us to the view that there are a few different arrangements that can be utilized to achieve the objectives of the reforms, while also complying with the legislative requirements.

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The circumstances surrounding each of the consortia groups are varied from rural geographies, to sophistication of systems, to availability of physical or human resources, to local cost considerations. None of these conditions are advantages or disadvantages that will make any consortium more or less meaningful than any other. There is not, and does not have to be, a one-size fits all approach to the consortia structures. So long as basic principles are adhered to, there are options for making allowances for these local variations.

Similarly, there are options with respect to the application of sales tax to these consortia structures. As has been shown, there may be more than one method for achieving sales tax efficiency, just as there may be several ways in which this efficiency can be unintentionally defeated.

On a case by case basis, there are probably a few steps that can, or should be taken by each consortium to help it meet its goal. Overall though, to the extent that we have reviewed a large number of consortium agreements or interviewed a selection of consortia governors or managers, we believe that most of them can move towards better tax efficiency without significant cost or effort.

Recommendations

We recommend that those charged with the governance of the student transportation consortia, take the following steps, as applicable, to help maximize the effectiveness and efficiency of their transactions with respect to sales tax:

That members of the Governance Committee and consortia managers, gain an understanding of the elements of the transactions that are relevant for sales tax purposes Who are the vendors, and who are the legal purchasers?; What property and services are being provided? What is the tax status of the property and services?

To review their particular consortium structure to ensure they have agreements in place to recognize the transactions that are occurring, and that clearly establish the intended relationships among the parties

To be aware of circumstances or relationships that could give rise to an incidence of tax;

Review the current tax treatment of the property and services provided to ensure compliance with CRA requirements;

To make any necessary amendments to existing agreements or processes to ensure that the transactions contemplated by the agreements are consistent with the supporting documentation, and the actual physical arrangement;

Where the circumstances warrant, to review the ability to take advantage of the buying group arrangement, or determine if the present arrangements will satisfy the CRAs cost-sharing policies;

To ensure steps are taken to obtain appropriate tax and legal advice when entering new agreements and business activities;

If treating the consortium as a flow-through entity, to obtain HST registration for the consortia entity, and to apply HST to supplies made by the consortium;

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Where there is use of a banker board, that care be exercised in separating the usual activities of the board, from those of the consortium entity, particularly with respect to the application of tax, or the entitlement to rebates.

In general, most of the consortia that we have reviewed have attempted to apply appropriate HST management to their operations. However, given the existing CRA audit environment, we strongly encourage the Ontario student transportation consortia to ensure their operations and related documentation will stand up to scrutiny in the event of an audit. As discussed, there is no one-size fits all approach to these issues, so the unique characteristics of each consortium can be taken into account in meeting the compliance requirements. We trust that members of the Governance Committees and consortia managers will benefit from the information contained in this report, and that it will help guide their decision-making with respect to the application of sales tax to consortia activities.

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Introduction Background

As a result of student transportation reforms initiated by the provincial government in 2006-07, almost all of Ontarios 72 school boards are now involved in one of 33 transportation consortia1. The reforms are intended to create efficiencies in the provision of daily transportation to approximately 40% of the almost 2 million students enrolled in one of the four board classifications English Public; English Catholic; French Public; and French Catholic.2

Prior to these reforms, student transportation was provided by individual boards to their own students, but this arrangement may have resulted in a duplication of activities and resources, and fewer economies of scale. In some cases, a board may have participated in a cooperative effort with other local boards to help share costs.

The reforms of 2006-07 resulted in a more rigorous approach to the establishment and operation of the cost-sharing arrangements. This approach included an increased focus on the business aspects of the structures, including governance, legal agreements, accounting and finance, and the use of available technology software for route planning and operations.

The Ministrys reasons for the reforms are outlined in its presentation document Student Transportation Overview, as follows:

Modernize the sector and raise management capacity and increase system effectiveness and efficiency;

Promote and encourage the adoption of good business practices;

Improve accountability, transparency and fairness in the student transportation funding;

Reduce the administrative burden on boards, allowing them to focus on student learning and achievement;

Reduce the use of transportation by boards as a tool to compete for students;

Develop an approach to adjust funding that supports safe, effective and efficient service.

The guidelines for the development of the consortia addressed issues of governance, organization, and operational planning. Once a consortium was created, its Governance Committee, with representation from the member school boards, was responsible for the development of operating policies and procedures that were consistent with the Ministrys goal of effective and efficient student transportation delivery.

Included in the business of consortia, is how they will manage and be accountable for the sales tax issues. While these tax considerations are not new, the harmonization of the federal and

1 Consortia, or its singular form, consortium, are not defined in the Excise Tax Act. The ordinary dictionary definitions include -

Consortium: (1) A group of separate individuals or companies that come together to undertake an enterprise or transaction that is

beyond the means of any one member. 2 Student and transportation statistics are provided by the Ministry of Education.

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provincial sales taxes in Ontario, in July 2010, has created a renewed focus on sales taxes for a few reasons: The transition to harmonization and its broader tax base has caused organizations of all types and sizes to review the application of sales tax to their operations; the cost of errors is now potentially more significant, especially for those organizations that are not able to fully recover sales taxes paid on their inputs; and, for those organizations that are in commercial activities, harmonization allows for a greater recovery of sales tax expense, than previously was the case.

The involvement of most of the school boards in a consortium is in the form of a member board for a particular consortium, to which it may provide services or staff, share in the consortiums costs, and receive transportation services for its students. In other cases, a board may be a participant in a consortium only to the extent that it is a purchaser of the transportation services.

The structure of the various consortia, may take different forms which have different legal status. The Ministry engaged legal assistance to examine and explain these structures, and that study culminated in the document Transportation Consortia Resource Guide3 (the Resource Guide). The Resource Guide focuses on the two primary business forms of the consortia an unincorporated entity, which is an extension of its member school boards; and an incorporated one, which is a separate legal entity. It discusses the most relevant considerations of the two forms, including legal implications, governance, liability, insurance, human resources, taxation, privacy, policies and processes.

The topic of sales tax was briefly addressed in the Resource Guide. It raises some of the relevant questions to be considered concerning the application of the Goods and Services Tax (GST), and now in Ontario, the Harmonized Sales Tax (HST)4, to the agreements and transactions related to the operation of the consortia. Answering these questions then, becomes the purpose of the present document.

The Brant-Haldimand Norfolk Catholic District School Board (BHNCDSB), on behalf of the Effectiveness and Efficiency (E&E) Advisory Committee5 of COSBO, has undertaken to manage the project to provide comprehensive tax guidance6 to transportation consortia and their member School Boards.

KPMG Scope

As noted above, 33 student transportation consortia are in operation, and are primarily of the unincorporated type. Most of those structures are similar, but many are at different stages of development. Some are moving towards incorporation, some are considering it, and some have not yet taken steps in that direction. Currently, 15 of the consortia are separately incorporated entities.

3 The Resource Guide was developed by Keel Cottrelle LLP (Keel Cottrelle), V.15 dated July 17, 2008 4 In Ontario, the GST was replaced by the Harmonized Sales Tax (HST) on July 1, 2010. A more detailed discussion of the

impact of this change follows in this report. 5 The COSBO Effectiveness and Efficiency (E&E) Advisory Committee is a sub-committee of the Council of School Business

Officials (COSBO). The Ministry of Education has provided funding to the Committee to identify key projects that would result

in cost savings, cost containment, and assist the sector to operate more effectively and efficiently. 6 This guide may not address all of the tax questions that can arise in a particular circumstance. It is to provide guidance

on the general application of HST to the structures and transactions outlined. Consortia managers should always seek

more detailed guidance on a particular transaction from their own tax advisors.

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In the majority of cases, the consortia are operating under the basis of one or more written agreements, which typically include an agreement between the member boards establishing the particular consortium, and the general principles and processes by which it will operate. There are often separate agreements for the supply of goods or services among the member boards, or between any or all of them and the consortium entity. As well, there may be agreements with those non-member boards that are just purchasing transportation services from a consortium entity. Most importantly, there will be one or more third-party supply agreements for the provision of the transportation services to a consortium. It is estimated that 85% of the current total student transportation funding of approximately $840 million, is consumed by the third-party transportation contracts.7 In addition to the third-party transportation contracts, a consortium may enter into agreements for the purchase of goods and services from other third-party suppliers. Generally, these other purchases may be small relative to the transportation contract, and periodic, and would not necessarily be governed by a formal written agreement.

KPMGs mandate was to sort through these different structures, agreements and transactions, to identify the potential incidences of tax, and to provide guidance to the member boards and the consortia with respect to their rights, obligations and entitlements under the Excise Tax Act (ETA), the governing legislation for the GST/HST.

Tax Note It is not within the scope of this report to recommend one form of business structure over another each has its own merits and drawbacks, and different structures may be more desirable under differing circumstances. Rather, it is our goal to provide a comprehensive resource guide for the application of the tax to the structures and transactions so chosen.

We recognize the fact that resources with the specific tax knowledge and experience are likely in limited supply within the school board system. However, the broad scope of the current sales tax landscape in Ontario, the assessing practices of the tax authorities, and the fact that school boards and other public sector entities are now entering into unfamiliar business relationships, all combine to make this assistance necessary. Working towards the Ministrys overall goal of improving the effectiveness and efficiency of student transportation services in Ontario, while minimizing the unintentional adverse consequences of the tax environment within which those services are provided, is the motivation behind compiling this report.

Methodology

KPMGs approach to this project is straightforward and summarized as follows:

To gain an understanding of the current consortia structures, we conducted a review and analysis of the relevant agreements, initially at a high level, and then with a more detailed look at a sample of the consortia. The sample was selected by the project management team with the aim of providing a mix of structure types, and organizations that are at different stages of development. Once we had an understanding of the nature of the structures and transactions, we could then apply the relevant tax considerations.

The second step of our approach was to determine how the tax should apply to the identified structures and transactions. This step consisted primarily of researching the relevant legislation, current policies of the tax authorities, interpretations and other documentation and commentary as considered necessary.

7 Student and transportation statistics are provided by the Ministry of Education.

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The third step was to gain an understanding of how the consortia were dealing with sales tax in actual fact. This helped us assess the strength of the available tax resources within the consortia system, and to identify any inconsistencies between the theoretical and practical application of tax. This step was carried-out through interviews and discussions with selected consortia managers, and other stakeholders

Finally, our findings were compiled into this report, for subsequent distribution to all member school boards and consortia.

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Consortium Overview For the most part, a single board will participate in one consortium, either as a full member, or as a purchaser of services. As full members, many boards will be both a seller and purchaser of services within its consortium, and as a result of geographies, some boards may participate in multiple consortia. For these multi-consortia boards, particular attention should be paid to the rules outlined later in this report since similar transactions may be taxed differently under different consortium structures. In practical terms, the category of a particular board for GST/HST purposes, the tax status of supplies that board makes or the credits it is entitled to will not change as a result of its participation in multiple consortia. However, when a school board is involved in more than one consortium, it may be subject to different transactions, with different tax implications, depending on the structure and activities of each separate consortium. Table A, in Appendix 1, is a listing of the existing consortia. It indicates the full member, and purchasing member boards of each consortium, as well as the consortiums status as an incorporated or unincorporated entity as of March 2011.

The listed consortia structures are set-up and described by a number of agreements that are similar from one group to another. However, each consortium will have different agreements depending on their local circumstances. In general, and subject to advice from members legal advisers, each major agreement to provide and/or purchase services should be evidenced by a written agreement between the parties.

The sample agreements drafted by Keel Cottrelle, provide a starting point for documenting the consortium relationships and transactions and from which each consortium can add its own provisions to reflect the specific workings of its group. Indeed, many of the actual agreements reviewed in the course of our research for this report, were variations of the suggested agreements.

The agreements reviewed, showed that the consortia have a number of common elements as follows:

An intention of the member boards to work together to achieve efficiencies on the provision of the transportation services ;

Equal representation of the member boards in the governance of the consortium;

Agreements for member boards to provide administrative services on behalf of the consortium, where such services typically include accounting, banking, information technology, human resources, payroll processing, etc;

The use of one board as a banker board, where the consortium does not have its own bank account;

In many cases, the secondment to the consortium of existing transportation staff from one or more of the member boards;

Where staff are seconded, they remain employees of their home boards, and all pay, benefits and employment rights and entitlements remain with the home board

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(notwithstanding that the home board may be partially reimbursed for these costs by other member boards, via the consortium);

Contracts for transportation services that are in the name of the consortium entity alone, or may also name the member boards as parties to the contract;

The consortium entity and its operations are often co-located in a space with a member board, or are in a separate space owned by a member board.

In contrast to these similarities, there are differences among the consortia with respect to the accounting and invoicing procedures, the GST/HST registration status of the consortium entity, and the application of GST/HST to the consortiums transactions.

Tax Note Some of these differences would represent compliance errors in the view of the CRA. In fact, many consortia are achieving the correct monetary outcomes even though their procedures may not fully comply with the provisions of the ETA. This may be the result of some inconsistencies with respect to an understanding of the applicable rules, and the CRAs documentary requirements. It is our intent, with this report, to help the consortia improve upon some of these inconsistencies.

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The Sales Tax Landscape GST Basics

The GST has been in operation in Canada since January 1, 1991. Simply put, it is a consumption tax structure that applies tax on the incremental value added to the good or service at each stage of the supply chain, such that the end user (consumer) pays tax on the full value of that good or service.

The tax applies to a very broad base of goods and services, with notable exceptions that include basic food and other necessities, used residential property, certain medical and dental services, certain educational services, financial services and exports. With limited exceptions, the tax is paid by all purchasers of taxable goods or services, and those purchasers that use or resupply goods or services in the course of their commercial activities8, will recover the tax paid on their costs by way of an input tax credit (ITC).

Other purchasers, especially public sector bodies (PSB), which include municipalities, universities/colleges, school authorities and hospitals (the MUSH sector), as well as charities and certain other not-for-profit organizations, are also entitled to claim ITCs but only to the extent that the goods and services are used in commercial activities. Since exemptions apply to many of the goods and services provided by PSBs, they are not in commercial activities with respect to these supplies, and are not eligible for an ITC on the related inputs. Instead, these entities rely on a series of rebates to partially recover the GST paid on their inputs.

Each sub-group of public sector bodies is generally able to claim rebates at a rate that is specific to that group. The rate is closely tied to the nature of that entitys purpose. For example, a school board would generally claim the rebate intended for school boards. However, there may also be instances where a member of one type of PSB is involved in activities which more typically are carried out by another type of PSB. For example, a charitable womens crisis centre providing elementary school education for children of women in the shelter. In this case, the crisis centre may receive separate rebates based on the rates attributable to each of their activities (i.e. the charitable rebate for the shelter activities and the school rebate for its classroom activities).

Tax Note With very limited exceptions, any person that is making taxable supplies in the course of its commercial activities, is required to become a GST/HST registrant, and to collect and remit tax on those activities. This requirement extends to public sector bodies such as charities and non-profit organizations, as well as to the traditional commercial businesses. However, charities and non-profit organizations make fewer taxable supplies because of the extensive exemptions available for their activities, that are not available to traditional commercial businesses.

8 Commercial Activity is defined in the ETA to refer to those activities that involve the making of supplies (sales) that are not otherwise exempt.

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In the case of a small supplier9, registration is not required, notwithstanding that the small supplier may be making taxable supplies. Similarly, by not being registered, a small supplier is not able to recover the tax paid on inputs by way of an ITC, but would still generally be entitled to a rebate, if that small supplier was also a PSB. Depending on the nature of the commercial activities and the types of costs involved, a person may voluntarily become a registrant, and once registered, is subject to the same obligations and entitlements as any other registrant.

In the years since GST was introduced, there have been countless amendments to the original legislation, all with the stated intention of streamlining the application of the tax for many organizations. Some of the most significant changes over the last few years have involved the lowering of the tax rate from the original 7% to 5%10. In 1997, three eastern provinces New Brunswick, Newfoundland and Nova Scotia, were the first to truly harmonize their provincial sales taxes with the GST to form the HST11. Effective July 1, 2010, Ontario and British Columbia became the latest provinces to harmonize their provincial taxes with the GST.

HST

The HST was created by merging the existing provincial sales tax12 of Ontario with that of the federal GST. While harmonization required several new rules to align the two tax regimes, it essentially follows the existing GST rules, only now applied at the combined rate of 13% in Ontario13. The new combined rate of 13% contains two components, the federal component of 5% and the provincial component of 8%14 but expressed as a single tax on invoices.

The purpose of harmonization from the governments view is to have one sales tax system, with one set of rules, one administration, one set of forms and one enforcement structure. The government expects that harmonization will reduce the compliance burden, and the associated costs, for most businesses in the supply chain. Consumers however, still pay 13% sales tax under harmonization as they did under the separate GST and PST systems, and in some cases, pay the provincial component of the HST on purchases that were not previously subject to PST. The difference now however, is that an expected trade-off should occur between the increased tax that is paid in some cases by consumers, and the lower prices that should result from the savings within the supply chain. In other words, the theory is that more tax is paid, but on a lower cost base for goods and services, so the total tax increase to consumers should not be as significant as it first appears. The most important change that the HST has brought to public sector bodies, is the creation of a rebate that enables them to recover a significant portion of the provincial component of the HST, in addition to the rebate that they were previously receiving for GST (now, the federal component of the HST). These rebate entitlements are summarized in the following table:

9 A small supplier is a person that generally has less than $30,000 of annual taxable supplies (sales) or in the case of a PSB, has less than $50,000 of annual taxable supplies, or if the PSB has more than $50,000 in annual taxable supplies, their total

revenues do not exceed $250,000. A small supplier is not required to become a GST/HST registrant, but may do so voluntarily. 10 The rate changed from 7% to 6% as of July 1, 2006, and then from 6% to 5% as of January 1, 2008. 11 In 1992, Quebec introduced a new provincial sales tax system that mirrors the GST system but is not in fact harmonized. 12 In Ontario, the 8% Ontario Retail Sales Tax. 13 Rates for other HST provinces (the participating provinces) British Columbia 12%; New Brunswick and Newfoundland

13%; Nova Scotia 15% (as of July 1, 2010). The Quebec Sales Tax (QST) at a general rate of 8.5% is charged separately from

the 5% GST, as is the case in Saskatchewan (5%), Manitoba (7%), and Prince Edward Island (10%). There are no provincial sales

taxes in Alberta or in the Northern Territories. 14 The provincial component is sometimes referred to as PVAT.

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Table B HST Rebates for Public Sector Bodies

Public Sector Body Rebate of 5% Federal Portion of HST

Rebate of 8% Provincial Portion of HST

Municipality 100% 78% University/College 67% 78% School Authorities15 68% 93% Hospitals 83% 87% Charities & Qualifying16 Non-profit Organizations

50% 82%

Proposed new partial rebate This new rebate creates some additional accounting complexities, however it should not increase costs because prior to harmonization, the PST that was paid on goods or services by public sector bodies, with limited exceptions, was not recoverable. The governments stated goal for the new HST rebates is to keep public sector bodies relatively cost neutral with respect to the overall sales tax burden. Under the HST, the provincial component will be applied to some goods and services that were not previously subject to PST17, and the new rebates help to reduce that impact.

It may be easier to keep in mind that where a school authority (school board) recovers taxes it pays by way of rebates, it will recover a combined rebate of 83.3% ((68% x 5/13) + (93% x 8/13) = 83.3%). This compares favourably to a charity or NPO, which would only recover 69.7% ((50% x 5/13) + (82% x 8/13) = 69.7%). Where a school authority or NPO also recovers tax by way of ITCs for its commercial activities, the total tax recovery will increase accordingly.

While the use of these combined rebate rates is practical for discussion and budgeting purposes, for the purpose of filing claims, or any other correspondence with the CRA, the rebates are to be calculated and identified separately.

Of course, the actual savings, if any, will be determined by the mix of expenditures within organizations, which can vary from year to year. For example, in years with high capital construction expenditures, the overall net sales tax cost (i.e. the HST paid, less any ITCs or rebate entitlements) will be expected to increase, but by far less than the provincial component of HST that is now added to the contracts. Similarly, for periods of increased expenditures on service contracts that were previously PST exempt, such as transportation contracts. The overall cost increase or decrease will be partially determined by HST savings realized by suppliers and passed along throughout the supply chain. This potential impact is illustrated by the following example:

15 School Authority as used in this report, is a defined term under the ETA. It broadly refers to an organization that operates

an elementary or secondary school consistent with provincial standards. Refer to the Glossary. We understand that the term may

have a different meaning within the educational sector. For the purposes of this report, school authority refers to a school

board. 16 Qualifying is a defined modifier under the ETA, and refers to a non-profit organization that receives at least 40% of its

funding from government sources. See the section Rules for Non-Profit Organizations, for a detailed discussion. 17 Most notably, professional and consulting services, and real property contracts.

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Example 1 Transportation Contract Prior to HST With HST With HST (Adj)

Transportation Contract $100.000 $100,00018 $98,00019

GST @ 5% $5,000 n/a n/a

PST @ 8% n/a20 n/a n/a

HST @ 13% n/a $13,000 $12,740

GST Rebate @ 68% ($3,400) n/a n/a

Rebate for Federal Portion of HST @ 5/13 x 68% n/a ($3,400) ($3,332)

Rebate for Provincial Portion of HST @ 8/13 x 93% n/a ($7,440) ($7,291)

Total Cost $101,600 $102,160 $100,117

As illustrated, the application of HST combined with the new rebates, results in a slightly higher cost for the school board, immediately post-GST. However, this assumes that the carrier has not reduced the contract price to reflect its savings of the PST that previously formed part of its cost. The further calculation indicates the impact to the school board for this same contract, under the assumption that the price has been adjusted to reflect the carriers savings. The indicated price reduction is an estimate, and any actual savings realized by the carrier will depend on the mix of inputs that were previously subject to PST. The important point to be aware of here is that costs should fall for most suppliers, so contracts for equivalent levels of goods or services, may eventually be priced lower. Whether the contract price is adjusted or not, the overall impact of HST to the school board in this example is relatively small, either way.

These potential supply chain savings were not expected to be realized immediately after harmonization, but should be reflected in pricing as suppliers update their systems and processes to fully implement the HST, and pass along any resultant cost savings.

A Word about PST

The provincial sales tax system that existed in Ontario prior to July 2010 (Ontario Retail Sales Tax, also known as ORST, or PST), applied tax at 8% to most goods, and to certain services. For most public sector entities, the largest expenditures are for salaries and benefits, and in some cases, capital expenses and professional fees. While PST was not applicable to the salaries and benefits of employees, whatever amount of PST that was previously paid by public sector entities on capital and operating costs, became a direct cost.

With harmonization, the former tax structure has essentially disappeared, but the compliance obligations and recovery opportunities that existed under the previous system continue to apply, subject to the statutory time limits. In general, there is a four-year time limit within which, a taxpayer can be reassessed for any tax deficiencies. For any errors common to public sector entities, such as failing to self-assess tax on imported purchases (typically software), or certain internal allocations (typically printing), that occurred prior to July 1, 2010, the entity may still be

18 For comparative purposes, it is assumed that the contract price remains the same post-GST as it was pre-HST. 19 This is the assumed price for the same contract, if the carrier passes through its PST that is now recoverable under HST. The

actual adjusted price will be determined by a number of factors. 20 The PST paid by the carrier on inputs, is a cost that is reflected in their price to the customer.

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reassessed within four years of when the tax was due (i.e. up until June 30, 2014 for purchases made up to June 30, 2010).

The audit branch of the Ministry of Revenue has the mandate to ensure that all taxpayers, including those in the public sector, are in compliance with their obligations under the Ontario Retail Sales Tax Act. Historically, public sector entities were not normally audited as frequently as commercial entities, but this may be changing, due in part to harmonization, and the wind-down of PST.

The Ontario Ministry of Revenue had publicly stated in 2010 that they intend to conduct retail sales tax audits of most businesses (and presumably public sector bodies) over the first two years of harmonization. The Ontario government wants to ensure that all retail sales taxes required to be paid under the former Retail Sales Tax Act have indeed been paid. School boards and the consortia that have been subject to audit should ensure they communicate with their vendors when audit assessments are issued. The Minister of Revenue has the authority to assess both parties in a transaction - the vendor for failing to collect tax, and the purchaser for failing to pay tax, but it will only intentionally assess one party, as long as the tax is paid once.

Note that the same four-year time limit applies where a taxpayer may be entitled to PST refunds or rebates. The taxpayer must submit a refund or rebate claim within four years of when the tax was paid, or in the event of a PST audit, request that the auditor offset any assessment by such overpayments (i.e. there is a 4-year moving window for purchases made up to June 30, 2010).

Therefore, while the previous PST system was changed with harmonization, it is important to bear in mind that the obligations and opportunities that arose prior to that time, continue to exist, and will be wound down over the next four years.

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Application of GST/HST How then, does GST/HST apply to the public sector? The CRA has produced a number of guides and other documents21 that help to explain the application of the GST/HST to various public sector groups. However, so as to not completely restate the published reference material, or the legislation itself, our comments here are intended to provide a basic understanding of the terms and concepts, a laymans guide, if you will. They are meant to help bring context and understanding to the following discussion of the tax implications for the transportation consortia. In all cases of particular transactions, activities or questions, users of this guide should seek the advice of their professional tax advisors.

Note The proper term for referring to the federal sales tax is GST/HST because HST applies in the participating provinces (which now include Ontario), and GST applies in the rest of Canada. Since this report deals only with Ontario school boards and consortia, and for the benefit of consistency, we will use the term HST for the balance of our comments, keeping in mind that all references to tax or HST, are references to GST/HST. Where a tax reference pertains to a period prior to the introduction of HST in Ontario, or pertains to a transaction in a non-participating province, the terms GST/HST or GST, may still be used.

Legislative Background

The ETA contains a number of specific definitions and references which are relevant to the consortia structures, both incorporated and unincorporated. In simplified terms22, some of these are:

Person A broad term that identifies an entity, activity or structure that would be treated independently for the purposes of the ETA, and includes an individual, partnership, corporation, or other association or organization. A transportation consortium would generally be viewed as a separate person under the ETA, and therefore subject to the same rules any other person. This consequence applies whether or not the consortium is a separately incorporated entity.

Public Service Body (PSB) - Refers to the broad category of entities that includes non-profit organizations, charities, hospitals, colleges, universities, school authorities and municipalities. PSB also refers to Public Sector Bodies, the broader category that also includes governments. For the balance of this report, PSB refers to Public Service Bodies.

Public Institution A subset of the PSBs, it consists of dual-status entities. That is, an entity that has registered charitable status, AND is also a hospital, college, university, or school authority, or an entity that has been granted municipal status under certain conditions.

Non-Profit Organization (NPO) Also a subset of PSBs, it is an organization operated solely for a purpose other than profit, and whose income is not available for the personal

21 See Appendices 2 and 3 for the list of relevant documents. 22 See Glossary for the legislative wording of these, and other relevant definitions.

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benefit of members or shareholders. A non-profit organization excludes individuals, charities and public institutions, among others.

Qualifying Non-Profit Organization A non-profit organization that receives at least 40% of its funding from a government.23

Charity Also a subset of PSBs, a charity for the purposes of the ETA is an entity that has registered charitable status, but is not a public institution.

School Authority One of the dual-status public institutions, it refers to an organization that operates elementary or secondary schools.

Supply The provision of property or a service in any manner.

Direct Cost As the name implies, this term refers to the resupply of purchased goods or services from one person to another, at a price that does not exceed its direct cost as defined by the ETA. The direct cost is the consideration paid by the supplier to acquire the inputs, plus the GST/HST paid, as well as any PST paid on the inputs that was not otherwise recovered by the supplier but generally does not include any allocated overhead or shared fixed costs.

Many of these terms can be confusing, but are intended to identify sub-groups of entities that are subject to specific rules or exemptions that do not apply to other groups. For example, by definition, a charity for HST purposes, specifically excludes an entity that is a public institution, even though a public institution is an entity that has charitable status. A reason for this distinction is that, under the ETA, there are exemptions that only apply to charities and similar, but slightly different exemptions that apply to PSBs other than charities, including public institutions. Even within the rules that pertain to PSBs other than charities, the exemptions for public institutions dont apply to other non-profit organizations, and they are broader than the exemptions that do apply to other non-profit organizations.

Tax Note Using these definitions, and for the purposes of this report, the school boards with charitable status are public institutions, while those without charitable status, if any, are qualifying non-profit organizations. Incorporated transportation consortia are also qualifying non-profit organizations. An unincorporated consortium may be an extension of a school board, and therefore potentially, a public institution, but as long as there are agreements or other documentation that would establish a consortium entity as a person for HST purposes, it will be a qualifying non-profit organization. Either way, neither school boards nor transportation consortia would be charities under the ETA.

There is a further important distinction to be made here. Under the ETA, an entity that is a public institution and in particular, a school board, is entitled to use one set of rebate rates, and an entity that is a qualifying non-profit organization would be entitled to use a different set of rebate rates per table B, above. Note that a non-profit organization that is not a qualifying non-profit organization is not entitled to any public sector rebates under the Act.24

Therefore, because of the differences in the exemptions and rebates applicable to the different groups, it is important to have a basic understanding of these relationships. Further, each

23 The level of government funding is determined by prescribed definitions and calculations as set out in the ETA Public Service

Body Rebate (GST/HST) Regulations 24 Although it may be entitled to ITCs to the extent it is involved in commercial (i.e. taxable) activities.

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consortium should be reviewed in the context of these definitions to determine which set of rules, and what rebates, if any, apply to it. As discussed previously, these considerations are particularly relevant for any board that may be involved in multiple consortia.

These relationships are illustrated in the following diagram:

Even though public institutions have dual status as both registered charities and non-profit organizations, they must follow the rules for non-profit organizations for HST purposes. This special status is indicated by the dashed arrow in the diagram.

Public Sector Bodies

Public Service Bodies

Registered Charity

Non-Profit Organizations

Public Institutions (incl. school boards

with charitable status)

Qualifying Non-Profit Organizations

(incl. incorp and unincorp consortium entities)

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Rules for Public Institutions The rules that govern the tax status of supplies made by school authorities, public sector bodies that are charities, and by those that are not charities, are found in separate parts25 of Schedule V, of the ETA. The exemptions for charities are broader, while the exemptions for public sector bodies that are not charities, are more specific - some apply to only one type of PSB (such as exemptions specific to municipalities), and some apply more broadly (such as the general exemption for public institutions). In addition, a separate schedule (Schedule VI) provides the rules that make a supply zero-rated.26

Supplies that are not specifically identified in the ETA as exempt supplies or zero-rated supplies will, by default, generally be taxable supplies. ETA Schedule VII contains some rules that would require a public sector entity to self-assess the applicable HST on certain imported purchases, and ETA Schedule IX helps to determine the rate of tax that would apply to a transaction for supplies that are made or received inter-provincially. For an entity that makes and receives all of its supplies in one province, the rules of Schedule IX are generally not applicable to day-to-day activities, but should be consulted in cases of non-standard transactions, where the supplier and the recipient are not necessarily in the same province, or where the goods or services are delivered in a province other than where the supplier is located.

The chart below outlines the two most common schedules of the ETA that are referenced for purposes of this guide:

25 Part V.1 and Part VI respectively, of Schedule V. 26 A zero-rated supply under the ETA is one that is taxable, but where the tax applies at a rate of 0%. This results in the

recipient of the supply not having to pay tax, similar to the result of an exempt supply. However, the terms exempt and zero-

rated have very different implications, and should not be used interchangeably, as often happens. The main distinction is that

the supplier of a zero-rated supply is generally entitled to claim ITCs for the tax paid on its inputs, while the supplier of an

exempt supply is not entitled to ITCs on inputs (but in many cases able to claim partial rebates).

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Table C - Schedule V Exempt Supplies Part I Real Property Describes the types of real property transactions that

are considered exempt.

Part II Health Care Services Describes various health care services that qualify for exemption.

Part III Educational Services Describes the various educational services such as elementary and secondary education, school transportation and extra-curricular activities that are exempt.

Part IV Child and Personal Care Services

Covers exemptions such as daycare.

Part V Legal Aid Services Contains a very narrow exemption for certain legal aid services.

Part V.I Supplies by Charities Contains the broad exemptions for registered charities that are not public institutions.

Part VI Public Sector Bodies (other than charities)

Contains the many exemptions available to public institutions (e.g. school boards), NPOs and municipalities.

Part VII Financial Services Provides for the exemption of most financial services offered in Canada such as payment of interest on loans or notes payable.

Part VIII Ferry, Road and Bridge Tolls

Provides exemption for various toll charges.

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Table D - Exceptions to the General Exemption for Public Institutions

Most educational supplies made by a school board, are HST-exempt under Part III of Schedule V. Most general, non-educational supplies of tangible property and services made by a public institution (which includes a school board) are HST-exempt under Part VI of Schedule V, with the exception of the following (i.e. the following supplies are generally taxable):

Property or service that is zero-rated (ie included in Schedule VI) If the supply is zero-rated, then that will take priority over it potentially also being exempt. This provision is beneficial to the supplier, but is unlikely to apply to transportation consortia as we have not identified any zero-rated supplies that a consortium entity may make;

A supply that is deemed to have been made under some other provision of the ETA Unlikely to apply to transportation consortia;

Non-capital property that the public institution had been using in its commercial activities May have limited application to transportation consortia;

Capital property that the public institution had been using in its commercial activities May have limited application to transportation consortia;

Tangible property that was new, but not donated to the public institution, that was acquired by the institution for the purpose of resupplying it This provision is likely to apply to transportation consortia;

Property that is supplied with a taxable supply of real property For example, media equipment supplied with short-term rentals of a meeting room, or office space This may have limited application to transportation consortia;

Catering services provided by the public institution at an event arranged by a third-party May apply to school boards generally, but not likely to transportation consortia;

Memberships for admission to recreational or amusement facilities Unlikely to apply to transportation consortia;

Supplies of performers to someone who, in turn, makes taxable supplies of admissions to the performance Unlikely to apply to school boards or to transportation consortia;

A service related to supervision or instruction in athletic or recreational activities Unlikely to apply to transportation consortia;

A right to participate in a game of chance Unlikely to apply to transportation consortia; Instruction in courses or administering exams This is removed from the general exemption

because there is a specific exemption in Part III (Education Services). Not applicable to transportation consortia.

Admissions to places of amusement, seminars or conferences (only if made by colleges and universities), and certain fundraising events These are removed from the general exemption, but may have a specific exemption elsewhere. Not applicable to transportation consortia;

Certain property supplied by a municipality, or designated municipality Not applicable to school boards or transportation consortia;

Property or services related to certain cosmetic medical procedures Not applicable to school boards or transportation consortia.

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Table E Schedule VI Zero-Rated Supplies Part I Prescription Drugs and

Biologicals Describes the types of drugs and biological substances qualifying for zero-rating.

Part II27 Medical and Assistive Devices

Describes various mobility aids, prosthetics and similar devices that are zero-rated.

Part III Basic Groceries Describes the conditions for zero-rating of food.

Part IV Agriculture and Fishing Covers provisions that allow for zero-rating of certain agricultural and fishing equipment and supplies such as livestock, feed and fertilizers.

Part V Exports Describes when goods or services are considered to be exported to non-residents and therefore zero-rated.

Part VI Travel Services Contains provisions for zero-rating international travel and tours.

Part VII28 Transportation Services Describes various forms of transportation including freight services and the conditions for zero-rating.

Part VIII International Organizations and Officials

Provides for zero-rating of various goods and services supplied to foreign diplomats and embassies in Canada.

Part IX Financial Services Describes when financial services provided to non-residents are zero-rated.

Part X Collection of Customs Duties

The general rule for the PSB exemptions is that any supply of a personal property or service made by a public institution is exempt, unless it falls within one of the listed exceptions, as outlined in Table D, above. Remember, this provision applies to public institutions which includes school boards, and not to other non-profit organizations, which would include transportation consortia. This is why a given supply, say of administrative services, would be exempt if supplied from the school board to the consortium, but taxable if supplied from the consortium to the school board.

Even if a supply falls within one of the listed exceptions to the general rule, it does not automatically mean that the supply is taxable, as the particular supply may be exempted by another more specific provision of Schedule V. If a supply is excluded from the general exempting rule, and is not otherwise exempted by a more specific provision elsewhere in Schedule V, then it is taxable. For example, if a school board purchased new goods to sell in its schools, say school t-shirts, then the sale of these items would be an exception to the general exempting rule, and therefore appear to be taxable. However, there is a subsequent, more specific exemption that says if the school makes this supply, but does so at a price equal to its direct cost (as defined), then the supply is still exempt.

27 Where school boards or transportation consortia are involved in the installation of mobility aids and/or vehicle modifications,

this Part contains specific exemptions that may apply. 28 Includes freight and passenger transportation services other than as they pertain to student transportation. These provisions

are largely not applicable to the discussion here.

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For the most part, the usual activities, and supplies made by public institutions will be HSTexempt. For school boards in particular, Schedule V contains specific exempting provisions relating to the supply of educational services29. Therefore, the broad impact of the specific educational exemptions and the general exemption, combine to result in school boards having to charge HST on few of the supplies they make. However, the opposite is not true none of these rules prevent school boards from paying HST on taxable inputs they acquire, unless the supplies of those inputs are also included in the exempting or zero-rated schedules.

Tax Note This is a note of caution for public sector bodies there is often the misconception that HST can be ignored entirely by an entity if it does not have to collect and remit it. That is not the case. Public sector bodies must still be cognizant of their obligations to self-assess HST for many purchases made from non-residents, and there is the incentive for entities to accurately track the HST that is paid, for the purpose of claiming its rebates rebates that are now considerably greater as a result of harmonization.

It is also noted, that the largest expense for most public institutions such as school boards, is for salaries and benefits of employees, which are not subject to HST.

29 Part III of Schedule V

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Rules for Non-Profit Organizations The same rules that apply to public institutions in Part VI of Schedule V, also apply to other public sector bodies (except charities), including non-profit organizations and municipalities. . An important difference is that not all of the provisions in this Part apply to all of the different types of public sector bodies equally. Some of the exemptions apply to one or more types of public service body but not to others, as illustrated in the example on the previous page. The following, is a more specific example of this situation:

Example 2 An example of this in the transportation consortia structure occurs in the case of the secondment of employees from a member board to the consortium. The application of HST to the typical transactions is as follows:

Payments of salaries and benefits from the member board to its employees Exempt from HST, as payments under an employment relationship are not taxable;

The member board then seconds the employees to the consortium entity and is reimbursed for the cost Exempt from HST under the general exemption for public institutions;

The consortium entity then resupplies (allocates) the cost of those employees, back to the member boards, including the member that supplied them initially Taxable for HST, as the consortium entity is not a public institution subject to the general exemption for services, nor are there other provisions in Schedule V that would exempt the labour services when resupplied by the consortium entity.

This sequence of transactions has taken an HST-exempt supply (employment labour) and turned it into an HST-taxable supply (when resupplied by the consortium). Granted, as the following example shows, the recipients of the taxable supply from the consortium, the member boards, would be entitled to rebates for a substantial portion of the HST paid to the consortium entity. However, a net-tax cost is created, as well as an additional cash flow timing difference between the payment of the tax and the claiming of the credits.

The example below demonstrates the tax calculations and net cost of the above situation:

Initial salary costs including benefits incurred by a school board for employees seconded to the consortium $1,500,000 (no HST)

Reimbursement from the transportation consortia ($1,500,000) (no HST)

Allocated salary costs charged back to the school board (50% member) $750,000 (plus HST)

13% HST on salary cost allocation $97,500 Federal rebate claimed by the school board ($ 18,750) Provincial rebate claimed by the school board ($55,800)

Net incremental HST cost to school board $22,950

It could also be argued that the incremental net-tax cost that is created, is more than offset by the efficiencies gained from the consortium structure in the first place. This is a valid point in many cases, but it should not serve as reason for not considering these implications as a matter

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of due diligence. In particular, if the consortium entity should have collected HST on the resupply of those labour services but did not, it is creating a tax exposure for itself for a portion of the tax not charged (HST on the supply, less the rebates the recipient would be entitled to $22,950 in Example 2, above ), plus penalty interest on that amount30.

The issue here is not so much that additional unrecoverable tax has been created by the secondment, because even if the labour services supplied by the consortium to its member boards, were performed by individuals who were employees of the consortium entity directly, HST would still apply. The bigger issue lies in not having the understanding of the tax status of supplies made by the consortium, and the problem of unknowingly building the tax exposure. Similar tax collection and remittance requirements will result from most other supplies made by the consortium entity in its own right, to the member boards, such as charges for the recovery of overhead and administration expenses.

The potential tax obligations will vary among the consortia, depending on the value of the resupplied labour, and the value of the administration expenses, if any. As such, these obligations should be considered in the context of the scale of each of the consortia, and the potential savings otherwise achieved by the structure. If the informed decision is that the additional non-recoverable tax cost has been more than offset by efficiencies, then the next step is to ensure that the consortium is in compliance. That is, that the supplying entity is correctly registered with the CRA for HST purposes, and that it correctly collects and remits the applicable tax.

Tax Note In later sections, we will discuss some other relevant concepts and provisions that exist within the ETA and, administratively, within the CRA that may apply in certain situations and that could help minimize some of the unintended exposures.

Direct Cost

One provision that applies to NPOs (both, those that are public institutions, and those that are not, as well as to charities) is the direct cost exemption. This provision makes the tax status of a supply exempt, if the supplier does not charge an amount for the supply that exceeds its direct cost. Direct cost is defined as the consideration paid for the supply, plus any non-recovered tax. This exemption applies only to supplies of goods and services that are purchased for resupply, and to the purchase of materials that are used to produce goods for resupply. The provision cannot be used to exempt other cost recoveries, such as reimbursements for the suppliers use of its own employees, or for intangibles.

The applicability of this provision can be considered in situations where there may not be an agency relationship between the parties (discussed below), but where there is an intention to flow-through costs from one party to another, without further mark-up or profit. However, if the supply by the consortium is exempt under this provision, it also means that the consortium may be limited in its recovery of any HST paid to the original supplier. Therefore, this provision should only be relied on where the original supply was not taxable (and there is no benefit to have tax apply on the resupply) or, where the flow-through entity is entitled to a higher tax recovery rate than is the eventual recipient, which would generally not be the case in the transportation consortium model.

30 It is also possible that penalty interest could be charged on the gross amount of HST that should have been charged by the consortium.

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Tax Note For a transportation consortium, it is preferable to have a properly-structured cost-sharing agreement in place, or a properly-structured supply/re-supply arrangement, rather than relying on direct cost to flow through the transportation expenses from the consortium to the boards. This will be explained further under Special Concepts, below.

Qualifying vs. Non-Qualifying NPO

Whether a consortium is incorporated or unincorporated, its status as a qualifying, or non-qualifying NPO may need to be verified to determine its entitlement to the NPO rebates a qualifying non-profit organization will be entitled to partial rebates for tax paid on inputs to its exempt activities, but a non-profit organization that is not a qualifying non-profit organization is not entitled to any rebates.

As defined, a qualifying non-profit organization receives at least 40% of its total revenue from government sources either directly, or indirectly, as set out in the regulations to the ETA. Government funding refers to certain identifiable grants and subsidies that supports or promotes the NPOs objectives but that are not for the purpose of purchasing goods or services on behalf of the government. Since the Ministry would not otherwise provide the student transportation services, the funding for this activity would be government funding, and not as consideration for the provision of services on behalf of the government.

The consortium entity will generally be considered to be in commercial activities with respect to its resupply of transportation services, labour services and overhead and administration services. To the extent that the consortium entity is in commercial activities for HST purposes, it will be entitled to ITCs for the HST paid on its inputs to those activities and will not be entitled to rebates. If the consortium also provides exempt goods or services, then it will be entitled to rebates to recover a portion of the HST paid on the inputs to those exempt supplies. In the course of our review, we did not identify any transactions that would benefit the consortium by being exempt transactions.

HST and First Nations

The application of HST to First Nations is not specifically addressed in the ETA, but is governed by administrative policy as outlined in Technical Information Bulletin B-039 (2006) (copy attached). Where the supply of a transportation service is made to a Band entity, and is delivered off-reserve, it is taxable. The Band, in turn, will generally be able to fully recover the HST paid on the transportation services, by way of rebates as outlined in B-039. This issue should be discussed with the First Nation purchaser of student transportation services, and further clarification sought from the parties tax advisors, if necessary.

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Special Concepts Cost-Sharing

After discussing the basic legislative framework of the HST, we now turn our comments to two of the special concepts that may be relevant to the student transportation consortia. They are: Cost-Sharing and Buying Groups.

Cost-sharing is an administrative term that is used to describe any one of a number of similar arrangements where two or more persons may be independently involved in a common activity, and where one or more of the participants purchases goods or services from third parties on behalf of other participants.

Under these arrangements, one party typically pays for another partys share of certain expenses, and then is reimbursed by that other party. The CRA views these arrangements in one of two ways:

The first party incurred the expense on its own accord, and then resupplied it to the other party, which would make the reimbursement payment generally subject to HST. Or,

The first party incurred the expense on the other partys behalf, in which case the reimbursement payment is generally not subject to HST.

The distinction between these two situations is often a very fine one, but it helps to step back and look at the impact of the overall transaction. A reason for wanting the reimbursement payment to be exempt seems to be simplicity - fewer transactions to be concerned about tax implications or the related record-keeping. However, where payments are treated as non-taxable reimbursements, but the written agreements support the alternate view that the transaction really is a purchase and resupply by one party, then the arrangement could lead to adverse results in case of an audit by the CRA, and lead to a greater overall tax cost.

To have reimbursement payments treated as tax exempt, there needs to be evidence that the other party was also a recipient of the original supply under the contract. For example, consider a transportation contract between a consortium and a carrier. If the consortium entity is recognized as being the only party to that contract, then the CRA is likely to be of the view that the consortium alone purchased the transportation services, and resupplied them to the member boards. The reimbursement payments by the members to the consortium are then taxable. If however, the contract with the carrier states that the consortium entity and each member are parties to the contract, then the reimbursement payments are more likely to be viewed by the CRA as non-taxable.

But what does this mean? It means that if the reimbursement payment to the consortium is not taxable, then the consortium would not be entitled to an ITC for the HST it paid on the carrier contract. The consortium may then be entitled to a partial rebate, but that rebate is less than what the member board would have been entitled to, so there is greater unrecovered tax in this scenario. The way to avoid these problems, of course, is to ensure consistency between the tax rules, the agreements, and the actual transactions.

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It is worth mentioning also, that having an arrangement viewed as a true cost-sharing arrangement, enabling each member to claim rebates on its proportional cost, or, ensuring that the consortium is a flow-through entity (pay full tax on purchases, claim full ITCs, and then charge full tax to the members), will both achieve the same end result of minimizing the total tax cost of the arrangement. The flow-through approach involves a few more steps, but it may be cleaner and less subject to questions or unintentional adverse tax consequences.

A good illustration of this concept is provided in the CRA Policy P-238 Application of GST/HST to Payments Made Between Parties Within a Medical Practice Organization. While written in the context of a medical practice, the cost-sharing principles, and the transactions that are discussed, would apply broadly, and are present in the transportation consortia arrangements. A link to this policy statement is included in the reference material in Appendix 3. For further illustration of these concepts, please see Consortium Example #3 at the end of this report, and the CRA ruling letter HQR0000990, in the reference material of Appendix 4. This ruling letter is specific to a student transportation consortium.

Partnerships

A cost-sharing arrangement should also be distinguished from a partnership, which is a structure that has specific legal meaning and implications. A partnership refers to persons who are working together for a common purpose, and the structure is governed by the Ontario Partnership Act. Important features of this structure are that each partner has joint responsibility for debts and obligations of the partnership, and partners can legally bind each other with respect to partnership activities.

For tax, a partnership is a separate person for GST/HST purposes, while under the Income Tax Act, the CRA looks through the partnership, and all revenues and expenses of the partnership are deemed to be those of each partner in proportion to its partnership interest.

Because of the liability implications, the Ministry of Education recommends, and the Resource Guide supports, that a consortium should not be set-up as a partnership. It is also their view that the purpose of the consortium structure is to share costs, and not because the members are intending to be in business together to provide the transportation services. Practically speaking, this line may get a little fuzzy, especially where the consortium entity is incorporated, consortia agreements should be clear that there is no intention by the parties to establish a legal partnership.

In reviewing some of the existing consortia agreements, we have noted that there are consortia that refer to themselves as partnerships. In those cases, the terms of the agreement overall, indicate that this reference may just be an example of the use of incorrect terminology, rather than an actual intention to form a legal partnership. If so, we suggest that those consortia consult with their advisors, and take steps to amend their agreements accordingly. Although a partnership has many of the same general characteristics as other cost-sharing arrangements, there are important differences as indicated, so the terms should not be used interchangeably.

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Buying Group

The Buying Group Method refers to a particular formal structure among participants that the CRA recognizes, and that has tax effects similar to those of proper cost-sharing arrangements.

The ETA contains a provision that allows the establishment of a buying group31. Subject to the specified criteria, the provision enables a designated buyer to purchase supplies on behalf of the groups members, and to have those purchases treated as though they were made by the members themselves, and not by the designated buyer. The result is that any tax that is paid on the purchases by the buyer is deemed to be tax paid by the members. The members are then entitled to claim their respective ITCs or rebates for that tax paid. This mechanism has the same outcome as if the buyer made the purchase, paid the HST, claimed an ITC, and then charged HST when it resupplied the purchased goods and services to the members. Having physically paid HST to the buyer, the members would then recover the tax by way of ITC or rebate. The benefit of the mechanism is that it eliminates the intermediate step for the buyer, and helps to avoid some of the documentary problems associated with having credits claimed by one person for invoices that are in the name of another person. Documentary inconsistencies are a large source of audit assessments by the CRA.

While many cost-sharing arrangements, including those of the transportation consortia, resemble the buying group structure, they may not be recognized as such by the CRA, without the structure having been formalized. For the purposes of this provision, the consortium entity would be the buyer.

To be recognized as a buying group by the CRA, the following conditions must exist:

At least 90% of the property or services resupplied by the buyer are to be passed-through at cost This means that any charges for its own labour services, overhead or administration made by the consortium to the members, would have to be less than 10% of the total, which would generally be the case. Where the labour is provided to the consortium by one or more members, it can be argued that the consortium has purchased these services, so this test becomes easier to meet.

The purchased property or services must be delivered from the original supplier, directly to the members or to others on behalf of the members This would appear to be the case at least, for the transportation services, wherein the services are rendered to the students of each member, on their behalf. The status of other purchases may not be as clear, and would need further consideration to see if they meet the test. Other purchased goods and services, if they did not meet this test, would not be considered to be pass-through supplies.

Lastly, the members would be required to pay the suppliers of the pass-through supplies, the transportation companies, directly Based on the payment processes in place for the consortia agreements we have reviewed, it appears that this would be the requirement that causes the transportation consortia to not be eligible for this method. As a potential solution to this stumbling block, it may be possible to amend the payment procedures with respect to the payments for the supply of the transportation services, so that the each member pays the service provider directly for its share of the services received. There could be other supplies obtained by the consortium that would be treated as pass-through supplies, but the transportation services would be the largest of those supplies.

31 ETA s178.6.

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If these three conditions are met by a particular consortium, then the group must make an application to the CRA to have the consortium entity designated as the buyer. The CRA has the ability to deny the request, but practically speaking, it is unlikely that it would do so, if there is reasonable evidence that the other requirements have been met.

In looking at the requirements above, and comparing them to the existing consortia agreements, it would appear that some of the consortia are very close to meeting these requirements, and in fact, may be operating as if the buying group request has been made, and has been granted.

As a subsequent step in our review, we will be submitting a ruling request to the CRA that seeks clarification of this provision, specifically in the context of a transportation consortium. We will provide a follow-up report with the CRAs response once it has been received.

Agency

Cost-sharing, buying groups and partnerships are concepts that are all based on the common law principles of an agency relationship, and agency determinations have broad implications under the ETA. The ETA applies GST/HST on payments that are consideration for the supply as illustrated in its main charging provision:

165. (1) Imposition of goods and services tax Subject to this Part, every recipient of a taxable supply made in Canada shall pay to Her Majesty in right of Canada tax in respect of the supply calculated at the rate of 5% on the value of the consideration for the supply.32

(2) Tax in participating province Subject to this Part, every recipient of a taxable supply made in a participating province shall pay to Her Majesty in right of Canada, in addition to the tax imposed by subsection (1), tax in respect of the supply calculated at the tax rate for that province on the value of the consideration for the supply.

Where persons are in an agency relationship, the payments between them are generally not consideration for a supply and therefore, would not be subject to HST as required by s165. Conversely, where an agency relationship does not exist in the context of a particular arrangement, payments between the participating persons are generally viewed as being consideration for a supply, and therefore, are subject to HST, unless an exempting provision applies.

Tax Note It is important to be aware that the existence or non-existence of an agency relationship is a question of fact, for each set of circumstances. Throughout common-law jurisprudence relating to agency, the courts have established that the existence or non-existence of a written agreement, or any one particular action is not necessarily conclusive evidence of whether there is an agency relationship. Rather, it is the essence of the agreement between the parties in combination with their actions that will direct the conclusion.

The CRA has issued a detailed policy paper P-182R33 - Agency that outlines what it considers to be the essential qualities for an agency relationship to exist, as determined by the courts. These qualities are:

32 Excise Tax Act, Part IX, s165 33 See Appendix 2

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Consent of both the principal and agent There should be some evidence, either verbal or written, that the parties actually intended to enter into an agency relationship, and that intention should be consistent with the actions of the parties.

Authority of the agent to affect the principals legal position In an agency relationship, the agent is acting as an extension of the principal, and there should be evidence that the principal has given the agent the authority to take actions that would affect the principals legal position, such as entering into contracts on behalf of the principal that then binds the principal to the terms and conditions of that contract.

The principals control of the agents actions Generally, a person (the principal) will have more control over the actions of another person when that other person is acting as an agent of the principal, rather than acting independently in its own right.

The courts and the CRA also include as indicators of an agency relationship, the agents actions with respect to its fiduciary duty to act in the best interest of the principal. In addition, who assumes the risks of a transaction, how the transaction is accounted for, and how the agent is compensated are all indicators, among others, of an agency relationship.

In a true cost-sharing arrangement, there would be an intention to have an agency relationship with respect to some, or all of the elements of a particular transaction or agreement. The establishment of this relationship could enable the parties to disregard the application of HST to what are essentially, reimbursement payments between them. In cases where the consortium and its member boards are not accounting for HST in this manner on the transactions between them, the CRA may be of the view that an agency relationship exists, despite any provision of the agreement that may state the parties intention as otherwise.

Where both parties are in commercial activities, or the supplies made between them are of similar tax status, an agency relationship becomes less important because there is little chance of creating unrecoverable tax costs. However, where the parties may not be entitled to ITCs, or are able to claim rebates at different rates, the issue becomes more important.

In 1998, the CRA issued an interpretation letter34 in response to an inquiry from a student transportation consortium. The letter provides a discussion of the concepts of agency, cost-sharing and direct cost in the specific context. For privacy purposes, references to the particular entities involved have been removed by the CRA, so parts of the explanations are difficult to follow. However, it is clear that the impact of all of these elements need to be considered in making choices regarding the transactions within a consortium. We note that the letter does not contain a discussion of the buying group method. This is likely because, based on their particular facts, the consortium would not be eligible under the provision.

34 RITS #HQR0000990, July 28, 1998. See Appendix 3 for copy of letter.

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Current Structures Tax Application to Current Structures

To begin the discussion on the tax implications to the current consortia, we note that the ETA exempts student transportation services only when they are made by a school board, to someone other than another school board as follows:35

5. School Busing A supply made by a school authority to a person other than another school authority of a service of transporting elementary or secondary school students to or from a school that is operated by a school authority.

The wording of this exemption is brief, but it contains four separate eligibility criteria, and to be exempt, the service has to meet all of them The service must be supplied by a school authority; It must be supplied to someone who is not a school authority; The service has to be of transporting students, and; The students must be taken to or from school. Even still, the implication is that the exemption would also apply to late busing, field trips and extra-curricular activities. Consequently, where one school board is determined to be supplying busing services to another school board, those services are taxable. Similarly, the provision also means that where the service is made by a person that is not a school authority, such as a transportation consortium, the supply is taxable. The wording of the provision is intended to ensure that, if students were ever to be charged for the busing services, the services would remain exempt. Further, the exe