Collecting taxes from clients is certainly not part of a law firm’s core business. It’s a task lawyers are usually content to leave to support staff and accountants. That’s why many lawyers have paid little attention to any of the details involved in the move to harmonized sales tax (HST) in Ontario and British Columbia. And it’s the reason why some law firms and sole practitioners are in for a few nasty surprises, according to tax experts in both provinces.
“My view is that lawyers are generally not prepared,” says tax lawyer Terry Barnett, a Vancouver-based partner at Thorsteinssons LLP and head of the firm’s commodity taxation practice. There will be a scramble, he says, as law firms try to get their systems programmed for the new tax at the last minute and realize that lawyers will have to make judgments on non-routine issues that cannot be handled by computer programs and support staff alone.
“I think lawyers are going to have some difficulty in implementing it, especially small law firms that provide services to clients outside the province,” says Cyndee Todgham Cherniak, counsel in the Toronto office of Lang Michener LLP.
For small law firms and sole practitioners serving clients in their own province, the transition to HST will likely be relatively painless, providing they set up their billing and accounting software or their manual billing and bookkeeping processes to collect HST on all services performed after July 1 and also track the tax paid on expenses. Software programs are providing updates to help with the transition. LexisNexis Canada Inc., for example, will offer an upgrade in June for the latest version of PCLaw and provide users of earlier versions with a workaround. Once these are installed, users will just have to enter the tax rate and modify the date range so the software can calculate the HST based on the transaction date, according to product manager Ravi Puvan.
Toronto family and employment lawyer Garry Wise says he plans to simplify matters by billing all clients at the end of June for work done prior to the HST implementation date. Work carried out and billed before that date is clearly not subject to HST, while work carried out and billed subsequently generally will be.
Wise, whose clients include a large number of individuals and small-business people, says his main concern about the HST is that it will add eight per cent to the cost of legal services in Ontario and this could place a huge burden on people who are inescapably caught up in litigation that will suddenly cost them thousands of dollars more. “I don’t think clients fully understand what’s coming,” he says, adding that he intends to spell out implications of the new tax in all retainer discussions and contact existing clients to provide them with explanations. “Of course, they’re going to be unhappy about it, but I think they’ll be resigned to it,” he says.
Similar concerns have not arisen in B.C., since the province already imposes a seven-per-cent provincial sales tax on legal services. In fact, Barnett says, many law firms in the province welcome the switch to HST because the old system puts them at a competitive disadvantage with accountants and other consultants who do not have to charge the PST.
Where law firms will likely run into difficulties is when they have to grapple with the complexities involved in the “place-of-supply rules,” which were outlined in a Canada Revenue Agency technical bulletin in February, but still subject to further revision. As recently as the last week in April, just days before law firms and other businesses were required to start collecting HST (for payments on contracts for work to be completed after July 1), Barnett and Todgham Cherniak were still waiting to see the statutory provisions or regulations that would set out these rules in a detailed final form and, as Barnett puts it, “put flesh on the bones.”
“It’s very frustrating for lawyers in order to advise clients, but also in order to implement it for law firms,” says Todgham Cherniak, referring to the delay in finalizing the rules and the consequent lack of lead time for figuring out how to apply them.
The place-of-supply rules, as outlined in the 47-page February bulletin, are to be used to determine what tax rate to apply to each service that a law firm or other business provides to clients — whether to charge the Ontario, Nova Scotia, New Brunswick, and Newfoundland & Labrador HST rate of 13 per cent, the B.C. HST rate of 12 per cent, or just the five per cent GST required in other provinces.
Under the first of these rules, the decision as to which tax to apply depends on the business address of the client. So, according to the example given by CRA, if an Ontario lawyer represents a client in Quebec on a general business matter that requires a written opinion and several meetings in Quebec to discuss the matter, it may end up that 60 per cent of the work is done in Ontario and 40 per cent in Quebec, but only the Quebec tax rate of five per cent GST will apply.
However, chartered accountant Gordon Jessup, of Fuller Landau LLP in Toronto, points out this situation would be different if the Quebec-based client had a Toronto office at which most of the service was performed, in which case the Ontario HST would apply. And if the situation is reversed and a Quebec lawyer is representing an Ontario-based client, the Quebec lawyer will have to collect HST at the Ontario rate — an example of how the introduction of HST in Ontario and B.C. can potentially affect law firms anywhere in Canada.
Life gets even more complicated if your law firm deals with clients from several provinces or from outside Canada, as further rules must be applied to determine which tax to apply. Then there is another set of rules for litigation. In one example provided in the CRA bulletin, when a B.C.-based business consults a law firm about possible legal action and subsequently hires the same firm to handle the litigation, filing a statement of claim in an Ontario court, the B.C. rate of HST is applied to the fee for the initial consultation, while the Ontario rate is applied as soon as the litigation is launched in Ontario.
Since many federal tribunals and other quasi-judicial bodies are located in Ottawa, law firms from anywhere in Canada may find they must charge clients HST at Ontario rates when they take a matter to the Competition Bureau, for example. And their disbursements for court reporters or transcript fees will also be subject to Ontario HST.
Yet another set of rules applies to services rendered in relation to real estate or personal property, since the tax is linked to the location of the property, rather than the business address of the client. However, as Barnett notes, it becomes difficult to determine what tax to apply if a lawyer is giving advice on the business aspects of a property deal or its tax implications. Or, Todgham Cherniak adds, what if a lawyer is advising on a merger and acquisition that involves property in several different provinces.
These are situations that one cannot easily program into a computerized billing system or expect support staff to figure out for themselves. They require that the lawyer makes judgments on a case-by-case basis about how the work fits with the various place of supply rules.
Todgham Cherniak recommends all law firms design a decision tree that would serve as a framework to help lawyers and support staff figure out what to do about HST in every foreseeable circumstance. And law firms should worry about getting it wrong, she says, not only because they may end up being assessed taxes, plus penalties and interest, but also because it would be a huge embarrassment for lawyers to show they don’t understand the tax regulations or that they haven’t bothered to put in the time and effort to put an effective decision-making process in place.
Although she has one last caveat: there is always a possibility the CRA may ask firms for documentation to back up their decisions about whether or not to collect HST and at what rate, so law firms need to ensure they document the reasons for their decisions. However, an issue may arise in future if the tax department wants to audit a law firm on these decisions because it may not be possible to show auditors the evidence without breaching solicitor-client privilege.
Freelance journalist and business writer Kevin Marron can be reached at firstname.lastname@example.org.