The Condominium Act in Ontario has the following section on funding levels for Reserve Funds:
“94
Plan for future funding
(8)Within 120 days of receiving a reserve fund study, the board shall review it and propose a plan for the future funding of the reserve fund that the board determines will ensure that, within a prescribed period of time and in accordance with the prescribed requirements, the fund will be adequate for the purpose for which it was established.”
However, the Act does not define “adequate”.
The Canadian Condominium Institute – Toronto and Area Chapter has recently prepared a legislative brief to the government with recommended changes to the Condominium Act. As part of this work, a sub-committee has met to come up with a definition of “adequate” funding. A consensus has now been reached. While it is not yet in the Condominium Act, we expect that consistent adoption of the definition by industry will influence the government to incorporate the definition into the Act.
There have been two “camps” in the industry since 2001; the “Inflation-matched” camp and the “no deficit” camp.
The “inflation-matched” believers argue that the intention of condominium Reserve Fund Planning is to fairly distribute the cost of repairing and replacing the common elements over past, current and future owners. Creating a funding program that is based on limiting annual contribution increases to no more than inflation achieves this goal.
The “no deficit” believers argue that without “adequate” defined, one must look at adequate per dictionary definitions, meaning “sufficient” or “just enough” rather than “plenty”. In the extreme, this could mean that a corporation could simply contribute each year an amount equal to the planned expenditure in the coming year. While this is clearly not the intent of the Act, the lack of a definition for adequate does mean that this interpretation is not out of the realm of reason.
At the industry forum, which included many reserve fund providers, lawyers, auditors and property managers (see list below), the issue was argued at length. Key points were:
Contributions should be spread as evenly as possible over all generations of owners over the service life of the building.
Some phase-in is reasonable if the negative impact on future owners is determined to be minor when compared to the “margin of error” of the study and/or when the bulk of the spending is more than about 20 years away.
It is not fair to current owners to implement a large increase in one step without giving them notice of the impending changes. Phasing-in over a number of years provides them (as well as potential unit purchasers) notice of the change.
The recommendation coming out of the forum is that section 94(8) be changed to the following:
“94
Plan for future funding
(8) Within 120 days of receiving a reserve fund study, the board shall review it and propose a plan for the future funding of the reserve fund that the board determines will ensure that, within a prescribed period of time and in accordance with the prescribed requirements, the fund will be adequate for the purpose for which it was established. In this context, adequate means that the year-over-year per cent change in the total contribution for each year of the 45 year term of the study is no greater than the assumed inflation rate except in the first three years where an increase greater than inflation is permitted and that the closing balance in any year in the 45 year term of the study does not go below zero.”
Allowing a three year phase-in period with increases greater than inflation softens the blow of required increases, provides time for unit owners to accommodate the required increase (or choose to sell their unit), but also prevents corporations from running long phase-in periods which simply defer contributions unfairly to future owners. This would apply to all condominiums (built before or after 2001).
You might also have noticed that we are recommending that the cash flow analysis be extended to 45 years, compared to the current 30 years so that longer service life elements are captured in the early studies.
While this notion of a three year phase-in period followed by inflation-matched increases is not yet law, by defining and communicating “industry-consensus”, CCI presents this as guidance for Corporations to follow until such time that the Ontario Condominium Act incorporates a definition for “adequate”.
Industry participants:
John Warren and Brian Antman -Adams & Miles LLP
Kim Coulter -Coulter Building Consultants Ltd.
Sally Thompson and Sean Allman -Halsall Associates Ltd.
Lucy Dias -Del Property Management
Gina Cody -Construction Control Inc.
Chris Antipas -ICC Property Management
Peter Harris - Harris, Chong & Crewe LLP
Don Sawyer - Canlight Hall Management Inc.
Nancy Longuiera - Morrison Hershfield Ltd.
Stephen Chesney - Parker, Carber & Chesney
Peter Leong - Cochrane Engineering Ltd.
Michael Le Page and R. Rupnarian - Maple Ridge Community Management Ltd.
John Deacon - Deacon, Spears, Fedson & Montizambert
Richard Weldon - Carson, Dunlop Weldon & Associates
Tony Gatto - Tony P. Gatto Professional Corporation
Harold Cipin - Times Property Management Inc.
Ralph Orvitz - Ralph Lando Orvitz Chartered Accountant
John AbedRabbo - Polyzotis and Co. LLP Chartered Accountant
Park Thompson - Furlong and Company LLP
Tom Park - Golder Associates Ltd.
Trisha Neimeyer and John Juffs - GRG Building Consultants Inc.
Blogs related to assessing, repairing, and renewing existing buildings.
Showing posts with label Ontario. Show all posts
Showing posts with label Ontario. Show all posts
Tuesday, March 2, 2010
Managing your Reserve Fund through HST Implementation
HST will come into force in Ontario on July 01, 2010 and will have a material impact on condominium reserve funds. Many corporations are confused about whether or not they need to get a special reserve fund study update completed in 2010 to reflect the impact of HST or if they can continue their existing 3-year update cycle. This article will provide recommendations regarding accommodating HST without requiring an interim reserve fund study update.
Your reserve fund study provider should be able to estimate the increase in contribution level due to HST without completing a full reserve fund study update. The increase can be calculated based on the current contribution level, the existing reserve fund balance and the time to the first critical year (refer to table below, which provides guidance).
We predict that HST will add, on average, about 5% to the underlying reserve fund costs. This does not translate into a simple 5% increase in the required contribution. Current and future owners do not only have to contribute the HST on their portion of future costs but also the HST on the portion of future costs already funded, as represented by the fund balance. The impact of catching up on the HST shortfall represented by the fund balance is impacted by the size of the balance and the time to “first critical year” (the year when the fund balance next drops to the “minimum” balance).
To give a simple illustration, imagine a condominium with only one planned expenditure of $1,000,000 required when it is ten years old, in a world with no inflation or interest.
If this condominium is brand new, it would previously have had to fund $1,000,000 over ten years, or $100,000/year. With HST, it now needs to fund $1,050,000 over ten years, or $105,000/year; a 5% increase.
However, if this condominium is nine years old and it has already saved up $900,000 towards this project, then in the next year it needs to fund $150,000 in one year; a 50% increase.
When interest and inflation are taken into account, the situation becomes more complex, but the underlying fundamentals remain the same.
We recommend that condominium corporations continue to update their studies on their normal update schedule. This recommendation is justified as follows:
• The impact of the elimination of PST on underlying costs will not be known until work starts to be tendered after July 1, 2010. Prior to that time, updating the study line-by-line is no more accurate than estimating the overall impact.
• The increase related to HST can be contributed to the reserve fund for the one or two years prior to the next reserve fund study update as an extra contribution without having to do a new Form 15. This additional contribution will be reflected in the opening balance of the next regularly scheduled update.
Table 1 illustrates Halsall’s recommended method for calculating the likely impact of HST on required annual contributions. These impacts are based on the “inflation-matched” scenario in your reserve fund study rather than the “phased-in” scenario, as we recommend that the impact of HST be taken into account in one year, when it clearly relates to the tax change, rather than blending it in with other required increases in any sort of phased-in scenario.
While phased-in scenarios are feasible, it seems prudent for the increased cost burden to come into place at the same time that planned individual rebates and personal income tax reductions (related to HST implementation) also start. Phasing in the HST impact does not reduce the amount to be funded; it simply defers the increase to future years, when we think a Board may look foolish trying to blame the ongoing increases on the previously implemented HST.
Once a corporation has calculated the likely impact, they can add this to their 2010 and 2011 budgets as a separate contribution to reserve in addition to the base contribution required by the reserve fund study and Form 15. In 2010, the increase will need to be factored by the number of HST-bearing months in the fiscal year (for a December 31st year end, this will be 6/12 months).
Reserve fund studies can simply continue to be completed according to the corporation’s normal schedule, and the board can rest assured that they have taken reasonable steps to accommodate HST in their reserve fund planning with no risks needing to be identified in status certificates.
Recommended Interim Annual Contribution Increases:
Your reserve fund study provider should be able to estimate the increase in contribution level due to HST without completing a full reserve fund study update. The increase can be calculated based on the current contribution level, the existing reserve fund balance and the time to the first critical year (refer to table below, which provides guidance).
We predict that HST will add, on average, about 5% to the underlying reserve fund costs. This does not translate into a simple 5% increase in the required contribution. Current and future owners do not only have to contribute the HST on their portion of future costs but also the HST on the portion of future costs already funded, as represented by the fund balance. The impact of catching up on the HST shortfall represented by the fund balance is impacted by the size of the balance and the time to “first critical year” (the year when the fund balance next drops to the “minimum” balance).
To give a simple illustration, imagine a condominium with only one planned expenditure of $1,000,000 required when it is ten years old, in a world with no inflation or interest.
If this condominium is brand new, it would previously have had to fund $1,000,000 over ten years, or $100,000/year. With HST, it now needs to fund $1,050,000 over ten years, or $105,000/year; a 5% increase.
However, if this condominium is nine years old and it has already saved up $900,000 towards this project, then in the next year it needs to fund $150,000 in one year; a 50% increase.
When interest and inflation are taken into account, the situation becomes more complex, but the underlying fundamentals remain the same.
We recommend that condominium corporations continue to update their studies on their normal update schedule. This recommendation is justified as follows:
• The impact of the elimination of PST on underlying costs will not be known until work starts to be tendered after July 1, 2010. Prior to that time, updating the study line-by-line is no more accurate than estimating the overall impact.
• The increase related to HST can be contributed to the reserve fund for the one or two years prior to the next reserve fund study update as an extra contribution without having to do a new Form 15. This additional contribution will be reflected in the opening balance of the next regularly scheduled update.
Table 1 illustrates Halsall’s recommended method for calculating the likely impact of HST on required annual contributions. These impacts are based on the “inflation-matched” scenario in your reserve fund study rather than the “phased-in” scenario, as we recommend that the impact of HST be taken into account in one year, when it clearly relates to the tax change, rather than blending it in with other required increases in any sort of phased-in scenario.
While phased-in scenarios are feasible, it seems prudent for the increased cost burden to come into place at the same time that planned individual rebates and personal income tax reductions (related to HST implementation) also start. Phasing in the HST impact does not reduce the amount to be funded; it simply defers the increase to future years, when we think a Board may look foolish trying to blame the ongoing increases on the previously implemented HST.
Once a corporation has calculated the likely impact, they can add this to their 2010 and 2011 budgets as a separate contribution to reserve in addition to the base contribution required by the reserve fund study and Form 15. In 2010, the increase will need to be factored by the number of HST-bearing months in the fiscal year (for a December 31st year end, this will be 6/12 months).
Reserve fund studies can simply continue to be completed according to the corporation’s normal schedule, and the board can rest assured that they have taken reasonable steps to accommodate HST in their reserve fund planning with no risks needing to be identified in status certificates.
Recommended Interim Annual Contribution Increases:
CASE 1:
- “New” condominium constructed in 2000 or later:
- Interim Annual Increase= 5% of previously calculated “inflation matched” annual contribution
- Example: 2010 RFS inflation-matched contribution = $220,000, HST increase: $11,000
CASE 2:
- Constructed 1990 to 1999
- Interim Annual Increase = 5% of previously calculated “inflation matched” annual contribution plus 0.5% of estimated June 30, 2010 fund balance
- Example: 2010 RFS inflation-matched contribution = $220,000, June 30 balance: $640,000, HST increase: $11,000 + $3,200
= $14,200
CASE 3:
- Constructed before 1990 and first critical year beyond 2020
- Interim Annual Increase: 5% of previously calculated “inflation matched” annual contribution plus 0.75% of estimated June 30, 2010 fund balance
- Example: 2010 RFS inflation-matched contribution = $220,000, June 30 balance: $640,000, First critical year: 2024. HST increase: $11,000 + $4,800 = $15,800
CASE 4:
- Constructed before 1990 and first critical year sooner than 2020
- Interim Annual Increase: Contact Reserve Fund Study Provider for guidance.
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