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:

CASE 1:

1. “New” condominium constructed in 2000 or later:
2. Interim Annual Increase= 5% of previously calculated “inflation matched” annual contribution
3. Example: 2010 RFS inflation-matched contribution = $220,000, HST increase: $11,000

CASE 2:

1. Constructed 1990 to 1999
2. Interim Annual Increase = 5% of previously calculated “inflation matched” annual contribution plus 0.5% of estimated June 30, 2010 fund balance
3. Example: 2010 RFS inflation-matched contribution = $220,000, June 30 balance: $640,000, HST increase: $11,000 + $3,200
   = $14,200

CASE 3:

1. Constructed before 1990 and first critical year beyond 2020
2. Interim Annual Increase: 5% of previously calculated “inflation matched” annual contribution plus 0.75% of estimated June 30, 2010 fund balance
3. 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:

1. Constructed before 1990 and first critical year sooner than 2020
2. Interim Annual Increase: Contact Reserve Fund Study Provider for guidance.