It is not uncommon for the CRA to issue administrative policies or directives that provide CRA auditors and the public with direction on how the Excise Tax Act (ETA) or Income Tax Act (ITA) should be applied to certain industries/situations. While people may believe that following these directives means they are following the law, these directives are simply the CRA's view of how the law should be applied. Accordingly, they can sometimes be a source of false comfort, and not accurately reflect the law. Such was the case in the recent Tax Court of Canada (TCC) decision of Dr. Brian Hurd Dentistry Professional Corporation v. The Queen, 2017 TCC 142 (Brian Hurd) where the Court found the CRA GST policy statement was wrong and misleading.
The Brian Hurd case involved two questions: (1) Was the Appellant orthodontist making a single supply, or multiple supplies? (2) Were those supplies zero-rated or exempt? The answers to these questions were important because a registrant making exempt supplies cannot claim Input Tax Credits (ITCs) in respect of same, whereas a registrant that provides zero-rated supplies can.
Back in May 2004, the CRA has written to the Canadian Dental Association setting out CRA's policy on the eligibility of dentists/orthodontists to claim ITCs. This policy basically provided that if a dentist/orthodontist identified they were making separate supplies of (1) orthodontic/dental appliances and (2) orthodontic/dental services, then the former would be zero-rated and the latter would be tax exempt. The policy also stated that:
"For administrative purposes the CRA accepts that dentists who claim ITCs on a periodic basis can use an estimate of 35% of the cost to the patient of the orthodontic treatment to represent the 'consideration' for the supply of the orthodontic appliance..."
In Brian Hurd, the Appellant orthodontist had patients sign contracts which covered the cost of both the orthodontic appliance and all related visits to the orthodontist. This contract identified the "appliance portion... of the fee" which was calculated separately as 35% of the total.
On audit, the CRA took the position that the Appellant had not sufficiently delineated the two supplies, so the CRA assessed the Appellant on the basis that it was providing a single supply of orthodontic services, which were fully exempt. This effectively meant the Appellant could not claim any ITCs on the supply.
At the TCC, the Appellant relied on the CRA policy to argue that it had provided two separate supplies: (1) an orthodontic appliance which was zero rated; and (2) orthodontic services which were tax exempt. The CRA argued that only a single supply was made and that since the provision of the orthodontic appliance was merely incidental to the orthodontic service, the single supply was tax exempt.
The TCC first considered if there was a single supply or multiple supplies. Notwithstanding that the contracts for each patient identified an orthodontic appliance portion, the TCC held that this was merely done to comply with the CRA directive and did not change the fact that the supply of the orthodontic appliance and orthodontic services were so entwined that there could be only a single supply. In other words, the Court found that because the orthodontic appliance would be useless without regular adjusting services and vice versa, it was clear that the entire contract was for a single supply.
The TCC was very critical of the May 2004 CRA policy and actually went so far as to say that "In the end, the CRA policy statement is simply wrong and more importantly misleading and cannot be defended in the manner the Respondent would have me do. I simply reject it and I do not intend to follow it."
The TCC ultimately concluded that the single supply of an orthodontic treatment was exempt, so the Appellant was not entitled to ITCs. In obiter, the TCC conceded that if multiple supplies were involved the supply of the orthodontic appliance would have been zero-rated.
The Court's ruling must have been an unpleasant surprise for not only the Appellant, but the entire dental/orthodontic industry, which had relied on the CRA's 2004 policy for years. However, the TCC is not bound by CRA administrative policies.
In any event, this case serves as a cautionary tale to those who rely on CRA administrative policies that should a case make its way before the TCC these policies have no legal weight.
A version of this article appeared in the October 2017 issue of Canadian Tax Foundation’s Tax for Owner-Manager.
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