Businesses (other than financial institutions) that provide a mix of both taxable and exempt supplies must utilize the allocation rules found in section 141.01(5) of the Excise Tax Act (ETA) to determine the proper amount of input tax credits (ITCs) to claim in their GST/HST return. This generally requires that the taxpayer employ a fair and reasonable method to determine the extent to which its inputs are each used in making taxable or exempt supplies.
The TCC decision in BC Ferry Services (2014 TCC 305) provides a good overview of various aspects of the ITC allocation rules for non-financial institutions.
On the facts of the case, BC Ferry Services (“BCF”) operated vessels providing ferry transportation services – an exempt supply. Some of its vessels also provided taxable supplies such as catering, room rentals and retail store sales. With respect to these vessels engaged in making mixed taxable and exempt supplies, BC Ferry allocated ITCs pursuant to a “deck-by-deck” formula that considered whether a particular deck of the vessel was used to provide exempt, taxable or common (i.e. both exempt and taxable) supplies.
CRA assessed BCF for GST/HST, taking issue with three main aspects related to BC Ferry’s ITC allocation: (1) CRA disagreed with BCF’s classification of the infrastructure deck (which housed the engine and other mechanical components) as “common use”; (2) CRA disagreed with BCF’s classification of the stateroom rentals as separate taxable services; and (3) CRA denied a full ITC on a new ferry imported by BCF, on the basis that it was not imported for use primarily in commercial activities.
Overall, the TCC decision was a partial win for both BCF and CRA.
On the first issue, CRA argued that the infrastructure deck should be classified as an exempt deck because, inter alia, no commercial activity took place thereon. The TCC disagreed, holding that it was reasonable to classify the deck as common use because some portion of that deck was indirectly connected to its taxable supplies, and the taxable supplies could not occur without the support of the infrastructure deck equipment.
On the second issue, CRA argued that stateroom rentals were exempt supplies because they were part of the single supply of ferry transportation services. The TCC also disagreed, concluding that the stateroom rentals were a separate supply, on the basis that the staterooms were not an essential component of the overall supply of transport services. It further held that the stateroom rentals were a taxable supply, which entitled BCF to ITCs in respect of same.
With respect to the last issue, CRA argued that BCF was not entitled to ITCs with respect to BCF’s importation of a new vessel, on the basis that it was capital property imported “primarily” for use in exempt transportation services. Here, the TCC agreed with CRA. Despite BCF’s own deck-by-deck allocation method (which the TCC determined to be fair and reasonable), which calculated 56.6% of the vessel as being used for commercial activities, the TCC employed the concept of qualitative and quantitative evidence in determining whether capital property was acquired or imported primarily for commercial activity.
In the TCC’s view, the qualitative analysis required a determination of the first, important or chief use of the property, while the quantitative analysis required a determination of percentage use.
Here, BCF relied mainly on the quantitative evidence, which the TCC noted was preferable to employ, unless qualitative evidence was sufficiently persuasive to displace it.
Unfortunately for BCF, the TCC did just that, and concluded that the qualitative evidence was sufficient to displace the quantitative evidence in this case, finding that the vessel in question was imported primarily for use in the provision of exempt ferrying services. The TCC found that the vessel was imported to use in BCF’s core services, namely providing ferry transportation, and that “the ancillary [taxable] services are just that – ancillary, that is, subordinate to its core business activities.” It was thus held that the main reason BCF acquired/imported the vessel was to be able to use it to provide exempt transportation services. Accordingly, section 199(2) of the ETA operated to deny BCF the ITCs sought.
By way of commentary, one cannot argue with the TCC’s decision on issues one and two, but one does wonder about issue three, and the “quantitative” versus “qualitative” analysis. In theory we would accept that qualitative evidence may be able to displace quantitative evidence, but one would have thought – in the GST/HST context – that this ought to be only in rare cases. The reason is that ITCs are linked to commercial activities because the GST is a multi-stage value added tax intended to be borne by the final consumer. Here, 57% of the vessel was being used to make taxable supplies, and the fisc was the main beneficiary of that (collecting the GST paid by the consumer of these taxable services), yet ITCs were denied. This is not good tax policy, and is inconsistent with the architecture of the GST itself.
And from another perspective – and contrary to the TCC’s view that the vessel was being acquired for BCF’s “core business” of exempt ferry services – if 57% of revenues are being achieved through the add-ons, who is to say that the core business is still “exempt ferry services” ? If it walks like a duck, and quacks like a duck, it may be a duck. The conclusion that we would have reached is that having regard to the ultimate use of the vessel (which was primarily for producing taxable supplies), full ITCs ought to have been allowed.
The decision has not been appealed.
As it stands, this case is notice to taxpayers that, even where the ITC allocation methodology is considered fair and reasonable, the “qualitative evidence” can take precedence over the use of that fair and reasonable methodology when it comes to determining whether capital property was acquired “primarily” for making taxable or exempt supplies. Accordingly, taxpayers must look beyond the 50% quantitative threshold in order to determine whether it should claim ITCs with respect to its capital personal property.