Tax Court OKs ITC Claims in Mixed Operations
Published:
September 20, 2023
Author(s):
Can a business providing both exempt supplies and taxable supplies of goods and services claim Input Tax Credits (ITCs) under the Excise Tax Act – and if it can, how does it determine the amounts of those ITCs? In its July 2023 decision in Marine Atlantic Inc. v. The King, the Tax Court of Canada decided it can – and it’s not required to retain valuators or establish costly accounting systems to separate property or services consumed in the context of mixed operations. It need only consistently use a methodology that allocates GST/HST paid on its taxable inputs to its commercial activities in a fair and reasonable manner.
The ITC Apportionment Rules
Under section 141.01 of the Excise Tax Act, businesses that provide a combination of exempt and taxable services can claim ITCs for a portion of the GST/HST they paid while acquiring goods and services for use in their commercial activities. But for many businesses, allocating each cost to a specific supply is time and cost prohibitive. In those cases, subsection 141.01(5) allows such a business to develop a method to estimate and attribute all direct and indirect costs incurred in the course of its business to the making of supplies of goods and services and allocate them to either taxable or exempt goods and services – if the method is fair and reasonable and the business applies it consistently throughout the year.
The Taxpayer’s Operations
Marine Atlantic is a federal Crown corporation providing a ferry service between Nova Scotia and Newfoundland. Under Schedule V, Part VIII, section 1 of the Act, “[a] supply…of a service of ferrying by watercraft passengers or property where the principal purpose of the ferrying is to transport motor vehicles and passengers between parts of a road or highway system that are separated by a stretch of water” is an exempt supply. However, Marine Atlantic took the position it made both taxable supplies and exempt supplies.
Taxable Supplies. Marine Atlantic was required to collect GST/HST on its taxable supplies of goods and services. These taxable supplies included the provision of passenger cabins, sleeper dorms, reserved seating, sale of items in retail stores, sale of food and beverage, provision of kennels, sale of items in vending machines, and provision of amusement machines, the values of which were significant:
- Passenger cabins’ annual revenue of between $4.5M and $7.3M.
- Catering services annual revenue of approximately $3M.
- Reserved seating annual revenue of $254,000.
- Retail stores’ annual revenue of $500,000 to $600,000.
Under the Act, Marine Atlantic was required to add all such GST/HST collected when ultimately determining its net tax for a particular reporting period.
Exempt Supplies. Marine Atlantic wasn’t required to collect GST/HST on its exempt supply of passenger and commercial ferry service.
Input Costs. Marine Atlantic paid GST/HST on supplies of goods and services it acquired, including fuel, expenses for repairs and maintenance, materials, supplies and services for the vessels, corporate headquarters and terminals. Under the Act, Marine Atlantic was entitled to claim ITCs for GST/HST it had paid assuming the property and services it acquired were consumed, used or supplied in the course of its commercial activities (excluding its exempt supplies of good and services) when calculating its net tax.
ITC Allocation. Based on its intended or actual use of the property or service in its commercial activities, Marine Atlantic developed a methodology to determine the extent to which each cost was acquired for consumption, use or supply in the course of its commercial activities (exclusive of its exempt supplies) and Marine Atlantic claimed a portion of these expenses as ITCs in its periodic reports. After retaining an engineering firm to complete measurements of all vessels and identify the various areas of vessels attributable to taxable areas, exempt areas and common areas (at a cost of over $70,000 and 1,000 hours of labour), Marine Atlantic:
- Reviewed each of its vessels and pinpointed areas it determined were used exclusively in the making of exempt supplies and areas used exclusively in the making of taxable supplies.
- Measured the size of these areas and categorized each based on its intended use.
- Calculated the ratio of taxable supply area to exempt supply area and used that percentage to determine its ITC claims.
The CRA Reassessment
Canada Revenue Agency, however, took the view that the income Marine Atlantic generated was in relation to provision of a ferry service, an exempt supply for which Marine Atlantic couldn’t claim ITCs, and that its methodology to allocate GST/HST paid on inputs to its commercial activities wasn’t reasonable or fair. It reassessed Marine Atlantic’s claimed ITCs. The amount in dispute was substantial, exceeding $7M. Marine Atlantic appealed CRA’s reassessment to the Tax Court of Canada.
The Court’s Decision
The issue before the Court was the level of Marine Atlantic’s entitlement to ITCs related to GST/HST it had paid on goods and services acquired for consumption, use or supply in the course of its business of providing a ferry service. Marine Atlantic’s ability to claim ITCs for GST paid on fuel it acquired to power its vessels, what the fuel was used for, and its inability to allocate those fuel costs to specific activities on board vessels was a particular subject of significant evidence. An exact allocation of the fuel used in the vessels proved impossible for Marine Atlantic: it couldn’t measure exactly how much fuel was used in propelling the vessels versus how much was used in generating electricity, heating the vessel, operating HVAC and providing energy to the taxable areas of the vessels. The Court agreed with Marine Atlantic and decided it was entitled to claim ITCs:
Test. The question wasn’t whether the methodology used would determine the exact extent to which Marine Atlantic acquired property or services for use in the course of its commercial activities; it was whether it provided a fair and reasonable estimate of such extent.
Fair & Reasonable. Focussing on the particular evidence presented at trial, the commercial realities of Marine Atlantic’s business and the particular activities that made use of the taxable inputs, the Court decided Marine Atlantic’s methodology to allocate GST/HST paid on its taxable inputs to its commercial activities was fair and reasonable.
Please contact your McInnes Cooper lawyer or any member of our Tax Solutions Team @ McInnes Cooper to discuss whether and how your business can claim ITCs.
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