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Citation: 2006TCC235
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Date: 20060412
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Docket: 2003-1693(GST)G
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BETWEEN:
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MUNICIPALITÉ RÉGIONALE DE COMTÉ
DES ÎLES-DE-LA-MADELEINE,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
[OFFICIAL ENGLISH
TRANSLATION]
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REASONS FOR JUDGMENT
Tardif J.
FACTS
[1] This appeal pertains to the period from January
1, 1997, to March 31, 1999. The issue is whether the assessment dated
March 26, 2002, was made in accordance with the applicable provisions
of the Excise Tax Act (the "Act"); in other words, has
the appellant established that it was entitled to the input tax credits (ITCs)
that it claimed on the basis that the ITCs were related to a taxable supply?
[2] To answer this question, the Court must first
determine whether composting constitutes a commercial activity that gives
entitlement to the ITCs claimed. If it does, was the allocation method chosen
by the appellant fair and reasonable?
[3] The Magdalen Islands (the "Islands")
form a 202-square-kilometre archipelago. Their fragile water table, isolation
from the mainland and lack of available landfill space were causes of concern
with respect to the management of some 7,000 tonnes of waste produced annually
on the Islands.
[4] In the early 1980s,
the problem became so serious that solutions needed to be implemented urgently.
Waste management was at that time a fundamental concern; the available
solutions were often excessively costly, and were, moreover, in some respects
uncertain.
[5] In 1984, it was decided that a solution to the
problem of waste management needed to be found. The appellant accordingly did
everything it could to find the ideal solution, although it did not expect
perfection.
[6] In 1988, after preparing a list of possible
solutions and visiting various sites, including sites in France, the
Municipalité régionale de comté des Îles-de-la-Madeleine (the "MRC")
concluded that composting, combined with incineration, would be the ideal
solution for the Islands.
[7] Composting would
make it possible to recover the waste, and the incinerator would eliminate the
undesirable elements, thereby reducing the volume of landfill considerably.
[8] After obtaining the necessary funding and all the
certificates of compliance to carry out the project chosen, the MRC had a waste
treatment and elimination plant built which housed both the composting and the
incineration operations. Construction began in 1993 and ended in 1994. The
plant began composting and incineration in 1994.
[9] The quality of the compost was initially
disappointing. Due to the presence of foreign objects such as glass and other
undesirable substances, the compost could not be used and was thus of no
interest or value.
[10] Because of the many
unknowns, this was a rather special undertaking. That reality no doubt accounts
for the private sector's lack of interest in this field, and this limited the
possibilities in terms of consultation and references.
[11] By 1996, the appellant had held various
consultations, attended various conferences and hired various experts to
analyze the composting process and make recommendations for improving the
quality of the product. Even though the changes suggested to improve the
quality of the compost were costly, the MRC chose to follow the
recommendations.
[12] In 1997, the authorities added the recovery
of recyclable materials to its waste collection program, and composting
operations were moved outside the building.
[13] Due to the
inevitable learning curve, and to circumstances over which it had no control,
the appellant had to deal with delays that were much longer than it had hoped.
Were the lengthy delays and the poor initial quality of the compost a
sufficient basis on which to conclude that there was no desire to make better
compost and subsequently sell it, or that this desire was abandoned?
[14] In 2001, after
considerable effort and unquestionable determination, the quality of the compost reached a level
that met the requirements of the Bureau de normalisation du Québec
("BNQ"). From that point onward, the compost was marketed; it sold
for $25 per tonne.
[15] Section 259 of the Excise Tax Act gives
entitlement to a rebate of the tax payable, based on a percentage prescribed by
regulation. For the period in issue, the appellant recovered in the form of a
57.14% rebate part of the tax paid; in addition, the MRC filed two GST/QST
returns with credit balances in which it claimed the remaining 42.86% as an
ITC. The claim concerned the tax payable on the current expenditures for 1994,
1995, 1996 and 1997, and the tax payable on the construction of the waste
treatment plant.
[16] Following an audit
by the tax authorities, the respondent refused, for the following reasons, to
remit the ITCs claimed by the appellant:
(a) the composting
cannot be considered to have been, during the period in issue, a commercial
activity carried on for the purpose of making taxable supplies and,
consequently, the ITCs claimed for operating expenditures and capital
expenditures cannot be allowed; and
(b) even if the
composting could be considered to have been a commercial activity carried on
for the purpose of making taxable supplies, the allocation method used by the
MRC for mixed supplies (exempt and taxable) is not fair and reasonable.
[17] The appellant argues
that, on the contrary, composting is indeed a commercial activity under the
Act, and the allocation method selected is fair and reasonable. Thus, the
appellant is claiming the ITCs.
[18] In order to be entitled to ITCs, a registrant must
have acquired or imported property or a service for consumption, use or supply
in the course of the registrant's commercial activities. This entitlement to
ITCs is set out in subsection 169(1) of the ETA:
169. (1) Subject to this Part, where a person acquires
or imports property or a service or brings it into a participating province
and, during a reporting period of the person during which the person is a
registrant, tax in respect of the supply, importation or bringing in becomes
payable by the person or is paid by the person without having become payable,
the amount determined by the following formula is an input tax credit of the
person in respect of the property or service for the period:
A x B
where
A is the tax in respect of the supply, importation
or bringing in, as the case may be, that becomes payable by the person during
the reporting period or that is paid by the person during the period without
having become payable; and
B is
(a) where the tax is deemed under subsection
202(4) to have been paid in respect of the property on the last day of a
taxation year of the person, the extent (expressed as a percentage of the total
use of the property in the course of commercial activities and businesses of
the person during that taxation year) to which the person used the property in
the course of commercial activities of the person during that taxation year,
(b) where the property or service is acquired,
imported or brought into the province, as the case may be, by the person for
use in improving capital property of the person, the extent (expressed as a
percentage) to which the person was using the capital property in the course of
commercial activities of the person immediately after the capital property or a
portion thereof was last acquired or imported by the person, and
(c) in any other case, the extent (expressed as a
percentage) to which the person acquired or imported the property or service or
brought it into the participating province, as the case may be, for
consumption, use or supply in the course of commercial activities of the person.
[Emphasis added.]
[19] In order to constitute a taxable supply and
thereby give entitlement to the input tax credit, the supply must be made in
the course of a commercial activity. Subsection 123(1) defines the term
"taxable supply" as follows:
"taxable supply" means a supply that is made in the
course of a commercial activity.
[20] This definition thus refers us to the term
"commercial activity", which is defined as follows in subsection
123(1):
"commercial activity" of a person means
(a) a
business carried on by the person (other than a business carried on
without a reasonable expectation of profit by an individual, a personal trust
or a partnership, all of the members of which are individuals), except to
the extent to which the business involves the making of exempt supplies by the
person.
[21] Lastly, the term "exempt supply" is also
defined in subsection 123(1) of the ETA, and the definition refers us to the
supplies included in Schedule V. The exempt supply that is concerned in this
appeal can be found in Part VI of Schedule V:
21.
[Municipal
services] – A supply
of a municipal service, if
(a)
the supply is
(i)
made by a government or municipality to a recipient that is an owner or
occupant of real property situated in a particular geographic area, or
(ii)
made on behalf of a government or municipality to a recipient that is an owner
or occupant of real property situated in a particular geographic area and that
is not the government or municipality;
(b)
the service is
(i) one
which the owner or occupant has no option but to receive, or
(ii)
supplied because of a failure by the owner or occupant to comply with an
obligation imposed under a law; and
(c) the service is not one of testing or inspecting any property for
the purpose of verifying or certifying that the property meets particular
standards of quality or is suitable for consumption, use or supply in a
particular manner.
[Emphasis
added.]
[22] Since the MRC is a municipality, any supply that
it makes to occupants of real property on its territory and which they have no
option but to receive is an exempt supply. However, despite this principle, it
is possible for a municipality to make mixed supplies.
[23] In the case at bar, the parties agree that the
incineration system is used only to make exempt supplies, and thus this dispute
is essentially about the composting activities.
[24] Is composting a commercial activity? If not, the MRC makes
exempt supplies only and is therefore not entitled to any ITCs (except, of
course, the 57.14% allowed by Parliament). However, if composting is a
commercial activity, it must be determined whether the commercial activity
began before or after the period in issue.
1) Composting as a commercial activity
[25] The analysis undertaken to answer the question as
to whether composting is a commercial activity must take several factors into
account.
[26] First of all, one must ask whether composting can
constitute a commercial activity. The Petit Robert defines compost as a
fertilizer consisting of a fermented mixture of organic waste and mineral
matter. Thus, the aim of composting, like that of recycling, is waste
recovery.
[27] Two technical
interpretations by the Canada Customs and Revenue Agency expressly recognize
that recycling and composting are commercial activities:
Sales of Scrap and Compost by Municipality,
No. 96 GTI 216, March 13, 1996
. . .
Municipalities providing recycling services are considered to be
making a combination of exempt and taxable supplies. The service of collecting
the compostable material and transporting it to a recycling centre would
qualify as an exempt supply of a basic garbage collection service. The
processing and marketing of the compost for subsequent sale to prospective
buyers is considered a commercial activity which results in a taxable supply.
That is, the sale of the compost by the municipality would be GST-taxable at a
current rate of seven per cent.
[Emphasis
added.]
Interpretation letter 95-0108753 — Supply of
services by an intermunicipal waste treatment authority, May 17, 1996:
[TRANSLATION]
. . .
Moreover, the amended version of paragraph 20(h)
of Part VI of Schedule V to the ETA specifies that, effective January 1,
1991, waste collection includes recycling collection services such as a
blue-box program and a compostable materials collection service. This exemption
applies to the collection of recyclable materials within the framework of a
neighbourhood collection program, and to the delivery of such materials to a
recycling facility. However, the processing of recyclable materials in
such a facility is considered a commercial activity and, thus, the sale of
recyclable materials by a registrant is taxable.
[Emphasis
added.]
[28] Although it can be concluded that composting can
constitute a commercial activity, the respondent submits — and rightly so — that it is wrong to assert that any
composting and recycling activity necessarily constitutes a commercial activity
within the meaning of the ETA. Thus, the facts are very important, and must be
assessed in their context having regard to all the relevant circumstances.
[29] Let us consider,
then, the facts of the case at bar in this light.
[30] The appellant essentially submitted that the
composting in the case at bar was indeed a commercial activity, because its
purpose was always to achieve superior‑quality compost that could be
sold. Apart from the significant environmental concern, the fundamental intent
was always to make compost of saleable quality. This objective moreover
made sense, because any non-saleable compost would have been a real
embarrassment in the long term, especially since it would have been something
of an aberration to produce compost without a purpose.
[31] It turned out that
several years of trials were needed before compost of a quality acceptable for
sale was obtained. The first sales were made in 2001, 2002 and 2003. The delays
are evidence of the determination and genuine desire to attain a reasonable
degree of quality.
[32] The respondent, for her part, submits that the
appellant's initial intent was essentially to find a solution to the waste
management problem, because waste could not continue to be sent to the landfill
indefinitely. In the respondent's submission, incineration and composting were
chosen somewhat willy-nilly as a waste management solution for the MRC. The
respondent argues as follows in support of her position:
(1) While the selling price of $25 per tonne of
compost was described as reasonable considering its quality, it does not even
cover the cost of producing the compost. The respondent adds that no private
business would have considered selling compost under such circumstances.
(2)
There was no actual
commercial activity related to composting during the period in issue for the
following reasons:
(a) the sales in 2001, 2002 and 2003 should not
be considered as conclusive in determining whether there was a commercial
activity from January 1997 to March 1999; and
(b) the remarks made by Mr. Gagnon at the Quebec forum on composting in 1995 contradict the
appellant's position that there was from the outset an intent to sell the
compost.
[33] The respondent's
approach is essentially based on traditional criteria such as viability,
profitability, or profit in the strictly accounting sense. What is more, the
respondent seems to believe that the production of compost can only be held to
be a commercial activity if there is a reasonable expectation of profit.
However, for GST purposes, reasonable expectation of profit is not a requirement.
[34] Moreover, where a
new product is involved, it is not unusual to experience a number of setbacks
before an acceptable formula is found.
[35] I believe that two
other very important factors should have been taken into account here. Indeed,
but for the composting activity, all the materials used for composting would
have had to have been incinerated. Thus, in the calculation of the profit
derived from composting the incineration costs saved should be taken into
account. In addition to this accurately quantifiable item, there is also the
environmental benefit, which constitutes a real component of the quest for an
acceptable product. In other
words, where the environment is involved, it is essential that the analysis
take account of factors foreign to the traditional economic‑cost‑versus‑monetary‑benefit
approach. The time has come when environmental costs and benefits are
inescapable components of the assessment of any project.
[36] In addition to this approach, I must take account
of the fact that the term "business" is found in subsection 123(1) of
the ETA:
"business" includes a profession,
calling, trade, manufacture or undertaking of any kind whatever, whether
the activity or undertaking is engaged in for profit, and any activity
engaged in on a regular or continuous basis that involves the supply of
property by way of lease, licence or similar arrangement, but does not include
an office or employment.
[Emphasis added.]
[38] In addition, GST/HST Policy Statement P-167R, Meaning
of the First Part of the Definition of Business, sets out the
guidelines used by the tax authorities to determine whether a person is
carrying on a business. The statement addresses expectation of profit as
follows:
Expectation
of Profit
Generally,
an activity carried on for profit will constitute a business for GST/HST
purposes. However, unlike the Income Tax Act, the definition of
"business" in subsection 123(1) of the Act includes the phrase
"... whether the activity or undertaking is engaged in for profit
...". A person is not required to be engaged in an activity or
undertaking with an expectation of profit to be considered to be in business
for GST/HST purposes. The definition of "business" (and by
extension, commercial activity) was structured to include not only those
activities that are considered to be a business for income tax purposes, but
also those activities undertaken without a profit motive that would stand in
direct competition with activities of profit motivated enterprises. The
exclusion of the profit test provides for a level playing field between profit
and non-profit organizations that are essentially making the same type of
supplies.
In addition, there is no statutory distinction
in the definition of "business" between public sector bodies (PSBs), such
as governments, non-profit organizations and charities, and other persons who
are not PSBs. As such, this policy statement applies to all persons who are
engaged in activities that may constitute a business, regardless of whether
they are motivated by profit or some other goal. . . .
[Emphasis
added.]
[39] Consequently, the MRC was under no obligation to
demonstrate profitability, or a reasonable expectation of profit, in order for
composting to be considered a commercial activity. In the broad sense, a
commercial activity is an activity that has a potentially uncertain outcome and
is motivated by the hope of achieving an acceptable goal or objective, provided
that it is carried on in a serious and reasonable manner.
[40] The fact that there were no sales of compost until
2001 is not decisive in ascertaining whether composting is a commercial
activity or not. Coming back to Policy Statement P-167R, it can be seen that
criteria other than the making of supplies are important in determining whether
there was truly a business:
The
Meaning of Business
. .
.
The
CCRA has generally taken a broad view of the meaning of "business" in
a number of instances dealing with the making of supplies and whether certain
supplies were taxable. However, the making of supplies cannot be
considered as the sole measure of whether a business is being carried on given
the absence of the profit test from the definition of "business".
As such, the issue is not so much determining if an activity that comprises or
directly involves the making of supplies is a business, but rather to
what extent an activity that does not directly involve the making of supplies
is a business.
In
some cases, a person may undertake activities that are themselves commercial in
nature and business oriented (within the ordinary meaning of those terms), but
which constitute neither a trade nor a manufacture (i.e., activities which
involve the making of, or the intent to make, supplies), nor could they aptly
be described as a profession or calling. Nevertheless, the inclusion of
the phrase "... undertaking of any kind whatever ..." in the
definition of "business" allows activities that are not strictly
speaking a "... profession, calling, trade, manufacture ...", within
the ordinary meaning of those words, to be included within the meaning of
"business". . . .
. .
.
In
establishing that an activity is sufficiently "business-like" to
qualify as an "undertaking", a number of factors should be considered, including:
1.
whether the activity is serious and earnestly pursued;
2.
whether the activity is actively pursued with reasonable and recognizable
continuity;
3.
whether the activity is conducted in a sound manner using recognized business
principles and records are maintained to that effect;
4.
whether the supplies, if any, are of a kind which, subject to differences of
detail, are commonly made by those who seek to profit from them;
5.
whether the activity facilitates or promotes the making of supplies (whether by
the person itself or by other persons); and
6.
whether the activity supports other activities which are directed towards
earning revenue.
While no one factor is itself more definitive
than another, the circumstances surrounding a particular activity may suggest
the need to provide more weight to a specific factor or factors. In addition,
given that a particular factor may be weighted more heavily than another, it is
not sufficient simply to total the number of factors that favour the existence
of a business against the total number of factors that favour the opposite
conclusion. For example, it may be possible, in the appropriate circumstances,
to conclude that a business exists even if only two of the six factors are met.
[Emphasis added.]
[41] The evidence shows
that the materials or waste sent to the incinerator generated major costs;
indeed, the cost of operating the incinerator was very high, both financially
and environmentally. Thus, it was in the MRC's interest to reduce the volume of
incinerated waste as much as possible, and that is why it was also in its
interest to pursue the composting option very actively.
[42] Everything that was
collected for composting did not need to be incinerated. This resulted in
substantial savings, and is a very important factor to consider in calculating
the benefits of composting.
[43] Initiatives of this
kind are generally undertaken by municipal or government authorities. They are
of very little or no interest to the private sector because profit in an
accounting sense is generally not part of the picture and, if it is, is too
marginal to generate any excitement.
[44] Before too long
environmental benefits will have to be regarded as true profits that are just
as important as profit in the classic sense. Until then, the environmental
aspect, while difficult to measure, must be taken into account in assessing the
viability of a project.
[45] With respect to the moment at which a business has
started up, Judge Bowman, in a decision dealing with the notion of business
under the ITA, has provided some highly pertinent clarifications:
. . . In determining when a business has commenced, it is not
realistic to fix the time either at the moment when money starts being earned
from the trading or manufacturing operation or the provision of services or, at
the other extreme, when the intention to start the business is first formed.
Each case turns on its own facts, but where a taxpayer has taken significant
and essential steps that are necessary to the carrying on of the business it is
fair to conclude that the business has started. (Gartry v. The Queen, No. 92-2492(IT)G,
April 14, 1994, 94 DTC 1947, at page 1949 (TCC)).
[46] In addition, in Two Carlton Financing Ltd. v.
The Queen, No. 96‑523(GST)G, June 2, 1998, 98 G.T.C. 2141
(TCC), the following statement is made in footnote 9 at paragraph 36:
I do not think it is necessary that in a "start up" of a
business, for example, any supplies need be made in order to be eligible for
ITCs. The expenditures giving rise to the ITCs should be made with the intent
of carrying on a commercial activity or in the course of a commercial activity.
There are also circumstances in which no GST is paid or payable and yet
entitlement to ITCs remains (for example, where taxable supplies are deemed
zero-rated pursuant to a section 156 election).
[47] Compost sales during the period in issue were by
no means essential to a finding that the MRC carried on commercial activities;
the appellant needed only to demonstrate that it took genuine and concrete
measures in furtherance of the goal of making sales. The duration of the
measures, and the efforts to implement them, are not absolutely decisive
factors. Depending on the constraints and on various problems, the time can
vary considerably from one case to another. In my view, the assessment must
consider good faith, genuine intent and continuity of effort toward the
achievement of the desired product.
[48] Where the product is
known or the evolution of the project can be predicted, it is possible to
estimate the probable duration of that project from the outset, before the
final version is achieved.
[49] However, when the
marketing of a product is subject to several factors that cannot always be
controlled, there can be ups and downs in the development process, and progress
toward creating an acceptable product may require very lengthy delays, without,
however, casting doubt on the coherence and seriousness of the process and the
resolve to attain an objective.
[50] Here it was not a
matter of marketing a simple fertilizer with components that were already known
and available for purchase. What was involved, rather, was developing compost
in a special context characterized by numerous constraints. Those concerned
demonstrated a tenacity and determination that does them credit in achieving a product
of acceptable quality.
[51] Under the
circumstances, the fact that no sales were made until 2001 does not prevent the
MRC from having carried on a commercial activity during the start-up period,
that is, the period in issue.
[52] The respondent gives undue weight to the following
comments made by Mr. Gagnon at the Quebec forum on composting in 1995:
[TRANSLATION]
Since for us it was more a matter of addressing a waste management
problem, our project was not designed with a view to the marketing of the
compost eventually produced; besides, the anticipated volume of compost and the
market for the product would have made it difficult to justify the scope of the
fixed assets that were necessary. However, from the outset — and our trip to France was very
revealing in this regard — we considered it an obligation to produce high-quality compost.
This aspect was of all the greater concern to us as we felt it was important,
since we had one of Quebec's first plants in 1986, to prove we could produce
good compost from household waste. In this regard, we support efforts to
standardize compost. Standardization will establish objectives for everyone,
including us, and will provide us with common benchmarking tools.
. . .
Also, in terms of uses for the compost produced, some local outlets
have been identified. First of all, the product will enable us to reclaim some
of the waste disposal sites that we have operated over the years. Later, we
anticipate using the compost for landscaping projects in parks or public spaces
and for the reclamation of some of our all-too-many quarries or sandpits; this
will serve as a demonstration project and will give the public the opportunity
to see the results of the collective effort that has gone into the sorting of
waste at the source. And while local contractors have already shown
interest, only later, once the credibility of the compost has been solidly
established and its price firmly set, will we be able to contemplate, or talk
about, marketing, but that will not be for at least two or three years.
[Emphasis added.]
[53] The respondent relies on these remarks as directly
contradicting the assertion that there was from the very outset an intention to
market the compost. In the respondent's submission, the intention to market
it arose after the period in issue, and so, even if composting is a commercial
activity, that activity began only after the period in issue.
[54] This interpretation of Mr. Gagnon's comments is
inappropriate and cannot be a basis for concluding that there was no intention
to market the compost. Rather, upon reading the entire speech, one can see
that the general intention in 1995 was to produce compost of sufficient quality
to be marketable within a realistic amount of time. Just because the
compost did not yet meet the quality standards required for marketing it cannot
be said that there was no intention to market the compost.
[55] Mr. Gagnon, in speaking of an initial intention,
is referring to 1986, when the project was first studied, on the exploratory
mission to France. In my opinion, it is clear that, once the project got
underway and concrete measures were being taken to produce compost by means of
an entire organizational structure, the operations were part of the MRC's
commercial activities.
[56] Mr. Gagnon's speech clearly shows that, at least
in 1995, the MRC indeed intended to market the compost as soon as an acceptable
quality was obtained.
[57] Contrary to the respondent's interpretation, Mr.
Gagnon's comments at the Quebec forum on composting confirm, rather than
contradict, the fact that the MRC intended to market the compost.
[58] Even if the initial intention in 1986 was to find
a waste management solution, and even if this main intention subsisted
throughout the period during which a better quality of compost was being worked
on, this did not prevent the existence of a secondary intention to market the
compost in the future; both intentions could coexist without contradicting each
other.
[59] It was possible for
the MRC to have two
simultaneous intentions: waste management, which included composting; and the
marketing of the compost thereby produced. In fact, this is what the MRC's
mixed supplies are based on.
[60] For all these reasons, I find that during the
period in issue, the MRC made supplies that were both taxable and exempt: the
activities related to composting were taxable supplies, but those related to
incineration were exempt supplies.
2) The allocation
method
(a) Direct
costs
[61] The relevant provision of the ETA concerning the
allocation method provides as follows:
141.01 (5) Method of determining extent of use,
etc. -- The methods
used by a person in a fiscal year to determine
(a) the extent to which properties or
services are acquired, imported or brought into a participating province by the
person for the purpose of making taxable supplies for consideration or for
other purposes, and
(b) the extent to which the consumption
or use of properties or services is for the purpose of making taxable supplies
for consideration or for other purposes
shall
be fair and reasonable and shall be used consistently by the person throughout
the year.
[62] Where the activities are
mixed, that is, there are both taxable and exempt supplies, an allocation must
take place. This is superfluous when dealing with a well-defined or clearly
identifiable exempt activity, in which case no ITC can be claimed.
[63] In 398722 Alberta Ltd. v. Canada,
F.C.A., No. A-706-98, May 11, 2000, Sharlow J.A. held, at
paragraph 22, that any business may consist of several components. For GST
purposes, activities that lead to the making of exempt supplies must be treated
in a special way:
22 Any business may consist of a number of
components, each of which is integral to the business as a whole. The definition
of "commercial activity" recognizes that possibility but requires,
for GST purposes, that any part of the business that consists of making exempt
supplies be notionally severed. . . .
[64] In Montréal
(City) v. Canada, [2003] T.C.J. No. 432 (QL), T.C.C., No. 2001‑3234(GST)G,
July 30, 2003, the Court had to decide whether the collection of
waste for hauling to the sorting and recycling plant was part of the city's
commercial activities. In holding that waste collection was an exempt supply,
in respect of which no ITC could be claimed, Lamarre Proulx J. referred to 398722 Alberta
Ltd., supra. She stated at paragraph 40 et seq.:
40 The Federal Court of Appeal
decided as follows in 398722 Alberta Inc. (supra): that any part
of the business that consists of making exempt supplies be notionally severed.
Collecting garbage, including recyclable material, is an exempt activity and
must be notionally severed.
41 This is clearly what is
said in subsection 169(1) of the Act. A registrant's input tax credit
that relates to an acquired good or service is calculated according to the
extent to which this good or service has been used within the course of the
registrant's commercial activities.
42 Inputs paid with
respect to the direct costs of the exempt activity cannot be claimed under
subsection 169(1) of the Act, nor can they be distributed under
subsection 141.01(5) of the Act.
[Emphasis
added.]
[65] In the case at bar, which component of the
business consists of making exempt supplies? The incineration aspect is indeed
an exempt activity and must be notionally severed from the appellant's
commercial activities.
[66] The inputs related
to the direct costs of incineration (which is exempt) do not give entitlement
to the credits under subsection 169(1)
of the ETA.
[67] As the Federal Court of Appeal held in 398722
Alberta Ltd., supra, any component of the business that consists in
making exempt supplies must be notionally severed. Since the incineration is an
exempt activity, it must be notionally severed.
[68] Consequently, direct costs related to the
incinerator cannot give entitlement to ITCs. Thus, with regard to call for
tenders no. 4096-0002, the contract of $2,877,282, including taxes, awarded to
Les Industries Pyrox Inc. for the supply, installation and start-up of a
waste incineration and gas purification system cannot give entitlement to the
ITCs claimed, because those inputs can be directly tied to the exempt supply of
the incinerator.
[69] The consideration under the Pyrox contract
was $2,877,282, including taxes, which means $180,993.66 in GST and $103,424.95
in QST. Of the GST, 57.14% has already been received as a rebate, leaving a
balance of 42.86% x $180,993.66 = $77,573.88 on account of GST. This
amount cannot be claimed as an ITC. By virtue of the allocation rules, it must
be excluded from the calculations.
[70] As for the other expenses incurred in the project
to construct the complex, they are inputs that may be claimed because they are
related to mixed activities. It thus becomes necessary to verify whether the
appellant's allocation method may be considered fair and reasonable.
(b) Fairness and reasonableness
[71] The decision in Magog (City of) v. The Queen,
No. A-829-99, June 21, 2001, 2001 FCA 210, is of considerable assistance
with respect to the allocation method used to calculate the input tax credit.
The Federal Court of Appeal reminds us that the ETA does not specify the
methods that must be used to allocate the goods or services acquired for use in
commercial and other activities. Noël J.A. wrote as follows in this regard:
15 The only issue before the judge was whether
the method elected by the appellant was fair and reasonable, as required by
subsection 141.01(5). She did not have to determine which of the two
methods in question was the best. Moreover, Memorandum 700-5-1
acknowledges in its 23rd paragraph that more than one method may be fair and reasonable
within the meaning of the Act (see also Navaho Inn v. The Queen, 3 GTC
2067, at page 2071 (T.C.C.)).
. . .
17 It is important in this
regard to note that the Act does not require the appellant to establish the
type of accounting systems that would enable it to separate out each property
or service that is consumed or used in the context of its mixed activities.
Parliament was aware that such a requirement could result in compliance
expenses that would exceed the tax yielded. So it left it to the taxpayer
to select an appropriate method, while requiring that the method chosen
be "fair and reasonable".
[Emphasis added.]
[72] Thus, I do not have to ask which of the two
methods presented is best. Rather, I must analyze whether the method
selected is fair and reasonable having regard to the circumstances.
[73] This principle is very well explained in the
recent decision in Bay Ferries Ltd. v. The Queen, 2004
TCC 663, 2004 G.T.C. 489, [2004] G.S.T.C. 135, where the Court stated
the following:
37 I do not have to decide whether the best or
most appropriate method is the method chosen by the Minister or the Appellant.
38 The first, and as far as I can determine,
only case where the Federal Court of Appeal has dealt with the allocation
method, under this subsection is the case of the Magog (ville) v. Canada,
[1999] T.C.J. No. 806. This decision clearly and definitively supports
non-interference with a taxpayer's chosen method provided it is fair,
reasonable and consistent.
39 The Minister cannot substitute its
own allocation method, simply because it appears to be more representative of
the situation or the better method. This reasoning establishes a degree of
deference to be given a taxpayer in choosing a method that is fair and
reasonable.
40 Of course I believe
that a taxpayer must always be able to satisfactorily substantiate that the
chosen method is, in fact, fair and reasonable and consistent. But if he is
able to do so, subsection 141.01(5) allows a registrant a broad latitude of
flexibility in choosing a method, provided it can be shown to be fair and
reasonable. This implies that the chosen method will reasonably reflect the
actual use of the property and services and the manner in which it conducts its
business generally.
41 There are no methods specified in the Act
which are to be used as guidelines. Again, it comes down to a review of the
facts in each case. It is generally accepted that the preferred method is
direct allocation, where the property or service can be directly allocated to
the activities. The direct method will produce the most accurate results. In
some circumstances this method cannot be applied. It was not practical for the
Appellant in this case to utilize the direct application method because of
shared overhead.
42 According to GST Memorandum 700-5-1, the
next preferred method is the input method, which was the Appellant's choice.
The third preferred method, if neither of the first two can be applied, will be
the output method, which was the Minister's choice as the appropriate
application in this case.
[Emphasis
added.]
[74] In Bay Ferries, supra, the appellant
operated a ferry. The appellant had two sources of revenue: tolls, which were
exempt supplies; and the rental of space on board the vessel for vending
machines, the cafeteria, gift shops, the bar, the lounge and the newsstand.
[75] In order to
determine the ITC to which it was entitled for the rentals, which were taxable,
the appellant compared the surface area in square feet rented to tenants with
the remaining surface area.
[76] The Minister had
reassessed the appellant using the output method, which consisted in comparing
gross rental revenue with toll revenue. The Court held that the appellant's
method, which was based on area, was fair, reasonable and practical under the
circumstances:
43 The Appellant's choice of the input method,
which relied on square footage measurements, was based on the fact that it was
more consistent from year to year. If Bay Ferries had adopted the output
method, as the Minister did, different percentages would have to be allocated
to these various commercial activities of food and beverage services depending
upon revenue generated. This would mean that the degree of consistency falls
far short of the consistency that can be established from year to year using
the input method.
[77] The Act is clear: the taxpayer must use a fair and
reasonable allocation method. There is no obligation to show that the method is
perfect or better than any other.
[78] The method must
essentially be reasonable, substantiated and used consistently. The method
chosen by the appellant cannot be rejected solely on the ground that it was not
the ideal method in the respondent's view. The reasonableness and fairness
of a method have in a way a subjective dimension to them, as it would otherwise
be difficult in practice to compare more than one method.
[79] The Minister prefers the cost-based method, which,
in his view, yields more reliable and consistent results year after year. The
Minister's method could certainly meet the reasonableness requirement; however,
the method based on the surface area used for commercial activities throughout
the fiscal year is also a fair and reasonable method.
[80] This method has been
recognized as acceptable not only in Bay Ferries, but also in Gamache v. The Queen, 2003 FCA
254, 2003 G.T.C. 1542, [2003] G.S.T.C. 9.
[81] The case law clearly gives taxpayers some leeway
in choosing the allocation method; in the instant case, the surface‑area
method was fair and reasonable. The appropriate finding is that the method
chosen by the MRC was fair and reasonable, and therefore acceptable. When both
methods are fair and reasonable, one must not substitute the Minister's method
for the method chosen by the MRC.
[82] Based on the allocation method chosen by the
appellant, namely, the surface‑area method, 64% of the activities are
attributable to composting (and thus to the commercial activity) and 36% are
attributable to the incineration system (and thus to the exempt activity).
[83] The balance of the expenses after excluding from
the calculation direct costs attributable to the incineration system (namely,
those incurred for the Pyrox contract worth $2,877,282) can be broken down as
follows:
(a) Current expenses (see Tab 16 of Exhibit A-1 –
list of documents)
|
Year
|
ITC claimed
|
ITR claimed
|
|
1994
|
$2,683.58
|
$2,597.46
|
|
1995
|
$2,367.11
|
$3,021.27
|
|
1996
|
$3,225.53
|
$4,262.10
|
|
1997
|
$2,623.73
|
$6,082.15
|
(b) Allocable expenses related to the building
|
Contractor
|
Contract
number
|
Expenses
(including taxes)
|
|
SNC Lavalin
inc.
|
4096-0000
|
$1,063,943.51
|
|
Les Industries
Pyrox
|
4096-0003
|
$118,997.00
|
|
Construction Beauce-Iles
inc.
|
4096-0004
|
$1,780,942.46
|
|
Koné-Landel
Canada inc.
|
4096-003
|
$109,348.00
|
|
Industries
Machinex inc.
|
4096-0003
|
$236,255.00
|
|
Industries
Machinex inc.
|
4096
|
$35,438.49
|
|
A.M.I.
Mécanique
|
4096-0005
|
$951,688.99
|
|
Total:
|
|
$4,296,613.45
|
[84] The following provisions apply to these expenses:
Section 123 of the ETA
“public service body” means
a non-profit organization, a charity, a municipality, a
school authority, a hospital authority, a public college or a university;
Section 209 of the ETA
209. (1) Real property of
certain public service bodies -- If a registrant
(other than a financial institution or a government) is a public service body,
section 141.2 and subsections 199(2) to (4) and 200(2) and (3) apply, with any
modifications that the circumstances require, to real property acquired by the
registrant for use as capital property of the registrant or, in the case of
subsection 199(4), to improvements to real property that is capital property of
the registrant, as if the real property were personal property.
. . .
Section 199 of the ETA
. . .
(2) Acquisition of capital personal
property -- Where a
registrant acquires or imports personal property or brings it into a
participating province for use as capital property,
(a) the tax payable by the
registrant in respect of the acquisition, importation or bringing in of the
property shall not be included in determining an input tax credit of the
registrant for any reporting period unless the property was acquired, imported
or brought in, as the case may be, for use primarily in
commercial activities of the registrant; and
(b) where the registrant
acquires, imports or brings in the property for use primarily in
commercial activities of the registrant, the registrant is deemed,
for the purposes of this Part, to have acquired, imported or brought in the
property, as the case may be, for use exclusively in commercial
activities of the registrant.
(3)
Beginning use of personal property -- For the purposes of this Part, where a
registrant last acquired or imported personal property for use as capital
property of the registrant but not for use primarily in commercial activities
of the registrant and the registrant begins, at a particular time, to use the
property as capital property primarily in commercial activities of the
registrant, except where the registrant becomes a registrant at the particular
time, the registrant shall be deemed
(a) to have received, at the
particular time, a supply of the property by way of sale; and
(b) except where the supply is
an exempt supply, to have paid, at the particular time, tax in respect of the
supply equal to the basic tax content of the property at the particular time.
(4)
Improvement to capital personal property -- Where a registrant acquires, imports or
brings into a participating province an improvement to personal property that
is capital property of the registrant, tax payable by the registrant in respect
of the acquisition, importation or bringing in shall not be included in determining
an input tax credit of the registrant unless, at the time that tax becomes
payable or is paid without having become payable, the capital property is used
primarily in commercial activities of the registrant.
. . .
[Emphasis added.]
[85] Given the definitions in sections 123 and 199 of
the Act, any municipality may claim ITCs in respect of real property that it
acquired or imported for use as capital property primarily in its
commercial activities, for, in such a case, the property is deemed to have been
acquired or imported by the registrant for use exclusively in its
commercial activities.
[86] Consequently, since more than 50%
(according to the method chosen by the appellant) of the real property is used
for commercial purposes, the MRC is entitled to all the ITCs claimed for the
building, except, of course, the ITCs related to the Pyrox contract, which are
not included in the calculation of the ITCs.
[87] Since composting was a commercial activity for the
MRC during the period in issue, the MRC made both taxable and exempt supplies:
the activities related to composting were taxable supplies and the activities
related to the incineration system were exempt supplies.
[88] Direct costs related to the incinerator do not
give entitlement to ITCs. In particular, with regard to call for tenders no.
4096-0002, the contract of $2,877,282, including taxes, awarded to
Les Industries Pyrox Inc. for the supply, installation and start-up of a
waste incineration and gas purification system cannot give entitlement to the
ITCs claimed, because those inputs can be directly tied to the exempt supply of
the incinerator. This amount must be excluded from the calculation when the
allocation method is applied.
[89] As for the remaining costs related to the construction
of the plant, they are inputs used for mixed activities. Since I have found
that the appellant's chosen allocation method, which is based on surface area,
is fair and reasonable under the circumstances, the ITCs can be claimed.
[90] For all these reasons, the appeal is allowed in
part, with costs to the appellant. The appellant is entitled to all the ITCs
claimed, except those related to the Pyrox incinerator construction
contract.
Signed at Ottawa, Canada, this 12th day of April
2006.
Tardif J.
on this 31st day
of January 2008.
Erich Klein,
Revisor
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