Citation: 2004TCC663
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Date: 20041001
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Docket: 2003-87(GST)G
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BETWEEN:
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BAY FERRIES LIMITED,
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Appellant,
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and
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HER MAJESTY THE QUEEN,
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Respondent.
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REASONS FOR JUDGMENT
(Edited from the transcript of Reasons for Judgment
delivered orally August 13, 2004 at Charlottetown,
Prince Edward Island)
Campbell, J.
[1] The Appellant was initially
assessed under the Excise Tax Act (the
"Act") for the period April 1, 1997 to
May 31, 1998, and for the period June 1, 1998 to December 31,
2000 by notices of assessment, dated October 21, 1999 and
March 29, 2001 respectively.
[2] These initial assessments were
both reaffirmed on September 23, 2002.
[3] The effect of these assessments
and reassessments was that the Appellant was not permitted to
claim input tax credits (ITCs) in respect to tax paid on certain
expenses relating to the Appellant's business of ferry
services.
[4] The issue in this case is whether
the method chosen by the Appellant to apportion ITCs, between
taxable supplies and exempt supplies was fair and reasonable and
used consistently throughout the relevant periods pursuant to
subsection 141.01(5) of the Act.
[5] The Appellant used the input
method to allocate ITCs between its taxable and exempt supplies.
The Minister disagreed and applied the output method, as the more
appropriate allocation method on the basis that the input method
was not fair and reasonable in the circumstances. Consequently,
the Minister determined that all or substantially all of the
Appellant's expenses were incurred in the supply of ferry
services, an exempt supply, and not in the course of a commercial
activity. Therefore, the Appellant was not permitted to claim
ITCs in respect to tax paid on those expenses pursuant to
subsection 169(1).
[6] It is a question of fact whether a
particular allocation method chosen by a registrant will be fair
and reasonable.
[7] The Appellant called two
witnesses: Gordon MacRae, Vice-President of Corporate Services
for Bay Ferries and Craig Bradley, Chartered Accountant.
[8] There were no witnesses called by
the Respondent.
[9] The Appellant operates two
passenger ferry services in the Maritime region. The Catamaran
vessel connects Yarmouth, Nova Scotia and Bar Harbour, Maine.
Because this ferry service is considered an international service
between Canada and the United States it maintains a zero rated
status, where passenger revenue is zero percent taxable, as per
the legislation. As a result, the Appellant is entitled to 100
percent of the ITCs.
[10] The "MV Princess of Acadia"
vessel offers the second service, which operates between Digby,
Nova Scotia and Saint John, New Brunswick. This appeal centres
around this second ferry service between Digby and Saint
John.
[11] Passenger revenue on tolls paid for
this ferry service is exempt. The problem arises because, in
addition to the vessel and passenger revenue for ferry services,
the Appellant leases space on board the vessel, so that food
services can be offered to its passengers.
[12] This results in two sources of revenue
from commercial activities - rental revenue and vending machine
revenue. The commercial rent is received for rental of space to
arm's length parties for a gift shop, cafeteria, bar and
lounge, news stand, washrooms, plus video area.
[13] The Appellant charges HST on the
commercial rent revenue.
[14] Gordon MacRae testified that it was
simply more economically feasible to lease the space and let
others provide the services to the passengers. Because the
Appellant provided both taxable and exempt services on board this
vessel, it could not claim 100 percent of its ITCs. This meant
that the Appellant had to choose an appropriate method to
allocate the ITCs between its taxable and exempt supplies.
[15] The method chosen by the Appellant to
allocate the ITCs was based on square footage. Gordon MacRae
outlined the steps and procedures used by the Appellant in
choosing this allocation method.
[16] Exhibit A-1 provided a vessel profile
and deck plans for the "MV Princess of Acadia". Mr
MacRae gave evidence respecting the size of the bar area located
on the boat deck, the cafeteria and the seating lounge, the
latter two areas being located on the upper deck. Exhibit A-1
also contained diagrams and a breakdown of square footage figures
for the crew area, passenger area and vehicle deck area, as they
related to the engine room, the main deck, the boat deck, the
upper deck and the navigational bridge deck.
[17] Mr. MacRae testified that the main deck
was used to park vehicles during the crossing. The boat deck had
a dedicated area for the crew plus the bar, lounge area and
washrooms were located here. The upper deck housed the retail
shops and cafeteria.
[18] Mr. MacRae referenced the passenger
area to the bar, washrooms and outside deck, on the boat deck
level, and to the cafeteria and other retail shop area on the
upper deck level. On cross-examination he testified that there
was no other area for the passengers to go, other than the areas
that he had identified.
[19] According to Exhibit A-1 the total
square footage of the vessel as calculated by the Appellant is
51,417.8 square feet, and the total passenger area is 15,534.5
square feet. Mr. MacRae stated that they then calculated the
percentage of passenger area to the total vessel area as 30.29
percent. He went on to provide a more detailed and specific
breakdown of the square footage figures for the different areas,
such as the bar, ladies and men's washrooms, baby change
area, gift shop, reception, tourist information area, lounge and
cafeteria.
[20] Based therefore on the square footage
of areas rented to the arm's length party (which operated the
bar, the cafeteria and so forth) compared to the total square
footage of the vessel and then considering the areas that would
be applicable to both types of activities or services, the
Appellant concluded that 30.29 percent of the total square
footage related to taxable services.
[21] However, when they prepared the GST/HST
returns, the Appellant reduced the actual 30.29 percent to 25
percent, because according to Mr. MacRae the Appellant gave
recognition to the fact that crew members as well as passengers
were able to use and access hallways and other common areas on
the vessel, that would be included in the 30.29 percent. He
testified that the Appellant felt this to be a reasonable
reduction and that the 25 percent figure represented a fair and
reasonable percentage for claiming ITCs in respect of taxable
services.
[22] The Minister contends that the
commercial rents and vending machine revenues comprise no more
than 1.2 percent of the Appellant's total revenue. In excess
of 90 percent of the expenses incurred by the Appellant relate to
services for the supply of ferrying vehicles and passengers and
do not relate to the earning of commercial rents or vending
machine revenues.
[23] In response to these assumptions, Mr.
MacRae testified that because the duration of this crossing is
approximately three hours, the provision of these services for
its passengers is an essential service.
[24] He was not aware of any other similar
ferry service which did not provide food and beverage services.
When asked about potential consequences for termination of these
on board services, Mr. MacRae stated that termination would
almost guarantee a substantial decline in traffic. Many
commercial vehicles utilize their service and want access to
meals. As well, all traffic has the option of driving between
these points rather than using the ferry.
[25] Because of the possibility of lost
revenue, Mr. MacRae stated that Bay Ferries would want to provide
this service even if the company, itself, had to operate this
service at a moderate loss.
[26] He explained that it was industry
standards that, where the food service is not supplied by the
owner of the ferry business, rent is charged based on a
percentage of sales and not square footage. He also disagreed
that 90 percent of expenses related solely to the ferry services
alone. In the example provided to the Court, he explained that in
respect to fuel consumption it is not only used in propulsion of
the ferry, but also for heat and electricity, which is part of
passenger comfort. Therefore, this expense becomes part of those
expenses incurred in providing services to and for the
passengers.
[27] For safety reasons passengers must
leave their vehicle during the crossing and remain upstairs in
the vessel, even if food services are not available. In addition,
in busy times the designated passenger areas for food services
are not sufficient to handle the number of people and the
overflow go to the lounge area.
[28] The second witness, Craig Bradley,
reviewed the basis of the Appellant's objection.
[29] He went on to explain why the Appellant
chose the input method for allocating expenses between commercial
activities that are taxable and exempt services. It was his
opinion that the input method used by the Appellant was fair and
reasonable and had been used consistently throughout. He stated
that the input method is the most consistent in the
circumstances, because calculation of square footage will never
change unless the Appellant renovates.
[30] On cross-examination, he testified that
he had seen copies of the leases respecting the food services
area on board the ferry but because he had not reviewed them in
detail, he could not be specific as to exactly what areas were
leased. The square footage figures were calculated and provided
to him by the Appellant.
[31] Subsection 169(1) of the Act
sets out the general rule for the calculation of ITCs, as
follows:
(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.
[32] In simplified terms, if a registrant
supplies only taxable services that registrant will be entitled
to all of the ITCs. If only exempt supplies are made, there will
be no entitlement to ITCs.
[33] Allocation problems occur when a
registrant's business is a mixed supply of taxable and exempt
activities. Here the Minister took issue with the input method
chosen and applied by the Appellant.
[34] The input method is based on usage of
the vessel by square footage calculations with 25 percent
being claimed by the Appellant for ITCs in respect to taxable
services.
[35] The Minister argues that this is not
fair and reasonable, and that the more appropriate allocation
method would be the output method based on revenue. The
Minister's argument is that the food and beverage services
were incidental to the main focus of the business operations,
which is to ferry vehicles and passengers. Based on the output
method, less than 10 percent of revenue would be generated from
taxable supplies and therefore all or substantially all of the
expenses were utilized in non-commercial activities. This method
would deny a claim for ITCs.
[36] The key phrase here is "fair and
reasonable", which comes directly from the wording in
subsection 141.01(5), which states:
(5) 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.
The only issue for determination is whether the method elected
by the Appellant is fair and reasonable pursuant to this
provision.
[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.
[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.
[44] If the Appellant decided to operate
these services itself rather than lease the space, it could use
the same square footage calculations which provides a more
consistent approach in the long run.
[45] I accept that the Appellant's
approach, which focuses on space, is fair, reasonable and
consistent. The uncontradicted evidence of the Appellant's
witnesses established a precise square footage formula which was
fair and reasonable. This formula provided consistency from year
to year, and could be applied whether the Appellant leased the
space to someone to operate the food services or decided to
provide the services itself.
[46] According to the Magog case, an
allocation method should not distort the financial reality of the
commercial activity. It is true the revenue received from the
leasing of this space is a small fraction of the Appellant's
total revenue, but the evidence clearly supports the fact that it
is essential that the Appellant provide a food and beverage
service to retain its volume of passengers. Bay Ferries must be
competitive as travellers have alternative options.
[47] If the Appellant decided to provide the
food services itself, ITCs can be claimed. The Appellant made a
business choice to leave the space to others who would provide
these services to its passengers, one that it felt was
appropriate in the circumstances.
[48] The Appellant is free to structure its
business activities in a manner that it feels appropriate to its
circumstances, provided it does not run afoul of the provisions
of the Act or some rule of law.
[49] As part of this structuring it obtained
professional accounting advice, chose the method to allocate its
expenses between its taxable and exempt supplies and completed
extensive square footage calculations to support its final figure
of 30.29 percent, which was reduced to 25 percent to reflect
common area spaces. This is a logical, practical and sound
approach to picking a method, particularly if it had chosen to
operate the service itself at some point in the future. It is
fair, reasonable and provides the consistency if Bay Ferries do
decide to operate the services, rather than lease the space.
Business environments are constantly changing and the Appellant,
if it changes its approach due to changing circumstances, will be
able to continue the method.
[50] The Minister has argued that the input
method might well be acceptable, if there was more evidence as to
the exact square footage that was actually leased and used
exclusively for taxable services.
[51] The bar and restaurant areas are
available to non-patrons for seating, and the Minister argues
that the capacity of the vessel (approximately 620 people)
compared to the seating lounge capacity of 244 people,
contemplates that passengers will use all areas of the vessel
regardless whether they buy food or beverages.
[52] Although the Appellant's
accountant, Mr. Bradley, did not have personal knowledge of
the exact lease measurements, Gordon MacRae did, and I
accept his evidence as straightforward and uncontradicted. In
fact, if I take the total square footage calculated as passenger
area, that is 15,534.5 square feet and subtract the passenger
seating area (the lounge), that is, 4,257 square feet, I am still
left with the balance of square footage in excess of 11,000
square feet.
[53] So, even if I delete the area where
passengers may be seated, without utilizing the food services
area, the remaining square footage of some 11,000 square
feet, comprising the bar, restaurant, gift shop, etc., is still
in compliance with subsection 141(3) where CCRA
administratively can apply a 10 percent rule. Where it
appears that substantially all of the use of a property or
service is in the course of a non-commercial activity, then all
of the use will be deemed to be in the course of those
non-commercial activities.
[54] In addition, there may be overlapping
between the actual dedicated leased space for services and the
passengers' seating area. Mr. MacRae noted that during
busy times passengers may take their meals to the seating area,
because there was no seating left in the cafeteria or lounge
area.
[55] When the direct method of allocation
cannot be used, as it could not be here, the remaining methods
will not provide an exact science for the necessary computations
and, in fact, the output method is ranked below the input method
in respect to better choices.
[56] The input method here is fair and
reasonable, and appears to be practical under the circumstances,
according to the facts as presented before me.
[57] Because I have concluded that this
method is fair and reasonable and therefore acceptable, I do not
have to decide if the Minister's choice would be a better
method in the circumstances.
[58] The appeal is therefore allowed with
costs, and referred back to the Minister for reconsideration and
reassessment on the basis that the Appellant is entitled to claim
the ITCs in respect to the periods in question.
Signed at Ottawa, Canada this 1st day of October 2004.
Campbell J.