Magog (Town) v. The Queen, docket 97-2797-GST-G

Date: 19991118

Docket: 97-2797-GST-G

BETWEEN:

VILLE DE MAGOG,

Appellant,

and

HER MAJESTY THE QUEEN,

Respondent.

Reasons for Judgment

Lamarre Proulx, J.T.C.C.

[1] This is an appeal from an assessment for the period from May 1, 1991 to December 31, 1994. The appeal concerns the application of subsections 169(1) and 141.01(5) of the Excise Tax Act (the "Act").

[2] Subsection 169(1) of the Act deals with input tax credits. Subsection 141.01(5) of the Act states that only fair and reasonable methods used consistently throughout a fiscal year may be used to determine the extent to which properties or services were acquired or used for the purpose of making taxable supplies or for other purposes.

[3] The appellant is a municipality which elected under Part V of the Streamlined Accounting (GST) Regulations (the "Regulations") to determine its net tax in accordance with that part. Under subsection 21(2) of the Regulations, a municipality which, in addition to providing the usual municipal services, operates an electricity service shall make a separate calculation for that service in computing its net tax, in the manner specified in that subsection. The appellant is such a municipality.

[4] Subsection 141.01(5) of the Act and subsection 21(2) of the Regulations read as follows:

141.01(5) The methods used by a person in a fiscal year to determine

(a) the extent to which properties or services are acquired or imported by the person for the purpose of making taxable supplies 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 or for other purposes,

shall be fair and reasonable and shall be used consistently by the person throughout the year.

21(2) Where a registrant carries on the business of supplying telephone services, electricity or natural gas in a separate division or department of the registrant and an election by the registrant to determine the net tax of the registrant in accordance with this Part is in effect during a particular reporting period of the registrant, the net tax of the registrant for the particular reporting period is equal to the positive or negative amount determined by the formula

A + B

where

A is the amount that would be the net tax of the registrant for the particular reporting period determined under subsection (1) if the registrant did not carry on the business and all property and services acquired or imported by the registrant otherwise than primarily for consumption, use or supply in the course of carrying on the business were the only property and services acquired or imported by the registrant; and

B is the amount that would be the net tax of the registrant for the particular reporting period determined in accordance with section 225 of the Act if the business were the only activity engaged in by the registrant and the property and services acquired or imported by the registrant primarily for consumption, use or supply in the course of the business were the only property and services acquired or imported by the registrant.

[5] The case concerns the fair and reasonable methods which the appellant may use to determine the extent to which properties and services were acquired or used to make the taxable supply in question (electricity services).

[6] Yves Gagnon, the appellant's director of finance and human resources and treasurer, and Réjean Leroux, a tax expert, testified at the request of counsel for the appellant. Yves Lacoste, an auditor with Revenu Québec, Hélène Boudreault, a section chief at Revenu Québec, and Marc-André Melançon, an auditor with Revenu Québec, testified at the request of counsel for the respondent.

[7] As Exhibit A-1, Yves Gagnon filed the computerized report on municipal expenditures for 1994. These expenditures are grouped under a number of operational headings including electricity. Other headings concern services provided for solely municipal purposes, namely: assessment, transportation, recreation and culture, parking, public safety, urban planning, water and sewers, and so on. Other municipal services are provided for mixed purposes, that is to say, for the purposes of the electricity service and for other services. The parties call these mixed-purpose services mixed activities. These activities appear at pages 9 to 15 of Exhibit A-1 and are therein referred to as Legislation, Law Enforcement, Financial and Administrative Management, Record Office, Personnel Management, Building Maintenance (Town Hall) and Communications.

[8] Réjean Leroux explained to the Court that, in the advice he gave the appellant, he was following Memorandum 700-5-1 which deals with input tax credit allocation for financial institutions.

[9] As both parties referred to this memorandum, which is for the use of financial institutions, I believe it would be useful to consider more closely a few paragraphs thereof. The fact that this memorandum was used does not mean that the municipality is a financial institution within the meaning of the Act. It is a public service body within the meaning of the Act. The memorandum was used as an example since there appears to be no other memoranda on the specific subject of the allocation of input tax credits in respect of taxes paid on expenditures incurred for mixed activities. Paragraph 19 of the memorandum states that the Act does not specify any methods that must be used to allocate property or services that have been acquired or imported for use in mixed activities. However, the memorandum does point out that the Act requires that the methods used be fair and reasonable in the circumstances and that they be used consistently throughout the year.

[10] According to the memorandum, the methods used should link the property or service on which the input tax was paid to the various activities. The method which allocates property and services directly to activities should yield the most accurate and equitable results. That is the direct allocation method. If this method cannot be used, the input-based method may be employed. In situations where neither of the aforementioned methods is appropriate, the output-based or income-based method may be used. The output-based method was not chosen by either the appellant or the respondent. There thus remains the direct allocation method, which was chosen by the respondent, except in respect of a certain class of expenditures, and the input-based method, which was chosen by the appellant.

[11] In an example given in the memorandum for the direct allocation method, office furniture, rent and maintenance are allocated on the basis of floor space or on time analysis of employees. Computer costs can be allocated on the basis of the time spent on an activity or on the number of transactions. Vehicle operating costs can be allocated on the basis of kilometers driven in the company vehicle that related to commercial and other activities.

[12] The memorandum states that the input-based method will be accepted if the directly allocated property and services represent a significant part of the registrant's overall property and services.

[13] The appellant prepared its input tax credit claim using the input-based method. Messrs. Gagnon and Leroux both contended that the direct allocation method could not be used because it did not permit an accurate determination of the extent to which the properties and services of the mixed activities had been acquired and used by the appellant for the electricity service and other services.

[14] The appellant calculated the total direct expenditures of the electricity service and the total expenditures of the municipal services excluding electricity and mixed activities. The first total divided by the second yields a percentage and the appellant used that percentage to allocate the inputs with respect to the mixed activities. Thus, as may be seen in Exhibit A-3, which is a worksheet of Mr. Leroux's for 1994, the direct expenditures of the power system amounted to $10,374,046. In the activities other than electricity and mixed activities, expenditures totalled $10,005,170. (These two classes of activities are described in paragraph 6 of these Reasons.) The resulting proportion is 50.9 percent. It is this percentage that was used to allocate the expenditures of the mixed activities to electricity. In the example given in the memorandum, the percentage used is that arrived at by dividing the expenses of one activity by total expenses for all activities. However, the calculation of the percentage is not at issue and it must be considered that if the input-based method is used, what counts is that the percentage can reasonably be defended.

[15] Yves Lacoste filed his audit report as Exhibit I-2 and various working documents as Exhibits I-1 and I-3 to I-9. He contended that the method used by the appellant, namely the purely input-based method, does not accurately represent the financial situation of the electricity activity. The example he gave appears at page 7 of his report: for 1994, 15.5, or 9.28 percent, of a total of 167.1 municipal employees were used directly by the power system. That is the percentage he used to allocate the total expenditures of the mixed activity called personnel management. The percentage used by the appellant, on the other hand, was 50.9 percent.

[16] At the time of his audit, the allocation method was not yet in dispute. It was not until his audit was completed that the auditor learned the appellant would be filing a tax claim based on the input method on the strength of the advice received from Mr. Leroux. So, at the time of his audit, Mr. Lacoste inquired of Mr. Gagnon as to the objects of the mixed activities. The allocation was made on the basis of those objects with the secretary-treasurer's consent. As may be seen on pages 7 and 8 of Exhibit I-2, the percentages used were so used with the agreement of the municipality's secretary-treasurer, Mr. Gagnon. The report was presented to him as is usually done and there is no documentary evidence of any dispute as to the objects of the mixed activities.

[17] The auditor used the input-based method for only one item, namely financial and administrative management appearing at page 9 of his report (Exhibit I-2). In his view, there were no matching criteria which would have made it possible to determine a direct allocation of these mixed expenses.

[18] Exhibit I-3 is the statement of revenue and expenditure for the electricity service. This is a budget document prepared by the appellant itself. It may be seen therein that, for 1994, total revenue was $13,850,699 and total expenses before apportionment and allocation were $11,614,031. The apportionment of $798,681 is described as the portion assigned to the municipality for energy consumption. The net allocations amount to $8,649. The document does not explain what this expression means. It may be taken to mean the allocation of the expenses of certain mixed activities. The excess of revenue over net expenditures, after apportionment and allocation, is $3,030,700. According to the appellant's reasoning, $5,000,000 should be added to expenditures, as shown in Exhibit A-3 (referred to above in paragraph 14 of these Reasons), thus creating a deficit of $2,000,000.

[19] Mr. Leroux says he relied on an agreement between the town of Jonquière and the Minister of National Revenue in recommending an allocation of mixed expenses using the input-based method. This agreement, filed as Exhibit A-4, consists of a letter from Mr. Leroux to Hélène Boudreault dated August 31, 1994, summarizing the discussions that took place at a meeting, and of Ms. Boudreault's written confirmation dated September 8, 1994.

[20] Hélène Boudreault gave testimony explaining the circumstances of the agreement. The agreement was reached without any audit of the books and records being conducted, based on explanations provided by Mr. Leroux and the treasurer of the town of Jonquière. The confirmation expressly stated that the agreement could not serve as a precedent and that each case would have to be considered individually.

[21] Mr. Leroux also mentioned a similar agreement with the town of Joliette. Marc-André Melançon testified, informing the Court that such was not the case. He filed a letter dated May 17, 1996 (Exhibit I-9) in which it is explained to Mr. Leroux that the method chosen must be verifiable in the sense that, based on the analysis of expenses, [TRANSLATION] "it is reasonable to believe that the chosen method corresponds to the actual situation and is attributable to the taxable activities". The cost allocation method must not produce results that distort the actual financial situation of the taxable activities of the electricity service and, using Mr. Leroux's method in the case of the town ofJoliette, one arrives at precisely such results: [TRANSLATION] "By allocating 54.07 percent of the mixed expenditures to the power system for 1993, we find we have a loss of nearly $800,000. An analysis of the system's profitability for the town of Joliette, which was provided to us by Richard Boucher, shows that revenue exceeded expenditures by $2.387 million during the same period."

[22] In the instant case, the use of the input-based method also leads to results that are far from reflecting the actual financial situation, as may be seen from the facts set out in paragraphs 14 and 17 of these Reasons respecting the allocation of personnel management costs and the analysis of the power system's profitability. As regards personnel management, the percentage used by the auditor seems, on the face of it, more reasonable than that used by the appellant. As to the profitability of the power system, the inclusion of the large amount of expenses for the mixed activities flagrantly contradicts the appellant's accounting analysis.

[23] In cross-examination, Mr. Lacoste was asked about the percentage he applied to certain expenses for the mixed activities. He stated that he had relied on the answers given him by the municipality's representative, namely the secretary-treasurer Mr. Gagnon. Following discussion, the percentage was determined with the secretary-treasurer's consent. It is incumbent upon municipal officials to provide the auditor with correct information. It is in fact up to those officials to establish the percentages of expenses based on objective criteria in accordance with the true factual situation.

[24] An organization such as a municipality wants to know the cost of its various services almost to the cent. It possesses all the necessary information to allocate expenses among its various activities. Consequently, it is not possible to have the cost of its services determined in the manner proposed by the appellant. A municipality must surely use a method which makes it possible to link objectively the expenses of mixed activities to the various activities.

[25] Fair and reasonable methods can only be those which most accurately reflect the actual financial situation of an activity. In this regard, I believe it is useful to draw as far as possible on Iacobucci J.'s remarks in Canderel Ltd. v. Canada, [1998] 1 S.C.R. 147, at pages 169 to 175, where he discusses the steps to be taken in order to create an accurate picture of a taxpayer's income for a particular period.

[26] In conclusion, the method proposed by the appellant produces distorted results which contradict its own data. That proposed by the respondent was arrived at in a painstaking fashion, following discussion with the appellant's representatives in authority; it was arrived at in accordance with logical, objective criteria and, I would go so far as to say, in keeping with the rules of plain common sense. It accurately reflects the financial situation of the electricity service and, in that sense, is the fair and reasonable method required by subsection 141.01(5) of the Act.

[27] The appeal is accordingly dismissed with costs.

Signed at Ottawa, Canada, this 18th day of November 1999.

[OFFICIAL ENGLISH TRANSLATION]

"Louise Lamarre Proulx"

J.T.C.C.