Please note that the following document, although correct at the time of issue, may not represent the current position of the Canada Revenue Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence du revenu du Canada.
Excise and GST/HST Rulings Directorate
11th Floor, Place de Ville, Tower A
Ottawa ON K1A 0L5
[Addressee]
Case Number: 194307
[Dear Client]:
Subject: [GST/HST INTERPRETATION]
Eligibility for ITCs […] [by the Financial Institution] on inputs used by […][the subcontractors]
Thank you for your [correspondence] regarding the eligibility of […] ([…][the Financial Institution]) to claim input tax credits (ITCs) on property and services acquired for use, in part, by […][the subcontractors]. We apologize for the delay in our response.
All legislative references are to the (Excise Tax Act) ETA unless otherwise specified.
[STATEMENT OF FACTS]:
We understand that […][the Financial Institution] is […], a listed financial institution, and a GST/HST registrant. It sells its financial products through […][the subcontractors] who are not employees of [the Financial Institution], as well as through […] its employees. It enters into two written agreements with [the subcontractors]: […][a Service Agreement ] and […][an Equipment Agreement ].
The relevant provisions of […][the Service Agreement] include:
[…]
[…][The subcontractor] is appointed by [the Financial Institution] to carry on the business of representing [the Financial Institution] in distributing [the Financial Institution]’s products.
[…]
[The Financial Institution] agrees to provide certain property to [the subcontractor] […]. [The Financial Institution] may charge a reasonable fee for this property […].
[…]
The relevant provisions of […][the Equipment Agreement] include:
[The Financial Institution] agrees to provide [the subcontractor] with access to [the Financial Institution]’s on-line computer data and computer networks and will lease (or sublease) computer, office and other equipment to [the subcontractor], and [the subcontractor] agrees to pay for this.
[…]
The amount [the Financial Institution] charged to [the subcontractors] for computer equipment, software and network services (the technology package) provided under [the Equipment Agreement] for each year was determined in accordance with its costing model, which resulted in its charging [the subcontractors] approximately […]% of the amount determined as the actual cost of […] the technology package.
The ITCs […] are for computer equipment, software, and network services (technology inputs) that are used by […][subcontractors] and employees. […]
It is our understanding that originally, when [the Financial Institution] filed its GST/HST returns for its fiscal years […][year 1, year 2 and year 3], it claimed ITCs related to the technology inputs based on the amount of GST/HST it collected from [the subcontractors] on its “resupply” of those inputs, […].
[The Financial Institution] filed for additional ITCs for the technology inputs it acquired in […][year 1, year 2 and year 3] when it filed the return for its fiscal year […][year 4]. […].
[The Financial Institution] based its claim for these additional ITCs on a [new ITC allocation method] […]
This new method has resulted in ITC claims for the technology inputs which are significantly larger than the amount of GST/HST collected by [the Financial Institution] on its supplies of these inputs […]
We understand that [the Financial Institution] is not a qualifying institution for purposes of section 141.02.
[INTERPRETATIONS REQUESTED]
1. Is [the Financial Institution] eligible to claim the additional ITCs on the technology inputs for its fiscal years […][year 2 and year 3] based on its new ITC allocation method?
2. Is [the Financial Institution] eligible to claim ITCs on the technology inputs for its fiscal years […][year 4 to year 6] based on its new ITC allocation method?
3. Is the supply of the technology package [made under the Equipment Agreement by the Financial Institution] to [the subcontractors] an arm’s length transaction?
[INTERPRETATIONS GIVEN]
1. Generally, the provisions of subsection 141.02(17) will apply to prevent [the Financial Institution] from altering its ITC allocation method for the technology inputs for the fiscal years […] [year 2 and year 3]. […]. See the section of our analysis below entitled, “Retroactive ITC claims ([…] [year 2 and year 3] additional ITCs)” for further explanation.
2. Based on the information provided, it appears that the new ITC allocation method of [the Financial Institution] does not meet the provisions of section 141.02, and specifically, does not conform to the criteria, rules, terms and conditions specified by the Minister, and may not be used for the technology inputs for the fiscal years […] [year 4 to year 6]. See the section of our analysis below entitled, “Use of new ITC allocation method for […] [year 4 to year 6]” for further explanation.
3. […]. See the section of our analysis below entitled, “Consideration of arm’s length and fair market value” for further explanation.
[EXPLANATION]
Section 169 generally allows an ITC on a property or a service to the extent that the property or service is acquired for consumption, use or supply in the course of the person’s commercial activities where all of the other conditions for claiming an ITC are met.
Under subsection 141.01(2), the extent to which a property or service is considered to be acquired for consumption or use in a person’s commercial activities is generally based on the extent to which the property or service is acquired by the person for making taxable supplies for consideration.
Section 141.02 applies in determining the extent under subsection 141.01(2) to which property or a service is acquired by a financial institution for consumption or use in making taxable supplies for consideration or otherwise and includes provisions that apply to financial institutions that are not qualifying institutions […].
Retroactive ITC claims ([…] [year 2 and year 3] additional ITCs):
Under subsection 141.02(16), any method that [the Financial Institution], as a non-qualifying institution, is required under any of subsections 141.02(10) to (15) to use for a fiscal year must be (subject to subsection (17)), fair and reasonable, used consistently by the financial institution throughout the fiscal year, and be determined by [the Financial Institution] no later than the day on or before which [the Financial Institution] is required to file a return under Division V for the first reporting period in the fiscal year.
Furthermore, under subsection 141.02(17), after that same date, [the Financial Institution] cannot alter or substitute a method used by [the Financial Institution] for that fiscal year under any of subsections 141.02(10) to (15) with another method without the Minister’s written consent.
Further, it is clear that the intention of the legislation is not to allow a retroactive ITC claim by a financial institution – according to the Department of Finance explanatory notes for subsection 141.02(17), “This rule is consistent with the policy intent underlying subsection 141.01(5) and existing practice that a person, once it has used a method in a year for the purposes of that subsection, cannot subsequently or retroactively alter that method in respect of that year without the consent of the Minister”.
[…].
Based on the facts provided, our understanding is that [the Financial Institution]’s original method was to pool an estimate of the technology inputs used, in part, in making supplies to […][subcontractors], and then to claim an amount of ITCs with respect to those inputs that was equal to the consideration it charged [the subcontractors] for its supplies of those property and services.
According to the documentation provided, [Financial Institution]’s new method , generally speaking, involves […].
Therefore, the facts show that there is a change in methodology for claiming ITCs on the technology inputs, […], and this was done without the consent of the Minister, past the deadline provided in subsection 141.02(17). Consequently, the provisions of subsection 141.02(17) will apply to the additional ITCs for [year 2 and year 3].
Use of new ITC allocation method for […] [year 4 to year 6]:
Categorizing inputs of [the Financial Institution]:
According to section 141.02, [the Financial Institution] must first categorize its inputs (whether excluded, exclusive, non-attributable or direct) and then apply the appropriate ITC allocation method set out in that section. We understand from the information provided that none of the technology inputs […] are excluded inputs (that is, they are not for use as capital property, or as an improvement to capital property, by [the Financial Institution]) as defined by subsection 141.02(1).
Under subsection 141.02(1), an exclusive input of [the Financial Institution] would include a property or a service (other than an excluded input) that is acquired, imported or brought into a participating province by [the Financial Institution] for consumption or use directly and exclusively for the purpose of making taxable supplies for consideration or directly and exclusively for purposes other than making taxable supplies for consideration. It should be noted that in the case of a financial institution[…] , exclusive means all (100%). We understand from the information provided that none of the technology inputs […] are exclusive inputs, because they are each acquired less than exclusively for one purpose – they are acquired, in part, to make supplies to [the subcontractors], and in part for [the Financial Institution]’s own use.
A non-attributable input of [the Financial Institution] is a property or service that is not an excluded or exclusive input, and cannot be attributed to the making of any particular supply by [the Financial Institution]. It does not appear that any of the technology inputs in question could be characterized as non-attributable inputs, as each of the inputs can be attributed to the making of particular supplies.
A direct input is defined in subsection 141.02(1) as a property or a service that is not an excluded input, an exclusive input, or a non-attributable input. Generally, a direct input of [the Financial Institution] is property or a service that is:
* neither capital property of [the Financial Institution] nor acquired for use as an improvement to capital property of [the Financial Institution];
* not acquired, imported or brought into a participating province by [the Financial Institution] for consumption or use directly and exclusively for purposes of making taxable supplies for consideration or otherwise; and
* can be attributed in whole or in part to the making of a particular supply or supplies by [the Financial Institution].
It appears that the technology inputs [...] are direct inputs of [the Financial Institution], because they are not excluded or exclusive inputs, and may be attributed to the making of particular supplies - the supply of the technology package to [the subcontractors] and supplies of financial services related to [the Financial Institution]’s products.
Once [the Financial Institution] has categorized its inputs, it must apply the appropriate ITC allocation method set out in section 141.02 for each input.
Allocation of direct inputs:
As [the Financial Institution] has not made an election under subsection 141.02(9), under subsection 141.02(12), [the Financial Institution] must use a direct attribution method to determine, for each particular fiscal year, the operative and procurative extent of each direct input. The procurative extent is the extent to which the input is acquired for the purpose of making taxable supplies for consideration or the extent to which it is acquired for purposes other than making taxable supplies for consideration. The operative extent is the extent to which the consumption or use of the input is for the purpose of making taxable supplies for consideration or the extent to which the consumption or use is for purposes other than making taxable supplies for consideration.
Criteria, rules, terms and conditions:
In determining its ITC eligibility for […] [year 4] and subsequent years, [the Financial Institution] must use direct attribution methods that determine the procurative extent or the operative extent of each direct input in the most direct manner and that conform to the criteria, rules, terms and conditions specified by the Minister […] in GST/HST Technical Information Bulletin, B-106, ITC Allocation Methods for Financial Institutions for Section 141.02 (B-106). [Effective July 2021, GST/HST Memorandum 17-12 Input Tax Credit Allocation Methods for Financial Institutions for Purposes of Section 141.02 cancels and replaces B-106.]
In order to conform to […][the criteria, rules, terms and conditions specified by the Minister], an ITC allocation method must employ an objective measure of use which is meaningful, unbiased and verifiable, and be applied in a manner that accurately reflects the use of the particular business input in the making of the supplies to which the input can be attributed. The method must providing comparable results and use cost pools only if they are appropriate cost pools.
Further, where a financial institution whose core business is making exempt supplies of financial services consumes or uses a business input for the purpose of making taxable supplies, the ITC allocation method chosen for that input should reflect the fact that the taxable supplies are being made as part of the financial institution’s core business.
The […] technology inputs are used by [the Financial Institution] to make both taxable supplies of the technology package (equipment, software, and network access) [under the Equipment Agreement] […][to the subcontractors], and to make exempt supplies […][of financial products]. Therefore, in order to meet [the criteria, rules, terms and conditions specified by the Minister], any ITC allocation method used by [the Financial Institution] for any of the technology inputs must properly reflect both of these uses. Further, as the acquisition of the technology inputs was in the context of [the Financial Institution]’s business of making exempt supplies of financial services, any ITC allocation method used must reflect the way [the Financial Institution] conducts its […] business generally.
That is, a direct attribution method must reflect the fact that the taxable supplies to [the subcontractors] are related to the financial institution’s core business; that [the Financial Institution] is providing the technology inputs to [the subcontractor] only so that [the subcontractor] can sell [the Financial Institution]’s products.
[…]
[…]. It could be argued that [the Financial Institution] recognized that a portion of the technology package provided to [subcontractors] was related to its own business when it agreed to share the costs with [the subcontractors] instead of fully billing [the subcontractors] for the cost of the technology inputs. [The Financial Institution] would only incur such a loss on a continuing basis if its real purpose in acquiring the technology inputs was not to earn revenue from supplying the technology package but to earn revenue from the sale of its financial products that must be sold using the technology inputs. Therefore, an ITC allocation method that considers the use by […][subcontractors or employees] to be the only use of a technology input is not comprehensive, does not reflect all of the uses of the input, and does not meet [the criteria, rules, terms and conditions specified by the Minister].
[…]
Tracking:
According to [the criteria, rules, terms and conditions specified by the Minister], in order for a method to be meaningful, tracking should be used where possible. Further, the most direct method would be a method that tracks the use of the input; therefore tracking must be used in a direct attribution method to the extent that it can be used. Tracking is recording to the extent possible the actual use of a particular input so that the actual use is linked to the purpose of making taxable supplies for consideration and to purposes other than making taxable supplies for consideration.
[…]
As it does not appear that [the Financial Institution] used tracking where it could be used, the method does not allocate in the most direct manner and is not meaningful. Therefore, it does not provide an accurate reflection of the use of the technology inputs, and the method does not meet [the criteria, rules, terms and conditions specified by the Minister] and may not be used.
Where tracking does not fully reflect the use of the input, […][the criteria, rules, terms and conditions specified by the Minister state] that another allocation must be used along with the tracking in a direct attribution method. In this case, another allocation may need to be used to determine the extent the technology inputs are acquired for [the Financial Institution]’s own use, versus the extent they are acquired for use in providing supplies to [subcontractors]. A more qualitative approach may need to be employed to reflect the fact that the principal purpose of [the Financial Institution] in acquiring the technology inputs was the furtherance of its […][sales of financial products] and that acquisition was carried out in connection with the business of making exempt supplies of financial services. […].
Causal allocation:
[…]. […], when using causal allocation, the allocation base must provide a reasonable approximation of the use or intended use of a business input and such approximation must be as direct as possible in the circumstances. The new method […] does not appear to be the most direct method.
[…]
Cost pools:
In addition, [the Financial Institution]’s new method does not provide an accurate reflection of the use of the inputs because of the use of inappropriate cost pools. [The Financial Institution] pools [certain inputs] together, and then uses the same method to allocate between the use by [subcontractors] and employees for [other inputs]. However, the extent of the use by [the Financial Institution] of each of these inputs appears to be different.[…]
Consideration of arm’s length and fair market value:
[…]. As the amount charged by the [Financial Institution] to the [subcontractors] for the technology package [is approximately [percentage…]% of the cost paid by the [Financial Institution] for the technology inputs, it is important to consider if they are dealing at arm’s length, and whether the consideration charged to [subcontractors] is at FMV.
Subsection 126(1) provides that for GST/HST purposes, related persons are deemed not to deal with each other at arm’s length and it is a question of fact whether persons not related to each other were, at any particular time, dealing with each other at arm’s length.
[…]
The FMV for the technology inputs may be best determined by considering the amount [the Financial Institution] is paying its suppliers for those same technology inputs. It is our understanding that [the Financial Institution] is dealing at arm’s length from its suppliers, and that both [the Financial Institution] and a supplier are knowledgeable, informed and prudent parties acting at arm’s length without a compulsion to transact. The amount charged by a supplier as consideration is reflective of an ordinary commercial dealing between parties acting in separate interests. […]. Furthermore, it is our understanding that there can only be one FMV of a particular property or service at a particular time, and it will be reflective of the highest price between parties acting at arm’s length. The facts provide that this highest price is the amount the supplier charges [the Financial Institution].
Although the failure to charge FMV may not by itself preclude an ITC of a supplier, pursuant to subsection 155(1), where a supply of a property or a service is made between persons not dealing with each other at arm’s length for consideration less than the FMV of the property and service at the time the supply is made, and the recipient is not a registrant who is acquiring the property or service for consumption, use or supply in its commercial activities, the value of the consideration is deemed to be equal to the FMV of the property or service at that time.
Therefore, if [the Financial Institution] and its [subcontractors] are not dealing at arm’s length in the supply of the technology package], it should be considered whether subsection 155(1) may apply to deem [the Financial Institution]’s supply, for GST/HST purposes, to be at FMV, such that it was required to collect GST/HST on the supply based on the FMV.
[In accordance with the qualifications and guidelines set out in GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service, the interpretation(s) given in this letter, including any additional information, is not a ruling and does not bind the Canada Revenue Agency (CRA) with respect to a particular situation. Future changes to the ETA, regulations, or the CRA’s interpretative policy could affect the interpretation(s) or the additional information provided herein.]
If you have further questions or require clarification on the above information, please contact me at 780-495-7507.
Yours Truly,
Eleanor Struth
Industry Sector Specialist
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate
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