25 March 2021 CBA Commodity Taxes Roundtable, Q.19

Aco changes its use of a building, which had been used 100% in making exempt supplies, so that thereafter it is used 90% for making exempt supplies and 10% in the course of commercial activities. Two years later, it further changes the building’s use so that it commences to be used 80% for making exempt supplies and 20% for commercial use. Can Aco claim a 10% ITC pursuant to: (a) s. 206(2) in the first scenario; and (b) s. 206(3) in the second?

The questioner noted that s. 197 indicates that changes of “less than 10%” are not to be taken into account, suggesting that a change of 10% is to be recognized for purposes of the change in use rules. However, s. 141 is to the effect that a use of 90% (under the CRA administrative practice) for exempt uses is equivalent to 100% for exempt use. S. 141 suggests that in the first scenario, Aco could not claim an ITC of 10%, whereas in the second scenario it could claim an ITC of 20%.

CRA responded:

While a change in use of 10% or more is normally considered to be a significant change in use (i.e. because section 197 considers any change of less than 10% to be insignificant), section 141 nevertheless considers that the entire use of the capital property is not commercial activities. In practice, therefore, there is no change in use.

Therefore, with respect to a registrant that is not a financial institution, subsection 206(2) only applies where the registrant begins to use capital property in commercial activities to an extent greater than 10%.

Therefore, Aco cannot claim an ITC when it begins to use 10% of its capital property in its commercial activities.

However, CRA went on to note that if Aco instead was a financial institution (to which the s. 141 rules do not apply), the rules in s. 206(2) would apply to the reduction in exempt use from 100% to 90% (and s. 197 would not apply because the percentage of use of the capital property assigned to commercial purposes was 10%., being a significant change in use), so that Aco would be entitled to claim an ITC for some of the tax that is deemed to have been paid pursuant to s. 206(2).

Regarding the second scenario, CRA stated:

Assuming that Aco is not a financial institution, the additional 10% use of capital property in its commercial activities, in addition to the first 10% change in use in its commercial activities, results in a significant cumulative change in use, allowing subsection 206(2) of the ETA to apply. In effect, Aco has changed its use of capital property from 100%, to 80% for exempt purposes and 20% for commercial purposes. Aco is therefore entitled to claim an ITC for some of the tax that is deemed to have been paid pursuant to subsection 206(2).

If Aco were a financial institution, it would have already begun using the capital property in its commercial activities after the first 10% change in use in its commercial activities. Under subsection 206(3) of the ETA, Aco is deemed to have received a supply of 10% of the capital property for use exclusively in its commercial activities and, assuming the supply is not an exempt supply, is deemed to have paid tax in respect of the supply. Aco is then entitled to claim an ITC for the additional 10% increase in use of the capital property in its commercial activities.

Aco changes its use of a building, which had been used 100% in making exempt supplies, so that thereafter it is used 90% for making exempt supplies and 10% in the course of commercial activities. Two years later, the commercial use is further increased to 20%.

ETA s. 197 indicates that changes of “less than 10%” are not to be taken into account, suggesting that a change of 10% is to be recognized for purposes of the change in use rules. However, s. 141 indicates that a use of 90% (under CRA’s interpretation of “substantially all”) for exempt uses is equivalent to 100% for exempt use, so that in Year 1, Aco could not claim an input tax credit based on a 10% change in use, whereas two years later, it could claim an ITC based on a 20% change in use.

CRA essentially confirmed this interpretation, stating:

While a change in use of 10% or more is normally considered to be a significant change in use (i.e. because section 197 considers any change of less than 10% to be insignificant), section 141 nevertheless considers that the entire use of the capital property is not commercial activities.

Accordingly, ETA s. 206(2) would only apply when the registrant (Aco) began to use capital property in commercial activities to an extent greater than 10% - which occurred two years later, permitting Aco at that time to claim an ITC based on a 20% change in use.

However, CRA went on to note that if Aco instead was a financial institution (to which the s. 141 rules do not apply), the rules in s. 206(2) could now apply to generate an ITC based on a 10% change of use in Year 1 and s. 206(3) would permit an ITC based on a further 10% change in use two years later.