31 August 2004 GST/HST Ruling 50429 - Sponsorship Agreements

Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.

This is in reply to your memorandum XXXXX to XXXXX the XXXXX Tax Services office which has been forwarded to us.

You have requested our comments with respect to the inclusion of deferred finance mortgage revenues in the input tax credit allocation formula of the registrant, a Canadian bank.

Our understanding of the facts is as follows:

Facts

1. XXXXX (the Bank) is a financial institution engaged primarily in the business of providing financial services.

2. The Bank enters into contracts to sell its mortgages to mutual funds. A copy of one such contract (the Agreement) XXXXX was provided in which the Bank entered into an agreement to sell mortgages to the XXXXX (the Mortgage Fund), with XXXXX (the Agent), acting as agent of the Mortgage Fund for acquiring the mortgages.

3. The consideration paid for the purchase of the mortgages by the mutual fund is determined by a "Mortgage Valuation Formula" contained in the Agreement.

4. The Mortgage Fund pays a Guarantee Fee and a Premium/Discount Fee. The Guarantee Fee is a fee to ensure that if a mortgagee defaults on the mortgage, the Bank will repurchase the mortgage from the Mortgage Fund at an agreed upon value. The Premium/Discount Fee is a fee paid for the difference between the contractual interest rate of the mortgage and the current market interest rate for a mortgage of similar terms and conditions.

5. The Bank continues to administer the mortgages in consideration for a fee in an amount that is agreed upon between the Bank and the Mortgage Fund.

6. The Bank uses an output based allocation method for determining the percentage of input tax credits (ITCs) it is entitled to claim.

7. The CRA (formerly CCRA) is proposing that XXXXXth of the average balance of the Deferred Finance Mortgages balance sheet account for the year be included in the denominator of the ITC allocation formula (i.e., added to Total Other Income).

Interpretation Requested

Does the portion of proceeds credited to Deferred Revenues by the Bank on the sale of its mortgage receivables qualify as exempt income and therefore represent a bona fide constituent of the exempt income component of the ITC allocation formula of the Bank?

Our Comments

The main issue in this case is whether the proceeds from the sale of the mortgages should be included in the ITC formula.

The Bank is using the following output based formula:

(Non-resident Interest Expense + Non-resident Interest Income + Other Income)

(Total Interest Expense + Total Interest Income + Total Other Income)

Should the proceeds of sale of the mortgages be a constituent of "Total Other Income" in the denominator of the above equation?

GST/HST Memorandum 700-5-1: ITC Allocation for Financial Institutions states that "an output-based method is acceptable for the allocation of certain property and services where it can be shown to be fair and reasonable in the circumstances, provided it:

(a) reasonably reflects the actual use of the property and services; and

(b) is the only practical or fair method that can be applied in the circumstances.

This method might use the ratio of revenue from taxable supplies to revenue from total supplies to determine the ITC for acquired property and services.

In that case, certain items should be excluded from the numerator and denominator to avoid distortion of the ratio. They might include:

(a) any amount receivable for the supply of capital goods used for business purposes (e.g., proceeds from the sale of fixed assets/lands);

(b) the value of the sale of a business as a going concern; and

(c) proceeds from the sale of financial instruments held in the registrant's own account.

Other deficiencies in the design of the specific revenue-based allocation method used by the registrant should also be addressed. For example, allowances should be made if products have different profit margins which would distort input allocations, or if revenues include amounts that relate to prior periods such as the recovery of a bad debt. These types of income should be removed from a revenue-based allocation formula.

The previous XXXXX noted on page XXXXX of his memo XXXXX that the wording of paragraph (c), i.e., "financial instruments held in the registrant's own account", implies that proceeds from the sale of financial instruments not held in the registrant's own account might be included. He also noted that the overriding determinant for the exclusions noted is to avoid distortion in the ITC ratio arising from non-routine type transactions. The XXXXX then concluded that since the sale of the mortgages is a routine transaction, it should not be excluded. We disagree with the conclusion that it should not be excluded.

Although the sale of mortgages is part of the regular business of the Bank, I believe it would fall within the description of items that could potentially distort the formula [paragraph (c) in the section of the Memorandum noted above]. The mortgages are financial instruments which have been issued by the Bank and as such are considered to be held in the account of the Bank. It is our opinion that the proceeds from the sale of the mortgages should not be included in the formula.

Should you have further questions, do not hesitate to contact me at (613) 952-9577 or Duncan Jones at (613) 952-9210.

Marilena Guerra
Senior Rulings Officer
Financial Institutions Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate

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2004/08/31 — RITS 50657 — Legal Services Provided to a Non-resident