1 April 1998 GST/HST Interpretation 1998-04-01 - Claiming ITCs on Reimbursed Amounts and the Factor Method

                                                                        XXXXX
XXXXX
XXXXX

This is further to a letter (with attachments) dated March 20, 1997, from Michael Chow of your office (Verification and Enforcement Division) concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to determine a person's input tax credit (ITC) entitlement using the factor approach to calculate the deemed tax paid on an amount reimbursed by a person to an individual. Please excuse the delay in replying.

Interpretation Requested

In the submission, it is stated that XXXXX claims their ITCs on all employee reimbursed expenses using the 6/106 factor method of calculating the deemed tax paid. These expenses mainly include taxable supplies but also include non-taxable supplies. XXXXX employee expense statement consists of six column headings which are treated by them as six separate expense categories for GST/HST purposes, namely; transportation, meals, hotel, board, entertainment, and miscellaneous. Specifically, the "miscellaneous" column is used to reimburse expenses that are not included in other columns such as; stationary and supplies, computer software, employee transfer expenses, postage, sales incentives, incentive awards, payroll, memberships, tuition, etc.

It is also stated that, for purposes of determining their ITC entitlement in respect of reimbursed expenses, XXXXX computer system, which processes approximately XXXXX employee expense statements per month, is programmed to calculate the deemed tax paid on those reimbursements by applying the 6/106 factor on each of the six column totals. Specifically, the program will perform this calculation provided the column satisfies the "all or substantially all" test. As a result, XXXXX ITC claim on reimbursements is calculated on an amount of deemed tax that not only includes supplies for which tax was actually paid by the employee but also includes supplies that were not subject to the tax.

With this in mind, the following interpretation is requested:

1) Whether, for purposes of determining XXXXX ITC entitlement, the 6/106 factor method of calculating the deemed tax paid on employee reimbursements allows XXXXX to include in the calculation expenses for which no tax was charged to the employee; and,

2) Whether, for purposes of claiming the credit under this method, XXXXX "miscellaneous" expense column is considered a single "category of expense", or rather several categories of expenses (thereby requiring that each category of expense under that column satisfy the "all or substantially" test).

Interpretation Given

Firstly, please note that the following interpretation not only applies to employee reimbursements but also to amounts paid by a partnership, charity or public institution as a reimbursement to a member of the partnership, or to a volunteer who gives services to that charity or public institution. For this reason and for greater accuracy, we will hereinafter refer to the employee of XXXXX as the "individual", and XXXXX as the "person".

Secondly, although the submission refers only to the application of the 6/106 factor for determining the person's deemed tax paid on reimbursed expenses, please note that the Department has also introduced the 14/114 factor which can be used in certain circumstances to determine the deemed tax paid on reimbursed expenses incurred in participating provinces (i.e., Nova Scotia, New Brunswick and Newfoundland). Consequently, since our comments which follow apply regardless of the tax factor being used by the person, we will refer to the factor approach of calculating the deemed tax paid as simply the "factor method". Lastly, for your information, we have attached a copy of a question and answer which discusses the application of the 14/114 factor method. Note that the Q&A also describes the manner in which to determine an ITC when using the factor method of calculating the deemed tax paid where the individual is reimbursed for expenses which include a mix of 7% GST and 15% HST taxable supplies. For this reason, we find that the information provided in the Q&A may have some relevance to XXXXX[.]

Question 1 - The Factor Method Calculation:

Subsection 175(1) of the Excise Tax Act (the "ETA") provides in general that, where a person reimburses an individual for an expense incurred by the individual on behalf of the person for a supply of property or service, and the individual paid the tax payable in respect of the supply, the person is deemed:

(a) to have received a supply of the property or service;

(b) to have consumed or used the property or service in relation to its activities; and,

(c) to have paid tax in respect of the supply at the time the reimbursement is paid.

Accordingly, where the person is a registrant and subsection 175(1) of the ETA applies to deem the person to have paid tax on the supply reimbursed (determined by the formula 'A x B' - commonly known as the "actual tax method"), that person may be eligible to claim an ITC in respect of that tax provided that all other ETA requirements are satisfied.

Subsection 169(4) of the ETA establishes the information that is required to support the ITC claim. Specifically, the person must, before filing the return for the reporting period in which the ITC is to be claimed, obtain sufficient evidence in such form containing such information to allow the amount of the ITC to be determined (including information prescribed under the Input Tax Credit Information Regulations). In addition, subsection 169(5) of the ETA provides the Minister of National Revenue the authority to exempt specified registrants, specified classes of registrants, or all registrants from any of the requirements provided for under subsection 169(4) of the ETA, as well as the authority to establish terms and conditions where the Minister is satisfied that there is (or will be) sufficient evidence to support the ITC claim.

With this in mind, for purposes of determining a person's ITC entitlement in respect of a reimbursement paid by the person for expenses incurred by an individual on behalf of the person, the Department may permit that person (in accordance with the ministerial authority granted under subsection 169(5) of the ETA) to opt for the factor method to calculate that person's deemed tax paid on those reimbursed expenses. Generally, this method is permitted where full documentary evidence of those expenses is not available. Specifically, the factor method calculates the deemed tax paid on a reimbursed amount within a category of expense to be equal to a prescribed factor (6/106 or 14/114 as the case may be) of the amount reimbursed for expenses (including tips, gratuities and, where applicable, provincial sales tax) incurred in Canada by the individual on behalf of the person for supplies of property or service where all or substantially all (90% or more) of those supplies (other than zero-rated supplies) for which the reimbursement is paid in that category are subject to GST/HST (this last condition is often referred to as the "all or substantially all" test).

For purposes of determining the ITC entitlement where the factor method is used to calculate the deemed tax paid, a person who is a registrant is exempt from the general documentary and information requirements established under subsection 169(4) of the ETA provided the registrant maintains proper books and records which captures information to substantiate the particulars of the relevant supplies (for a listing of the required information, please refer to GST Memoranda 400-2: Documentary Requirements, paragraph 69, or 400-1-1: Allowances and Reimbursements, paragraph 28). Lastly, these books and records must be made available for review upon request by the Minister.

Also note that where a person satisfies the above requirements and uses the factor method to determine the deemed tax paid on reimbursed amounts within a category of expense, the Department has always maintained that the person will calculate that tax on the total amount reimbursed in that category (including those expenses reimbursed for which no tax was charged to the individual).

As a result, referring to the example provided in the submission (i.e., 95% of the expenses reimbursed to the individual are in respect of 7% taxable supplies while the remaining 5% of the expenses are in respect of exempt or zero-rated supplies), we agree that the "all or substantially all" test (explained above) has been satisfied within that category of expense permitting the person to use the factor method to calculate the deemed tax paid in respect of the reimbursement paid to the individual. However, the tax will be deemed to be equal to 6/106 of the total (100%) amount reimbursed in that category. In other words, the total reimbursed amount used in the calculation of the deemed tax paid for that category of expense will include that portion (5%) of the reimbursement paid to the individual for exempt and zero-rated supplies.

It is important to note that the above calculation only determines the person's deemed tax paid on reimbursed amounts within a category of expense. Therefore, once the deemed tax paid has been established (by way of the factor method or the actual tax method), that person will only be entitled to an ITC in respect of that tax provided that the reimbursement paid conforms to all other ETA requirements. Accordingly, we agree with the comment made in the letter that a person who is a registrant would thus be precluded from claiming an ITC on all or a portion of the deemed tax paid on a reimbursed amount within a category of expense where paragraph 170(1)(b) of the ETA applies to a supply of property or service reimbursed by the registrant (i.e., the supply reimbursed is for the exclusive personal consumption, use or enjoyment of an officer or employee or an individual related to the officer or employee).

Question 2 - The "Miscellaneous" Column:

As you are aware, the Department also introduced the requirement that, for purposes of determining an ITC in respect of reimbursed amounts, the method chosen to calculate the deemed tax paid (either the actual tax method or the factor method) must be used consistently by the person within each "category of expense" reimbursed throughout the person's fiscal year. For instance, where the factor method of calculating deemed tax paid is used to determine an ITC claim for one category of expense reimbursed to one individual, the person must use the same method of calculating the deemed tax paid during the fiscal year for that category of expense reimbursed to all other individuals.

The Department has never defined the term "category of expense", nor has it ever provided an exhaustive all-inclusive list of accepted expense categories (other than a few typical examples such as "airfare, hotel accommodation, food, beverages and entertainment" which are mentioned in departmental publications). The reason is that, rather than provide a strict interpretation of the term and/or a rigid classification of expense categories, the Department found it necessary to allow a person some amount of latitude or flexibility when identifying their particular categories of expenses. However, it is important to note that a "category of expense" must be reasonable and will only be accepted as such by the Department where the category comprises of reimbursed expenses of a similar nature (i.e., of the same type, class or kind: with the same general characteristics) based principally on the commercial activities of the person and the practices within the particular industry.

With this in mind, although under certain circumstances the Department may accept a person's "miscellaneous" column as a single "category of expense", it is a question of fact whether for GST/HST purposes this column of reimbursed expenses is reasonable or whether it is better characterized as a broad grouping of many dissimilar expenses in nature (i.e., a "catch-all" column). Where the latter is the case, that person would be required to either use the actual tax method to calculate the deemed tax paid in respect of the reimbursed expenses in that column (determined by the formula in subsection 175(1) of the ETA), or divide the column into two or more reasonable categories of expenses and then choose the appropriate method for each category. Once again, the "reasonableness" of the category must be evaluated by the Department on a case by case basis determined on the facts of the particular situation.

Summary

To respond to the issues raised in the letter, the above interpretation included an explanation of both the applicable ETA provisions and the Department's current GST/HST policy. In general, the Department's policy intent with respect to the factor method can be seen as an administrative approach which relieves registrants the burden of obtaining full documentary evidence required under subsection 169(4) of the ETA when determining their ITC entitlement under subsection 169(1) of the ETA on reimbursed amounts.

Note that the Department will generally allow the use of the factor method within a category of expense. However, given that its use stems from the delegated authority granted under subsection 169(5) of the ETA, the Department has the discretion to disallow the use of this method where there is an unintended tax benefit to the person. Moreover, this discretionary power also permits the Department to specify, for instance, that certain restrictions be maintained within a category of expense prior to agreeing to its use (for example, the Department may restrict certain reimbursed expenses from a category of expense where it is determined that those expenses are not similar in nature to the remaining expenses in that category).

Please note that a copy of this letter as well as a copy of the submission with attachments has been sent to the Verification, Enforcement and Compliance Research Branch for their review and consideration.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-9700.

Yours truly,

Paul Lafond
A/Senior Rulings Officer
General Operations Unit
General Operations and Border Issues Division

Encl.