23 December 1999 GST/HST Interpretation 8309/HQR0001915 - Direct Cost Exemption

Dear XXXXX

Thank you for your facsimile of August 10, 1999 and letter of November 22, 1999, concerning the application of the direct cost exemption. Since no particular organization has been identified, our reply is in the form of an interpretation letter rather than an application ruling.

Please note that as November 1, 1999 Revenue Canada became the Canada Customs Revenue Agency (the CCRA).

Background Facts

1. A provincial government body currently sells information via the internet to a number of resellers of the information and directly to end users within a specific industry.

2. A non-profit-organization (NPO) is in negotiations with the province to become the sole distributor of the information.

3. The distribution agreement will give the NPO distribution rights for 10 years.

4. Under the written agreement, the NPO is required to pay the following amounts to the province in order to be the sole supplier of the information to current users:

An annual licence fee: In return for exclusive rights to resell the information, the NPO must pay the provincial government an annual licence fee, payable in 52 weekly installments.

Set-up and running costs: The NPO is required to pay the following costs annualized over the life of the contract:

•   Pilot period and transition expenses

•   Provincial government's delivery system

•   Provincial government's equipment relocation costs

•   System changes

•   Testing and operation of message link

•   Disaster recovery procedures

•   Delivery channels

Cost Neutrality Remuneration: The NPO is required to pay certain provincial government's costs that are over and above an agreed "baseline cost", not including the foregoing costs. These costs are also annualized over the lifetime of the contract.

Project Expenses: The NPO is required to fund the provincial government's costs in developing two specific programs to be run by the provincial government, again annualized over the life of the contract.

5. The supply by the province to the NPO is an exempt supply of a service of providing information under paragraph 20(d) of Part VI of Schedule V to the Excise Tax Act (The ETA). That is, for purposes of this interpretation, it may be assumed that the supply meets the requirements of that exempting provision.

6. The province maintains ownership of the information at all times, and the sale of the information is not a sale of any or all of the province's right, title or interest in the information.

7. The NPO intends to resell the information on exactly the same basis as the province currently sells it (i.e., a cost per unit of information with discounts for high volume usage).

Interpretations Requested

You have requested our views and interpretations concerning the following questions:

i) What is included in the direct cost of the NPO's acquisition of the service?

ii) Does the NPO "resupply" that service at the usual charge by the body for such supplies to such recipients?

iii) Does the supply made by the NPO fall under the direct cost exemption pursuant to section 6 of Part VI of Schedule V to the ETA and is it reasonable that since the contract is for a period of ten years with an annual fee, and all non operating costs are amortized over the life of the contract, that the NPO determines whether its supply is exempt based on an annual contract costs versus annual information resale revenues?

Interpretations Given

i) What is included in the direct cost of the NPO's acquisition of the service?

Section 6 of Part VI of Schedule V to the Excise Tax Act (the ETA) exempts certain supplies by an NPO made for consideration that does not exceed the direct cost of these supplies.

The direct cost exemption has very limited application to services, applying only to those that are purchased and "resupplied" in the same form to the recipient. It appears in the present situation, that the end user will be receiving the same information (and in the same format) from the NPO as it would have from the provincial government body. Accordingly, it is apparent that the NPO is "resupplying" the information service in question. For this reason, any amounts paid by the NPO to the provincial government body which represent reimbursement for costs incurred by the provincial government body in providing the information service will represent consideration for that service and as such will be components of the direct cost. However the sole distribution rights are not "resupplied" so any amount attributed to the cost of this will not be a component of the direct cost of the information service. This will be the case with any other item which is not part of the "resupplied" service (it is unclear as to whether the two programs that the NPO funds, referred to under fact #4, are part of the information service).

ii) Does the NPO "resupply" that service at the usual charge by the body for such supplies to such recipients?

It is our position that the direct cost exemption may apply where the same service is supplied at various rates depending on, for example, the volume or quantity purchased. In this situation, we would view the NPO as meeting the requirement that it has supplied the service "at the usual charge". That is, the "usual charge" may vary - the "usual charge" for one class of users may differ from that of another.

iii) Does the supply made by the NPO fall under the direct cost exemption pursuant to section 6 of Part VI of Schedule V to the ETA and is it reasonable that since the contract is for a period of ten years with an annual fee, and all non operating costs are amortized over the life of the contract, that the NPO determines whether its supply is exempt based on an annual contract costs versus annual information resale revenues?

In the absence of more specific information, we are unable to conclude whether or not the direct cost exemption applies in this situation. However, we trust that the preceding information will assist you in making that determination. Also we recognize the difficulty in determining the "consideration" and "direct cost" amounts of specific supplies in a situation such as this where some costs are amortized over a ten year period, and where fees vary according to the volume of information purchased. In such situations, the CCRA will accept a reasonable basis of determining the consideration and direct cost amounts. It would appear that your suggestion that this determination be made on an annual basis (as opposed to a transaction-by-transaction one, or one based on the overall 10 year period) is quite reasonable.

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed amendments to the Excise Tax Act, if enacted, could have an effect on the interpretations provided herein. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST/HST Memoranda Series, do not bind the Department with respect to a particular situation.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 952-0329.

Yours truly,

Gabrielle Nadeau
Charities and Non-Profit Organizations Unit
Public Service Bodies and Governments Division
Excise and GST/HST Rulings Directorate