6 November 2002 GST/HST Interpretation 42347 - GST/HST APPPLICATION RULING [Input Tax Credit Entitlements]

Dear XXXXX

On XXXXX, you met with Mr. Ivan Bastasic, Mr. Costa Dimitrakopoulos and myself and made a number of representations on behalf of your client, the XXXXX City XXXXX. During this meeting you asked us to address a number of questions. We provide this ruling in response to questions numbered 1, 2 and 3, below. However, we are unable to provide a ruling with respect to the question numbered 4 as the issue to be addressed is administrative in nature.

We confirm that we have received written authorization from the City for you to discuss Goods and Services Tax (GST) issues on their behalf.

Statement of Facts

1. The City is a "municipality" and a "registrant" for GST/HST purposes, as defined is subsection 123(1) of the Excise Tax Act (All legislative references in this interpretation letter are to Part IX of the Excise Tax Act or to Schedule V thereto unless otherwise stated.).

2. Since January 1, 1991, the City has elected to use the Special Quick Method for Public Service Bodies pursuant to subsections 227(1) to (6) and Part V of the Streamlined Accounting (GST/HST) Regulations (the SQM).

3. In early XXXXX, the City acquired largely unimproved lands from XXXXX the College XXXXX by way of lease for a term of XXXXX years with an option to renew the lease but without an option to purchase the lands (the Land Lease).

4. On XXXXX, the City entered into XXXXX the Construction Contract XXXXX with XXXXX the Contractor XXXXX to construct the XXXXX on the leased lands for a total cost of approximately XXXXX. According to a letter dated XXXXX from the City Solicitor, the copy of the Construction Contract provided was fully executed. For purposes of this ruling, it is assumed that the Construction Contract, together with the Outline Specification for the XXXXX, represents the entire agreement between the City and the Contractor for the construction of the XXXXX.

5. Excerpts of the basic articles of the Construction Contract relied upon for this ruling are listed in the XXXXX to this letter.

6. The Land Lease states that title to and ownership of the XXXXX, exclusive of the lands, vests with the City for the duration of the Lease notwithstanding any rule of law to the contrary.

7. On XXXXX, the City entered into a lease (the Operating Lease) with XXXXX the Operator XXXXX to sub-lease the land portion of the XXXXX and lease the buildings and related site improvements (the buildings) portion of the XXXXX to the Operator.

8. As of the date of this letter, the City has not filed an election under section 211 (an election) in respect of the real property that forms the XXXXX.

Transactions

The City entered into the Construction Contract and received one or more taxable supplies made by the Contractor pursuant to the Construction Contract.

The City is making a supply by way of sub-lease of the land portion of the XXXXX and a supply by way of lease of the buildings portion of the XXXXX, to the Operator.

The City is contemplating the filing of an election under section 211 in respect of the real property that forms the XXXXX. Should the City decide to file this election the City will be deemed to have both made and received a taxable supply of the buildings portion of the XXXXX.

Ruling Requested

1. Did the Contractor make a supply by way of sale of real property, being the buildings portion of the XXXXX, to the City for GST purposes pursuant to the Construction Contract?

2. Is the City eligible to file an election under section 211 (the election) in respect of the XXXXX without having to revoke its election to use the SQM?

3. What are the GST consequences to the City of filing the election, particularly in terms of input tax credit entitlements under subsections 193(2) and 169(1)?

Ruling Given

Based upon the facts set out above, we rule as follows.

1. The City received a supply of services from the Contractor for the design and construction of the XXXXX and did not receive from the Contractor a supply of real property by way of sale.

2. The City is eligible to file an election under section 211 in respect of the XXXXX without having to revoke its election to use the SQM.

3. Should the City decide to file the election it would be deemed under paragraph 211(2)(a) to have made a taxable supply by way of sale of the buildings portion of the XXXXX immediately before the day the election comes into effect (election day). In addition the City would be deemed to have collected GST equal to the basic tax content (BTC) on election day. The City would be required to account for the full 7% GST on this deemed sale in calculating its net tax for the reporting period in which the deemed sale takes place.

The City would be permitted to claim an ITC under subsection 193(2) as a result of having made a deemed sale under paragraph 211(2)(a).

The City would be deemed to have received a taxable supply by way of sale of the XXXXX buildings on election day and to have paid GST equal to the BTC on election day in accordance with paragraph 211(2)(b).

The City's sublease of the land portion and lease of the buildings portion of the XXXXX to the Operator under the Operating Lease would be excluded from exemption under section 25 of Part VI of Schedule V by virtue of paragraph 25(g) of the same Part and Schedule.

Since no other exemption applies, the supplies made under the Operating Lease would become taxable on the due date of the first monthly installment of annual rent occurring on or after election day.

Where election day does not coincide with a due date for a monthly installment of annual rent under the Operating Lease, the supplies made under the Operating Lease would not become taxable until the due date of next monthly installment. In this case, the City would be subject to a change-in-use under subsection 206(2) on the due date of the first monthly installment of annual rent after election day. Paragraph 206(2)(b) would deem the City to have paid GST equal to the BTC of the XXXXX buildings on the day of the change-in-use.

The City would be permitted to claim an ITC equal to the BTC of the buildings portion of the XXXXX on whichever day, the election day or the change-in-use day, that the supplies made under the Operating Lease become taxable.

The City would be required to charge and collect GST on the first monthly installment of annual rent that falls due, or is paid without falling due, after the election comes into effect and on every lease payment thereafter while the election remains in effect. For all reporting periods where the SQM is in effect, the City would be required to include 5.8% of the GST collectible on all taxable lease payments in its calculation of net tax.

Explanation

1. There was a supply of construction services from the Contractor to the City and not a supply of real property by way of sale.

At our meeting on XXXXX you referred to the decision of the Canadian International Trade Tribunal (CITT) in Brial Holdings Ltd. and the MNR (Brial Holdings Ltd. and the MNR, Appeal No. AP-92-039, issued July 27, 1993.) in support of the view that the Contractor made a supply of real property by way of sale to the City.

In Brial Holdings Ltd. the CITT decided that a contractor who entered into a contract to construct real property (in this case a residential complex) for a client on land owned by the client made a supply that "qualifies as a taxable supply by way of sale".

However, on essentially identical facts, the CITT decided in Michael and Arlene Tugwell v. the MNR (Michael and Arlene Tugwell v. the MNR, Appeal No. AP-92-278, issued May 2, 1994.) that there was "never any taxable supply of a residential complex by way of sale, or by any other way". Therefore, in our view, the CITT jurisprudence is inconclusive on the matter of characterizing a supply as a service of construction or a sale of real property in the above noted circumstances.

In Snider v The Queen (Snider v The Queen [2002] 2885 ETC (GST)I), a GST decision of the Tax Court of Canada heard under informal procedure, the issue was whether a single unit residential complex was "builder-built" or "owner-built" for New Housing Rebate purposes. In this case the appellant bought a piece of land from a builder before construction of the residential complex was started and entered into a contract with the same builder to build a residential complex on that land. The TCC found that section 254, the rebate for "builder-built" complexes, was not applicable "because the transfer took place before construction was substantially completed". In quoting The Right Honourable Sir Robert Megarry (The Law of Real Property, 5th Edition at page 731.), the TCC included the following in its decision:

"... The materials used for building a house are thereby converted from chattels into land, and so automatically pass out of the ownership of the person who owned them as chattels and become the property of the owner of the land to which they are attached ..."

While there is limited GST jurisprudence focusing directly on this issue there is a significant body of jurisprudence for income tax purposes. In Will-Kare Paving & Contracting Ltd. v. Canada (Will-Kare Paving & Contracting Ltd. v. Canada [2000] 1 S.C.R. 915 issued by the Supreme Court of Canada on July 20, 2000.) the appellant constructed its own asphalt plant. Asphalt produced by the plant was mostly used in the taxpayer's own paving business (i.e. supplied to customers pursuant to contracts for work and materials) but part of the asphalt production was sold to third parties. In Will-Kare the majority of Supreme Court of Canada (SCC) held:

"... the plant was used primarily in the manufacturing or processing of goods supplied through contracts for work and materials, not through sale. Property in the asphalt was transferred to the appellant's customers as a fixture to real property."

In Will-Kare the majority of the SCC also stated

"... the word "sale" has an established meaning, the technical nature of the Income Tax Act does not lend itself to broadening the principle of plain meaning to embrace popular meaning, although it would be open to Parliament to provide for a broadened definition of sale for the purpose of applying incentives with clear language to that effect."

For GST purposes, a "sale" is defined in subsection 123(1) as follows:

"sale", in respect of property, includes a transfer of ownership of the property and a transfer of possession of the property under an agreement to transfer ownership of the property.

Under GST/HST Policy Statement P-111 - The Meaning of Sale with respect to Real Property, the CCRA states that a sale of real property requires either a transfer of a legal interest in real property (e.g. a registrable interest), a transfer of an equitable interest in real property or a transfer of possession of real property. In the latter case, P-111 states that "an agreement to transfer ownership, however, is required for a transfer of possession to be considered a "sale"."

In our view, there is no evidence in the Construction Contract to support that real property, whether legal or equitable, has been supplied by way of sale from the Contractor to the City.

In addition, although there is a reference to full possession of the "work" upon completion being given to the Client (the City) in contract condition XXXXX, it is our position that the Construction Contract is not "an agreement to transfer ownership" of real property as described in the definition of sale in subsection 123(1). Rather, the key articles of the Construction Contract support that the purpose of the contract is for the Contractor to supply design and construction services to the City to enable the XXXXX to be constructed. XXXXX[.] As this position is consistent with the facts relied upon in our previous interpretations dated XXXXX and XXXXX, there is no change in our position that the City is not entitled under the SQM to claim ITCs for the construction of the XXXXX.

2. The City can file an election in respect of the XXXXX without having to revoke its election to use the SQM.

The City is eligible to file an election in respect of any real property that is capital property of the City or that has been acquired by way of lease, licence or similar arrangement (lease) by the City for the purpose of making a supply of that real property by way of lease, in accordance with subsection 211(1).

In this case, the land portion of the XXXXX is real property acquired by the City by way of lease for resupply by way of lease to the Operator. Also, as the Land Lease specifies that ownership of the buildings portion of the XXXXX vests in the City, the XXXXX buildings are capital property of the City.

Note that if the City decides to file such an election, it must be filed in respect of the entire area of land designated in the Land Lease with the College and all buildings situated on that land that are capital property of the City.

Although the City can file an election in respect of the XXXXX without having to revoke the SQM in accordance with subsection 227(3), the impact of the election on the calculation of net tax will be subject to the SQM for all reporting periods where the SQM remains in effect.

3. The GST consequences of filing such an election, particularly in terms of ITC entitlements under subsections 193(2) and 169(1), are as follows.

As stated above, the direct consequences of filing the election in respect of the XXXXX are:

(a) the City would be deemed to have made a taxable supply by way of sale of the buildings portion of the XXXXX immediately before election day and to have collected GST equal to the BTC of the XXXXX buildings on election day, under paragraph 211(2)(a);

(b) the City would be deemed to have received a taxable supply by way of sale of the XXXXX buildings and to have paid tax equal to the BTC of the buildings on election day under paragraph 211(2)(b); and

(c) the City's sublease of the land portion and lease of the buildings portion of the XXXXX to the Operator would be excluded from exemption under paragraph 25(g) of Part VI of Schedule V and, as a result, become a taxable supply under the definition of "commercial activity" in paragraph 123(1)(c) and of "taxable supply" in subsection 123(1).

Effect of the SQM on section 211

The City is required to determine its net tax for those reporting periods where the SQM is in effect using the formula "A + B - C" prescribed in section 21 of Part V of the Streamlined Accounting (GST/HST) Regulations (the SQM Regulations).

3(a) Deemed Taxable Sale and Collection of GST

Subsection 19(1) of the SQM Regulations defines a "specified supply", as follows:

"specified supply", in respect of a registrant, means

(a) a supply by way of sale of real property,

As a result of filing the election, the City would be deemed to have made a "specified supply" under paragraph 211(2)(a), as stated above.

Paragraph (a) of element "B" in the SQM net tax formula requires the City to include in its calculation of net tax all amounts that became collectable or were collected as or on account of GST in respect of "specified supplies" in a particular reporting period where the SQM is in effect. Therefore, in calculating its net tax, the City must account for the full 7% GST in respect of the deemed sale under paragraph 211(2)(a).

A PSB that makes a taxable supply of real property by way of sale is permitted to claim an ITC under subsection 193(2) where, immediately before the tax becomes payable in respect of the sale, the real property was not used primarily in commercial activities of the registrant and an election under section 211 was not in effect at the time of the sale.

Paragraph (b) of element "C" in the SQM net tax formula includes:

"(b) all amounts in respect of specified supplies made by the registrant that may be deducted under Division V in determining the net tax for the particular reporting period and that are claimed in the return under Division V filed by the registrant for the particular reporting period, ...".

An ITC under subsection 193(2) would be an "amount in respect of specified supplies made by the registrant [City] that may be deducted under Division V in determining the net tax". ITCs under subsection 193(2) are therefore included in paragraph (b) of element "C".

Where immediately prior to election day the City is supplying the XXXXX buildings to the Operator by way of lease, the City would be using the XXXXX buildings exclusively otherwise than in its commercial activities (i.e. in making an exempt supply by way of lease). Thus the City would be entitled to claim an ITC under subsection 193(2) equal to the BTC of the XXXXX buildings on the day immediately before election day. This ITC would entirely offset the tax liability arising from the deemed sale of the XXXXX buildings, referred to above.

3(b) Deemed Taxable Purchase and Payment of GST

For the City to include an ITC amount in the calculation of net tax, the amount must be included in element "C" of the SQM formula for net tax. Subparagraph (a)(i) of element "C" includes:

"(a) all amounts each of which is an input tax credit of the registrant

(i) for the particular reporting period or a preceding reporting period of the registrant during which the election was in effect in respect of real property acquired by way of purchase by the registrant or an improvement to the property, and is claimed in the return under Division V filed by the registrant for the particular reporting period, ...".

An ITC determined under subsection 169(1) with respect to the deemed GST paid under either section 211 or 206 would be an amount "in respect of real property acquired by way of purchase". Therefore, assuming the City would be entitled to an ITC under subsection 169(1) in respect of the deemed tax paid (refer to 3(c), below), the City would be permitted to include this ITC amount in its calculation of net tax. The ITC amount would be equal to the BTC of the XXXXX buildings on whichever day, the election day or the change-in-use day, that the supplies made under the Operating Lease become taxable.

3(c) Operating Lease excluded from Exemption

In addition to requiring that the ITC amount be included in element "C", in order to qualify for an ITC under subsection 169(1), the deemed purchase of the XXXXX buildings must occur for the purpose of making a taxable supply. Filing the election in respect of the XXXXX means that the XXXXX will be held by the City for the purpose of making a taxable supply.

Where election day does not coincide with a due date for a monthly installment of annual rent under the Operating Lease, the supplies made under the Operating Lease would not become taxable until the due date of the next monthly installment.

In this case, the XXXXX buildings would undergo a change-in-use (i.e. the lease of the XXXXX buildings would become a taxable supply) on the first due date of a monthly installment of annual rent occurring after election day. In a manner similar to paragraph 211(2)(b), paragraph 206(2)(b) would deem the City to have paid GST equal to the BTC of the XXXXX buildings on the day of the change-in-use.

The City would be required to charge and collect GST on the first monthly installment of annual rent that falls due, or is paid without falling due, after the election comes into effect and on every lease payment thereafter while the election remains in effect. Element "A" in the net tax formula under the SQM Regulations is the total of all amounts determined in respect of all particular supplies to which the SQM rate applies. Since supplies of real property made otherwise than by way of sale (e.g. by way of lease) are not "specified supplies" they are included in element "A". For the City, the SQM rate is 5.8% where the City is acting in its capacity as a municipality and the particular supplies are made in a non-participating province. Thus, for all reporting periods where the SQM is in effect, the City would be required to include 5.8% of the GST collectible on all taxable lease payments in its calculation of net tax.

Additional Information

Since the following question is administrative in nature we are unable to provide your client with a ruling. However, we can provide the following information to assist you in understanding our administrative position on this matter.

4. Can a section 211 election filed in respect of the XXXXX apply retroactively?

Subsection 211(3) states that an election comes into effect for a period beginning on the day specified in the election. Subsection 211(5) requires that an election must be filed with the Minister in prescribed manner and form. Paragraph (b) of this subsection requires that the election specify the day it is to become effective. However, paragraph (c) of this subsection requires the election form (GST 26) be filed with the Minister within one month after the end of the reporting period of the person in which the election comes into effect.

In circumstances where the election is late filed (i.e. the date specified on a filed election form is earlier than the day permitted) the decision as to whether the CCRA will permit election to take effect retroactively falls within the purview of the Compliance Programs Branch. In the past, CCRA has issued Headquarters letters suggesting that it was prepared to administratively accept late-filed elections under certain conditions. A common condition for permitting a late-filed election to take effect retroactively was that the PSB had been charging GST on supplies of the real property as if the election had been filed in accordance with subsection 211(5).

In addition, it was emphasized that CCRA's acceptance of a late-filed election was not automatic and that each situation must be reviewed on a case-by-case basis.

This ruling is subject to the general limitations and qualifications outlined in section 1.4 of Chapter 1 of the GST/HST Memorandum Series. We are bound by this ruling provided that there are no relevant changes in the future to the Excise Tax Act, or to our interpretative policy; and that you have fully described all necessary facts and transactions for which you requested a ruling.

However, as the information provided in this letter under the heading Additional Information does not form part of this ruling, we are not bound with respect to it.

For your convenience, find enclosed a copy of section 1.4 of Chapter 1 of the GST/HST Memoranda Series.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at 613 954-8852.

Yours truly,

Daryl J.A. Hooley
Real Property Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate