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Citation: 2004TCC663 |
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Date: 20041001 |
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Docket: 2003-87(GST)G |
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BETWEEN: |
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BAY FERRIES LIMITED, |
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Appellant, |
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and |
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HER MAJESTY THE QUEEN, |
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Respondent. |
REASONS FOR JUDGMENT
(Edited from the transcript of Reasons for Judgment delivered orally August 13, 2004 at Charlottetown, Prince Edward Island)
Campbell, J.
[1] The Appellant was initially assessed under the Excise Tax Act (the "Act") for the period April 1, 1997 to May 31, 1998, and for the period June 1, 1998 to December 31, 2000 by notices of assessment, dated October 21, 1999 and March 29, 2001 respectively.
[2] These initial assessments were both reaffirmed on September 23, 2002.
[3] The effect of these assessments and reassessments was that the Appellant was not permitted to claim input tax credits (ITCs) in respect to tax paid on certain expenses relating to the Appellant's business of ferry services.
[4] The issue in this case is whether the method chosen by the Appellant to apportion ITCs, between taxable supplies and exempt supplies was fair and reasonable and used consistently throughout the relevant periods pursuant to subsection 141.01(5) of the Act.
[5] The Appellant used the input method to allocate ITCs between its taxable and exempt supplies. The Minister disagreed and applied the output method, as the more appropriate allocation method on the basis that the input method was not fair and reasonable in the circumstances. Consequently, the Minister determined that all or substantially all of the Appellant's expenses were incurred in the supply of ferry services, an exempt supply, and not in the course of a commercial activity. Therefore, the Appellant was not permitted to claim ITCs in respect to tax paid on those expenses pursuant to subsection 169(1).
[6] It is a question of fact whether a particular allocation method chosen by a registrant will be fair and reasonable.
[7] The Appellant called two witnesses: Gordon MacRae, Vice-President of Corporate Services for Bay Ferries and Craig Bradley, Chartered Accountant.
[8] There were no witnesses called by the Respondent.
[9] The Appellant operates two passenger ferry services in the Maritime region. The Catamaran vessel connects Yarmouth, Nova Scotia and Bar Harbour, Maine. Because this ferry service is considered an international service between Canada and the United States it maintains a zero rated status, where passenger revenue is zero percent taxable, as per the legislation. As a result, the Appellant is entitled to 100 percent of the ITCs.
[10] The "MV Princess of Acadia" vessel offers the second service, which operates between Digby, Nova Scotia and Saint John, New Brunswick. This appeal centres around this second ferry service between Digby and Saint John.
[11] Passenger revenue on tolls paid for this ferry service is exempt. The problem arises because, in addition to the vessel and passenger revenue for ferry services, the Appellant leases space on board the vessel, so that food services can be offered to its passengers.
[12] This results in two sources of revenue from commercial activities - rental revenue and vending machine revenue. The commercial rent is received for rental of space to arm's length parties for a gift shop, cafeteria, bar and lounge, news stand, washrooms, plus video area.
[13] The Appellant charges HST on the commercial rent revenue.
[14] Gordon MacRae testified that it was simply more economically feasible to lease the space and let others provide the services to the passengers. Because the Appellant provided both taxable and exempt services on board this vessel, it could not claim 100 percent of its ITCs. This meant that the Appellant had to choose an appropriate method to allocate the ITCs between its taxable and exempt supplies.
[15] The method chosen by the Appellant to allocate the ITCs was based on square footage. Gordon MacRae outlined the steps and procedures used by the Appellant in choosing this allocation method.
[16] Exhibit A-1 provided a vessel profile and deck plans for the "MV Princess of Acadia". Mr MacRae gave evidence respecting the size of the bar area located on the boat deck, the cafeteria and the seating lounge, the latter two areas being located on the upper deck. Exhibit A-1 also contained diagrams and a breakdown of square footage figures for the crew area, passenger area and vehicle deck area, as they related to the engine room, the main deck, the boat deck, the upper deck and the navigational bridge deck.
[17] Mr. MacRae testified that the main deck was used to park vehicles during the crossing. The boat deck had a dedicated area for the crew plus the bar, lounge area and washrooms were located here. The upper deck housed the retail shops and cafeteria.
[18] Mr. MacRae referenced the passenger area to the bar, washrooms and outside deck, on the boat deck level, and to the cafeteria and other retail shop area on the upper deck level. On cross-examination he testified that there was no other area for the passengers to go, other than the areas that he had identified.
[19] According to Exhibit A-1 the total square footage of the vessel as calculated by the Appellant is 51,417.8 square feet, and the total passenger area is 15,534.5 square feet. Mr. MacRae stated that they then calculated the percentage of passenger area to the total vessel area as 30.29 percent. He went on to provide a more detailed and specific breakdown of the square footage figures for the different areas, such as the bar, ladies and men's washrooms, baby change area, gift shop, reception, tourist information area, lounge and cafeteria.
[20] Based therefore on the square footage of areas rented to the arm's length party (which operated the bar, the cafeteria and so forth) compared to the total square footage of the vessel and then considering the areas that would be applicable to both types of activities or services, the Appellant concluded that 30.29 percent of the total square footage related to taxable services.
[21] However, when they prepared the GST/HST returns, the Appellant reduced the actual 30.29 percent to 25 percent, because according to Mr. MacRae the Appellant gave recognition to the fact that crew members as well as passengers were able to use and access hallways and other common areas on the vessel, that would be included in the 30.29 percent. He testified that the Appellant felt this to be a reasonable reduction and that the 25 percent figure represented a fair and reasonable percentage for claiming ITCs in respect of taxable services.
[22] The Minister contends that the commercial rents and vending machine revenues comprise no more than 1.2 percent of the Appellant's total revenue. In excess of 90 percent of the expenses incurred by the Appellant relate to services for the supply of ferrying vehicles and passengers and do not relate to the earning of commercial rents or vending machine revenues.
[23] In response to these assumptions, Mr. MacRae testified that because the duration of this crossing is approximately three hours, the provision of these services for its passengers is an essential service.
[24] He was not aware of any other similar ferry service which did not provide food and beverage services. When asked about potential consequences for termination of these on board services, Mr. MacRae stated that termination would almost guarantee a substantial decline in traffic. Many commercial vehicles utilize their service and want access to meals. As well, all traffic has the option of driving between these points rather than using the ferry.
[25] Because of the possibility of lost revenue, Mr. MacRae stated that Bay Ferries would want to provide this service even if the company, itself, had to operate this service at a moderate loss.
[26] He explained that it was industry standards that, where the food service is not supplied by the owner of the ferry business, rent is charged based on a percentage of sales and not square footage. He also disagreed that 90 percent of expenses related solely to the ferry services alone. In the example provided to the Court, he explained that in respect to fuel consumption it is not only used in propulsion of the ferry, but also for heat and electricity, which is part of passenger comfort. Therefore, this expense becomes part of those expenses incurred in providing services to and for the passengers.
[27] For safety reasons passengers must leave their vehicle during the crossing and remain upstairs in the vessel, even if food services are not available. In addition, in busy times the designated passenger areas for food services are not sufficient to handle the number of people and the overflow go to the lounge area.
[28] The second witness, Craig Bradley, reviewed the basis of the Appellant's objection.
[29] He went on to explain why the Appellant chose the input method for allocating expenses between commercial activities that are taxable and exempt services. It was his opinion that the input method used by the Appellant was fair and reasonable and had been used consistently throughout. He stated that the input method is the most consistent in the circumstances, because calculation of square footage will never change unless the Appellant renovates.
[30] On cross-examination, he testified that he had seen copies of the leases respecting the food services area on board the ferry but because he had not reviewed them in detail, he could not be specific as to exactly what areas were leased. The square footage figures were calculated and provided to him by the Appellant.
[31] Subsection 169(1) of the Act sets out the general rule for the calculation of ITCs, as follows:
(1) Subject to this Part, where a person acquires or imports property or a service or brings it into a participating province and, during a reporting period of the person during which the person is a registrant, tax in respect of the supply, importation or bringing in becomes payable by the person or is paid by the person without having become payable, the amount determined by the following formula is an input tax credit of the person in respect of the property or service for the period:
A x B
where
A is the tax in respect of the supply, importation or bringing in, as the case may be, that becomes payable by the person during the reporting period or that is paid by the person during the period without having become payable; and
B is
(a) where the tax is deemed under subsection 202(4) to have been paid in respect of the property on the last day of a taxation year of the person, the extent (expressed as a percentage of the total use of the property in the course of commercial activities and businesses of the person during that taxation year) to which the person used the property in the course of commercial activities of the person during that taxation year,
(b) where the property or service is acquired, imported or brought into the province, as the case may be, by the person for use in improving capital property of the person, the extent (expressed as a percentage) to which the person was using the capital property in the course of commercial activities of the person immediately after the capital property or a portion thereof was last acquired or imported by the person, and
(c) in any other case, the extent (expressed as a percentage) to which the person acquired or imported the property or service or brought it into the participating province, as the case may be, for consumption, use or supply in the course of commercial activities of the person.
[32] In simplified terms, if a registrant supplies only taxable services that registrant will be entitled to all of the ITCs. If only exempt supplies are made, there will be no entitlement to ITCs.
[33] Allocation problems occur when a registrant's business is a mixed supply of taxable and exempt activities. Here the Minister took issue with the input method chosen and applied by the Appellant.
[34] The input method is based on usage of the vessel by square footage calculations with 25 percent being claimed by the Appellant for ITCs in respect to taxable services.
[35] The Minister argues that this is not fair and reasonable, and that the more appropriate allocation method would be the output method based on revenue. The Minister's argument is that the food and beverage services were incidental to the main focus of the business operations, which is to ferry vehicles and passengers. Based on the output method, less than 10 percent of revenue would be generated from taxable supplies and therefore all or substantially all of the expenses were utilized in non-commercial activities. This method would deny a claim for ITCs.
[36] The key phrase here is "fair and reasonable", which comes directly from the wording in subsection 141.01(5), which states:
(5) The methods used by a person in a fiscal year to determine
(a) the extent to which properties or services are acquired, imported or brought into a participating province by the person for the purpose of making taxable supplies for consideration or for other purposes, and
(b) the extent to which the consumption or use of properties or services is for the purpose of making taxable supplies for consideration or for other purposes,
shall be fair and reasonable and shall be used consistently by the person throughout the year.
The only issue for determination is whether the method elected by the Appellant is fair and reasonable pursuant to this provision.
[37] I do not have to decide whether the best or most appropriate method is the method chosen by the Minister or the Appellant.
[38] The first, and as far as I can determine, only case where the Federal Court of Appeal has dealt with the allocation method, under this subsection is the case of the Magog (ville) v. Canada, [1999] T.C.J. No. 806. This decision clearly and definitively supports non-interference with a taxpayer's chosen method provided it is fair, reasonable and consistent.
[39] The Minister cannot substitute its own allocation method, simply because it appears to be more representative of the situation or the better method. This reasoning establishes a degree of deference to be given a taxpayer in choosing a method that is fair and reasonable.
[40] Of course I believe that a taxpayer must always be able to satisfactorily substantiate that the chosen method is, in fact, fair and reasonable and consistent. But if he is able to do so, subsection 141.01(5) allows a registrant a broad latitude of flexibility in choosing a method, provided it can be shown to be fair and reasonable. This implies that the chosen method will reasonably reflect the actual use of the property and services and the manner in which it conducts its business generally.
[41] There are no methods specified in the Act which are to be used as guidelines. Again, it comes down to a review of the facts in each case. It is generally accepted that the preferred method is direct allocation, where the property or service can be directly allocated to the activities. The direct method will produce the most accurate results. In some circumstances this method cannot be applied. It was not practical for the Appellant in this case to utilize the direct application method because of shared overhead.
[42] According to GST Memorandum 700-5-1, the next preferred method is the input method, which was the Appellant's choice. The third preferred method, if neither of the first two can be applied, will be the output method, which was the Minister's choice as the appropriate application in this case.
[43] The Appellant's choice of the input method, which relied on square footage measurements, was based on the fact that it was more consistent from year to year. If Bay Ferries had adopted the output method, as the Minister did, different percentages would have to be allocated to these various commercial activities of food and beverage services depending upon revenue generated. This would mean that the degree of consistency falls far short of the consistency that can be established from year to year using the input method.
[44] If the Appellant decided to operate these services itself rather than lease the space, it could use the same square footage calculations which provides a more consistent approach in the long run.
[45] I accept that the Appellant's approach, which focuses on space, is fair, reasonable and consistent. The uncontradicted evidence of the Appellant's witnesses established a precise square footage formula which was fair and reasonable. This formula provided consistency from year to year, and could be applied whether the Appellant leased the space to someone to operate the food services or decided to provide the services itself.
[46] According to the Magog case, an allocation method should not distort the financial reality of the commercial activity. It is true the revenue received from the leasing of this space is a small fraction of the Appellant's total revenue, but the evidence clearly supports the fact that it is essential that the Appellant provide a food and beverage service to retain its volume of passengers. Bay Ferries must be competitive as travellers have alternative options.
[47] If the Appellant decided to provide the food services itself, ITCs can be claimed. The Appellant made a business choice to leave the space to others who would provide these services to its passengers, one that it felt was appropriate in the circumstances.
[48] The Appellant is free to structure its business activities in a manner that it feels appropriate to its circumstances, provided it does not run afoul of the provisions of the Act or some rule of law.
[49] As part of this structuring it obtained professional accounting advice, chose the method to allocate its expenses between its taxable and exempt supplies and completed extensive square footage calculations to support its final figure of 30.29 percent, which was reduced to 25 percent to reflect common area spaces. This is a logical, practical and sound approach to picking a method, particularly if it had chosen to operate the service itself at some point in the future. It is fair, reasonable and provides the consistency if Bay Ferries do decide to operate the services, rather than lease the space. Business environments are constantly changing and the Appellant, if it changes its approach due to changing circumstances, will be able to continue the method.
[50] The Minister has argued that the input method might well be acceptable, if there was more evidence as to the exact square footage that was actually leased and used exclusively for taxable services.
[51] The bar and restaurant areas are available to non-patrons for seating, and the Minister argues that the capacity of the vessel (approximately 620 people) compared to the seating lounge capacity of 244 people, contemplates that passengers will use all areas of the vessel regardless whether they buy food or beverages.
[52] Although the Appellant's accountant, Mr. Bradley, did not have personal knowledge of the exact lease measurements, Gordon MacRae did, and I accept his evidence as straightforward and uncontradicted. In fact, if I take the total square footage calculated as passenger area, that is 15,534.5 square feet and subtract the passenger seating area (the lounge), that is, 4,257 square feet, I am still left with the balance of square footage in excess of 11,000 square feet.
[53] So, even if I delete the area where passengers may be seated, without utilizing the food services area, the remaining square footage of some 11,000 square feet, comprising the bar, restaurant, gift shop, etc., is still in compliance with subsection 141(3) where CCRA administratively can apply a 10 percent rule. Where it appears that substantially all of the use of a property or service is in the course of a non-commercial activity, then all of the use will be deemed to be in the course of those non-commercial activities.
[54] In addition, there may be overlapping between the actual dedicated leased space for services and the passengers' seating area. Mr. MacRae noted that during busy times passengers may take their meals to the seating area, because there was no seating left in the cafeteria or lounge area.
[55] When the direct method of allocation cannot be used, as it could not be here, the remaining methods will not provide an exact science for the necessary computations and, in fact, the output method is ranked below the input method in respect to better choices.
[56] The input method here is fair and reasonable, and appears to be practical under the circumstances, according to the facts as presented before me.
[57] Because I have concluded that this method is fair and reasonable and therefore acceptable, I do not have to decide if the Minister's choice would be a better method in the circumstances.
[58] The appeal is therefore allowed with costs, and referred back to the Minister for reconsideration and reassessment on the basis that the Appellant is entitled to claim the ITCs in respect to the periods in question.
Signed at Ottawa, Canada this 1st day of October 2004.
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"Diane Campbell" |
Campbell J.
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CITATION: |
2004TCC663 |
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COURT FILE NO.: |
2003-87(GST)G |
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STYLE OF CAUSE: |
Bay Ferries Limited and Her Majesty the Queen |
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PLACE OF HEARING: |
Charlottetown, Prince Edward Island |
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DATE OF HEARING: |
August 9, 2004 |
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REASONS FOR JUDGMENT BY: |
The Honourable Justice Diane Campbell |
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DATE OF JUDGMENT: |
October 1, 2004 |
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APPEARANCES: |
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Counsel for the Appellant: |
James Travers, Q.C. |
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Counsel for the Respondent: |
Peter Leslie |
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COUNSEL OF RECORD: |
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For the Appellant: |
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Name: |
James Travers, Q.C. |
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Firm: |
Stewart McKelvey Stirling Scales Charlottetown, Prince Edward Island |
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For the Respondent: |
Morris Rosenberg Deputy Attorney General of Canada Ottawa, Canada |