To prevent tax cascading, the GST/HST legislation generally offers registrants the ability to claim ITCs under section 169 of the Excise Tax Act (the "ETA") to recover GST/HST payable or paid on business costs and inputs, including ones that are on capital account.
Conflicting Jurisprudence
In A&W Trade Marks Inc. v R ("A&W"),1 the Tax Court of Canada (the "Tax Court") allowed a registrant's ITC claims to recover GST paid on expenses incurred in relation to an IPO to raise funds to invest in the registrant. In the recent case of PDM Royalties Limited Partnership v R ("PDM"),2 the claimant sought to claim ITCs to recover GST paid on fees for services incurred in structuring and selling income fund units. However, unlike in A&W, in PDM the Tax Court disallowed the ITC claims, finding that the claimant was not the "recipient" of the taxable supplies of services.
Facts in PDM
PDM Royalties Limited Partnership (the "LP") carries on the business in Canada of acquiring, owning and licensing intellectual property rights (i.e., making taxable supplies) relating to certain franchised restaurants. The LP, therefore, engages in a "commercial activity". The limited partner of the LP is a trust (the "Trust"). The LP raises funds for its operations through an income fund trust (the "Fund"). The Fund engages in making exempt supplies of financial services relating to investing in securities, issuing Fund units to investors, and issuing debt securities. As such, the Fund is not engaged in a "commercial activity".3
In 2004, the Fund conducted an IPO of its trust units. In 2005, the Fund raised additional monies with a private placement of its trust units (the "Placement"). In each case, there were a series of additional transactions involving financing and investment in the Trust and LP units. The LP claimed ITCs to recover GST paid on IPO and Placement expenses relating to acquiring professional legal, accounting and assurance services, trademark and other intellectual property valuation services, printing, publishing, and public listing on the TSX, and to remunerating and reimbursing the Fund's trustees (collectively, the "IPO and Placement Supplies").
General Principles for Claiming ITCs
In PDM, the Tax Court applied the principles for determining ITC eligibility enunciated in General Motors of Canada Limited v R (the "GM Canada Decision").4 While the GM Canada Decision has been overturned by the legislative amendment with respect to the particular issue in dispute in that case, the general principles set out in that decision for determining ITC eligibility remain good law.
In the GM Canada Decision, the Tax Court outlined the following three conditions to be satisfied under section 169 of the ETA in order to claim ITCs to recover GST (or HST) payable or paid on an expense:
- the claimant must have acquired the property or services that gave rise to the ITC claim;
- the GST (or HST) was paid or payable by the claimant; and
- the property or service was acquired for consumption, use or supply in the claimant's "commercial activity".5
Application of Principles in PDM
In PDM, the Tax Court found that for the purpose of the first condition set out above, the person who "acquired" a taxable supply of property or service effectively meant the "recipient" of that supply. The "recipient" of a supply is generally the person who is contractually liable to pay the consideration to a supplier under the agreement with the supplier.6 As the LP was not the "recipient" of the IPO and Placement Supplies under the relevant supplier agreements and, therefore, did not satisfy the first condition above, the Tax Court denied the ITC claims made in respect of the IPO and Placement Supplies.
In reaching this conclusion, the Tax Court considered the Financing Agreement entered into among the LP, the Fund, the Trust (the LP's limited partner) and the LP's general partner. Under the Financing Agreement, the parties agreed that the expenses relating to the IPO and Placement Supplies would be "incurred by or on behalf of" the LP. The LP argued that under Financing Agreement, the LP is the "recipient" of the IPO and Placement Supplies. The Tax Court rejected this argument because the suppliers of the IPO and Placement Supplies did not agree to make their supplies under the Financing Agreement (in fact, these suppliers were not parties to the Financing Agreement).
Under separate Administration Agreements entered into by the LP with each of the Fund and the Trust, the LP agreed, as Administrator and agent, to assume responsibility for the administration and management of the Fund's and the Trust's general and administrative affairs. The LP was required to pay the "remuneration and expenses" of the trustees of both the Fund and the Trust. For its services under each of the Administration Agreements, the LP was entitled to annual fees, not to exceed $25,000, from each of the Trust and the Fund (although such fees were never actually collected).
According to the Tax Court, the Administration Agreements supported the Crown's contention that the Fund was the recipient of the IPO and Placement Supplies. In entering into contracts with suppliers as agent on behalf of the Fund, as provided for in the Administration Agreements, the LP "created direct contractual relationships between the Fund and the service providers whose invoices are at issue. It was the Fund, as principal, who was contractually liable to pay under the agreements with the suppliers and it is the Fund who was the recipient of the services provided and who acquired the services."7 The Tax Court rejected the LP's argument that the conduct of the parties evidenced an unwritten agreement that the LP would incur the expenses on its own behalf as principal and this unwritten agreement should supersede the Administration Agreements.8
Although the above conclusions were sufficient for the Tax Court to find that the LP was not entitled to claim the ITCs for the IPO and Placement Supplies, the Tax Court gave an additional reason why the ITCs could not be allowed. In the Tax Court's view, "the services were not used by the [LP] in the course of its commercial activity." That is, the third condition above was unsatisfied.9 Even if the LP were considered the "recipient" of the IPO and Placement Supplies, "it cannot be said that the expenses were used in the course of its commercial activities."10 The Tax Court concluded that the "services purchased by these expenses were not used by the [LP] in the course of its commercial activities. They were used by the Fund."11
Reconciliation of PDM with A&W
The LP argued that the A&W precedent should be followed and applied in PDM. In fact, the LP admitted that the income fund structuring in PDM was modeled on the one in A&W.12 In PDM, the Tax Court distinguished A&W from the current case in two ways.
Firstly, the Tax Court observed that "in A&W, it was found that the taxpayer acquired the goods and services." In PDM, on the other hand, the LP (ITC claimant) acquired the IPO and Placement Supplies as agent on behalf of the Fund. The Administration Agreements in PDM were "similar to but not the same as the administration agreement in A&W." Notably, in A&W, the administrator, who claimed the ITCs, did not incur the relevant expenses as agent on behalf of the A&W Income Fund, but incurred them as principal on its own account.13
Secondly, the Tax Court noted that "it is not clear from the decision [in A&W] whether it was argued that the expenses in question were related to the provision of exempt supplies by the income fund." In A&W, the Tax Court did find linkage between the expenses incurred by the ITC claimant and the claimant's commercial activities. As noted in PDM, the "Court in A&W found that the taxpayer "acquired the goods and services to enable it to borrow money in order to carry on its commercial activities"." In this regard, the Tax Court distinguished PDM from A&W. In PDM, the LP's expenses were linked with partnership units issued in exchange for financing (i.e., exempt supplies of financial services) rather than any commercial activities of the LP.14
Lessons from PDM
To justify their ITC claims, claimants need to structure their transactions appropriately. Ironically, while the LP and its legal counsel apparently took care to model the transactions in PDM after the structure in A&W,the LP's ITC claims were disallowed. While the Tax Court in PDM did distinguish the two decisions, to the extent that they do conflict, PDM would likely have greater precedential authority given that it was decided under the General Procedure (whereas A&W was decided under the Informal Procedure.)
In the appropriate case, section 185 of the ETA might prove useful to an ITC claimant. Where a non-financial institution registrant acquires business inputs directly linked to making exempt supplies, but "that relate to commercial activities of the registrant," the inputs are deemed to be acquired by the registrant "for consumption, use or supply in the course of those commercial activities" and, therefore, eligible for ITC claims pursuant to section 169 of the ETA.15
The principles enunciated in PDM go beyond the context of IPOs and other means of raising capital for business ventures. For example, as a matter of ordinary business practice, borrowers reimburse their lenders' legal expenses. If the borrower indemnifies the lender for these expenses, but has no direct liability to the lenders' legal counsel, then the borrower would apparently be ineligible to claim ITCs to recover the GST/HST payable on the lender's legal fees.
If, on the other hand, the borrower enters into a 3-way agreement with the lender and its legal counsel to pay the legal fees of the lender's counsel directly, then it is possible that the borrower could access ITCs to recover the GST/HST payable on the legal fees (assuming that the borrower is engaged in a "commercial activity"). Such structuring could result in the borrower being considered (1) to be the "recipient" of the legal services supplied (by the lender's legal counsel) and (2) to acquire such legal services. The 3-way agreement would need to take into account special considerations, such as the protection of solicitor-client privilege between the lender and its legal counsel.
Footnotes
1 A&W Trade Marks Inc v R, 2005 CarswellNat 2815, 2005 TCC 493, [2005] GSTC 149 (TCC [Informal Procedure]).
2 PDM Royalties Limited Partnership v R, 2013 Carswell Nat 3090, 2013 TCC 270, [2013] GSTC 105 (TCC [General Procedure]).
3 Under subsection 123(1) of the ETA, a "commercial activity" means inter alia a business carried on by a person, except to the extent to which the business involves making exempt supplies by the person. In addition, if the person is an individual, a "personal trust" or a partnership with only individuals as partners, the business must be carried on with "a reasonable expectation of profit" to constitute a "commercial activity".
4 General Motors of Canada Limited v R, 2008 CarswellNat 454, 2008 TCC 117, [2008] GSTC 41, at paragraph 30 (TCC [General Procedure]), affirmed 2009 CarswellNat 880, 2009 FCA 114, [2009] GSTC 64 (FCA).
5 Supra, footnote 3.
6 Definition of "recipient" in subsection 123(1) of the ETA, notably in paragraph (a).
7 Supra, footnote 2, paragraph 31.
8 Supra, footnote 2, paragraph 29.
9 Supra, footnote 2, paragraph 34.
10 Supra, footnote 2, paragraph 42.
11 Supra, footnote 2, paragraph 43.
12 Supra, footnote 2, paragraph 45.
13 Supra, footnote 2, paragraph 46.
14 Ibid. Consider whether paragraph 185(1)(b) of the ETA could have deemed the expenses to be for consumption, use or supply in the claimant's commercial activities and, therefore, eligible for ITC claims. This point is discussed further in the last Section of this article.
15 In Mac's Convenience Stores Inc. v The Queen, 2012 TCC 393, the Tax Court of Canada broadly interpreted and applied paragraph 185(1)(b) of the ETA to justify and allow the appellant's ITC claims.
The foregoing provides only an overview. Readers are cautioned against making any decisions based on this material alone. Rather, a qualified lawyer should be consulted.
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