British Columbia Ferry Services Inc v. The Queen

British Columbia Ferry Services Inc v. The Queen
Court (s) Database
Tax Court of Canada Judgments
Date
2014-10-14
Neutral citation
2014 TCC 305
File numbers
2008-1600(GST)G, 2013-4206(GST)G
Judges and Taxing Officers
Diane Campbell
Subjects
Part IX of the Excise Tax Act (GST)
Decision Content
Dockets: 2008-1600(GST)G
2013-4206(GST)G
BETWEEN:
BRITISH COLUMBIA FERRY SERVICES INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
Appeals heard on June 3, 4, 5 and 6, 2014
at Nanaimo, British Columbia
Before: The Honourable Justice Diane Campbell
Appearances:
Counsel for the Appellant:
Kimberley L. Cook
Asif Abdulla
Counsel for the Respondent:
Ron D.F. Wilhelm
Michael Taylor
JUDGMENT
The appeals from assessments made under Part IX of the Excise Tax Act, for the period from April 2, 2003 to June 30, 2005 and the period of March, 2007 are allowed, in part, and the assessments are referred back to the Minister of National Revenue for reconsideration and reassessment based on the following:
1. British Columbia Ferry Services Inc. (“BCF”) is entitled to claim ITCs in accordance with its chosen “deck by deck” input allocation method, that is, the infrastructure decks, used for steering and propulsion, on those vessels carrying on commercial activities, have been properly categorized as supporting both taxable and exempt supplies.
2. The provision of stateroom rentals is a taxable supply for which ITCs may be claimed. In addition, because the normal reassessment periods have expired, BCF’s claim for ITCs regarding stateroom rentals cannot be offset by the Minister in respect to the GST that BCF failed to collect.
3. BCF is not entitled to claim ITCs in respect to fuel and lubricants.
4. BCF is not entitled to any of the ITCs claimed in respect to the acquisition and importation of the vessel “Northern Adventure”.
As success is divided, there shall be no award of costs.
Signed at Ottawa, Canada, this 14th day of October 2014.
“Diane Campbell”
Campbell J.
Citation: 2014 TCC 305
Date: 20141014
Dockets: 2008-1600(GST)G
2013-4206(GST)G
BETWEEN:
BRITISH COLUMBIA FERRY SERVICES INC.,
Appellant,
and
HER MAJESTY THE QUEEN,
Respondent.
REASONS FOR JUDGMENT
Campbell J.
Introduction [1] British Columbia Ferry Services Inc. (“BCF”) operates and administers one of the largest and most complex fleet of ferries in the world, based on the number of passengers transported annually and the supporting transportation infrastructure (Exhibit A‑1, Tab 2). On some of its routes along the British Columbia coast, it provides the service of ferry transportation only, which is an exempt supply. On other routes, along with this core ferry service, BCF also provides certain commercial or ancillary services which are taxable supplies.
[2] The ancillary services include the following:
10. …
a. Catering (buffet restaurants, snack bars, cafeterias);
b. Specialty lounges (eg. The Seawest Lounge, and the Raven??? [sic] Lounge on the Northern Routes);
c. Retail store;
d. Massage chairs;
e. Stateroom rentals (northern vessels and spirit class);
f. Conference room rentals;
g. Vending machines (throughout the fleet);
h. Video arcades;
i. ATM machines, and,
j. Third party advertising.
(Appellant’s Brief, Part 1, paragraph 10)
[3] BCF is entitled to claim input tax credits (“ITCs”) but only to the extent they are used in the course of providing those taxable supplies, the ancillary commercial activities. However, the Minister of National Revenue (the “Minister”) took issue with how BCF allocated certain inputs between the provision of its exempt and taxable supplies. The monthly Goods and Services Tax (“GST”) reporting periods that are in issue are those periods from April 2, 2003 to June 30, 2005 (the “First Period”) and the period of March, 2007 (the “Second Period”) (collectively the “Periods”).
[4] There are several issues which arose in these appeals. The first related to the categorization of the infrastructure decks and staterooms located on some of the ferries. While the Minister categorized these as exempt supplies, BCF treated the propulsion and steering-related decks, as well as those decks containing the overnight staterooms, as providing a common service that would be both taxable and exempt. As well, BCF categorized the stateroom deck on the vessel, the Northern Adventure, as taxable. The ITCs which BCF claimed, in respect of fuel and lubricants, were also an issue. BCF submitted that fuel is a common input, acquired and consumed in the provision of both taxable and exempt supplies. The Minister contended that substantially all of the fuel and lubricants were acquired and consumed to provide ferry transportation, an exempt supply. Finally, BCF claimed ITCs, equal to 100 percent of the GST paid in the acquisition and importation of the Northern Adventure vessel, because it calculated that over 50 percent of the vessel’s area was used in making a taxable supply. The Minister submitted that this vessel was acquired primarily to provide exempt ferry transportation and, therefore, BCF is not entitled to any of the ITCs it has claimed.
The Facts [5] The parties submitted an Agreed Statement of Facts, which I have attached as Schedule “A” to these reasons.
A. BCF [6] BCF provided core ferry services for vehicles and passengers on 25 routes, along the coast of British Columbia, supported by 37 vessels and 47 terminals.
[7] From 1977 until April 2003, BCF existed as a provincial Crown corporation which was not assessed GST. On April 2, 2003, BCF was incorporated by way of statutory conversion pursuant to the Coastal Ferry Act, [SBC 2003] C. 14, (the “CFA”). This act redefined the legislative framework for the operation of the Province’s ferry system. When BCF was converted to a company under the Business Corporations Act (British Columbia), it became liable to pay federal taxes, including GST.
B. The British Columbia Ferry Authority [8] Under the CFA, the British Columbia Ferry Authority (the “BCFA”), a no-share capital corporation and not-for-profit entity, was established. The directors of BCFA also served as directors of BCF. Consequently, BCFA owns and controls BCF. Upon dissolution of the BCFA, all of its assets, if any, would vest in the Province. BCFA’s annual reports and general meetings were required to be open to the public.
[9] Under provincial law, the activities of BCF are separated in respect to the core provision of ferry services and the provision of ancillary commercial services on some vessels. The CFA defines ferry transportation services as “the transportation of vehicles and passengers on designated ferry routes” but specifically excludes ancillary services from this definition (CFA, Part 1 – Interpretation). The regulatory scheme, provided for in the CFA, applies only to the core ferry service that BCF provides, but does not apply to the ancillary services provided. This was in keeping with the reasons respecting the transition of BCF from a Crown corporation to a private corporation which required BCF to operate the ferry service system in a commercially viable manner.
C. The Coastal Ferry Service Contract [10] BCF operates in a highly-regulated environment. When the BCF was incorporated in 2003, it entered into the Coastal Ferry Services Contract (the “Contract”) with the Province. This Contract regulated the operation and the activities of the Province’s ferry system and provided for the payment by the Province of service fees to BCF in exchange for, among other things, the provision of core ferry service levels. Under the CFA, BCF was required to operate its ferry services according to commercially viable principles. Consequently, although BCF was to be independent from government, it was required to operate on a commercial basis. (the Contract, page 1). This Contract also contained a number of prohibitions. BCF could not, without the Province’s consent, adjust the ferry schedule, adjust core service levels or assign the Contract. If for any reason the Contract was terminated, any rights granted to BCF under the Contract, or the CFA, vested in the Province.
D. The British Columbia Ferries Commissioner [11] Under the jurisdiction of the CFA, the provincial British Columbia Cabinet appointed a Commissioner to regulate BCF’s provision of core ferry services and to establish a price cap on the tariffs that could be charged for such services. The Commissioner, however, had no regulatory powers over the ancillary services provided by BCF, although he possessed extensive powers otherwise to regulate BCF’s ferry transportation services. In summary, the provision of these core ferry services is subject to, not only the Provincial statute, the CFA, but also, its provincially owned parent, the BCFA, the terms of the Contract with the Province as well as the regulation of its watchdog, the Commissioner. Although the BCF provides ancillary commercial services onboard some of its vessels, which are meant to subsidize the core ferry transportation services, the Commissioner is specifically prohibited from regulating these ancillary services. Generally, BCF is entitled to claim ITCs for GST paid on its inputs to the extent that those were acquired for consumption, use or supply in the course of its ancillary or commercial activities.
E. BCF’s Allocation Method [12] To the extent that an input was used directly and exclusively in BCF’s commercial activities, it was entitled to claim a full ITC. Similarly, where an input was used directly and exclusively in BCF’s exempt activities, it was not entitled to claim any ITCs. Where BCF was unable to directly attribute its inputs to taxable supplies, it was entitled to choose a “fair and reasonable” method to allocate common ITCs between taxable and exempt supplies. Initially, between April 2, 2003 and May 31, 2005, BCF employed the output method to calculate the percentage of its operations that related to taxable supplies in order to determine its ITC entitlement. This method “… prorated the amount of taxable revenue from ancillary services against the exempt Core Ferry Service revenue on each route. These amounts were then prorated in totality to determine an overall percentage which was then applied to inputs associated with general operating expenses (eg. head office, etc.)” (Appellant’s Brief, paragraph 61).
[13] In 2005, and upon the advice of a tax consultant, BCF switched its ITC allocation method to the input method. Where possible, BCF directly attributed what it considered to be single-use inputs to either exempt or taxable supplies. BCF attributed the cost of goods sold in food and retail operations, catering supplies and expenditures related to food and retail services together with paid terminal parking to its taxable activities for which it claimed and was allowed 100 percent of ITCs on which GST had been paid. BCF then calculated a taxable supply percentage for each vessel and each terminal in order to allocate non‑single use, or common, inputs between taxable and exempt activities. The various decks on the relevant vessels and the areas at each terminal utilized by BCF were classified into one of three categories: exempt areas, used only in the making of exempt supplies, taxable areas, used only in the making of taxable supplies and common areas, used in the making of both taxable and exempt supplies.
[14] In respect to the terminals, BCF measured the area that was devoted to each of these three categories. Areas with paid parking, retail and restaurants were categorized as taxable while the ramp areas and holding areas for cars and passengers were determined to be exempt. The terminal areas relating to administration and electrical buildings, as well as employee parking areas, were categorized as common. There was no dispute respecting BCF’s entitlement to ITCs using this method of allocation in respect to its terminals.
[15] The percentage of taxable use on ferries was calculated using a “deck by deck” method. Each vessel deck was categorized as belonging to one of the three categories, that is, exempt, taxable or common, and then the entire area of that deck was attributed to that particular category.
[16] The Minister did not dispute the “deck by deck” method as being fair and reasonable. The issue arose over how BCF categorized some of the decks on certain vessels.
[17] There is no dispute respecting BCF’s categorization of the car decks as exempt or the passenger decks, where ancillary services occurred, as taxable. However, the dispute arose over the categorization of the infrastructure and stateroom decks.
F. Classification of Infrastructure and Stateroom Decks [18] BCF categorized those decks containing the infrastructure, that is, the propulsion and steering, as common because they constituted both a direct and indirect input to the provision of ancillary services. The provision of staterooms was treated as part of a taxable supply. The Minister contended that BCF’s categorization was neither fair nor reasonable and that all decks in issue provide exempt services related to the core ferry services for which no ITCs can be claimed.
[19] BCF calculated a percentage of each vessel and terminal used in the making of taxable supplies using the following formula:
total taxable area in square metres
x 100
total area – total common area
(Agreed Statement of Facts, para 71)
[20] Based on this formula, BCF calculated that 13 vessels and 11 terminals had taxable use percentages of less than 10 percent. Therefore, BCF was not entitled to claim any further ITCs beyond those in its direct attribution claims. For the remaining ferries and terminals, BCF claimed ITCs based on the taxable use percentages that it calculated for each according to the formula.
G. Fuel and Lubricants [21] BCF submitted that fuel consumption serves a dual purpose. In addition to propulsion of the vessels, fuel supports the provision of ancillary services because those commercial activities require additional weight and space onboard the vessels. Therefore, not all fuel is used for propulsion. Consequently, since fuel and lubricants can be viewed as common inputs in the provision of both taxable and exempt supplies, BCF claimed ITCs proportional to the percentage of commercial activity on each vessel.
[22] The Minister’s position was that these items constitute a single use input, substantially all of which is consumed in the propulsion of the vessels and, therefore, they relate to the provision of exempt ferry transportation services.
H. The Importation of the Northern Adventure [23] When the Queen of the North vessel sank in March, 2006, BCF commenced a search for a replacement vessel to service its northern routes. Without another vessel, BCF could not meet its contractual obligations with the Province to provide core ferry service levels. In July, 2006, BCF requested and obtained from the Commissioner a declaration respecting the expenditure of $233 million for a replacement vessel. In October, 2006, the Northern Adventure vessel was acquired from a company outside of Canada.
[24] The parties agreed that the Northern Adventure was a capital asset that was to be used on the northern routes. When a registrant imports a capital asset, it may claim 100 percent of the related GST as ITCs provided the asset is acquired for use “primarily” in its commercial activities. However, if it is acquired and imported “primarily” for use in exempt activities, then ITCs cannot be claimed.
[25] The Northern Adventure was purchased for $51 million and imported into Canada in March, 2007. BCF paid approximately $13.1 million in customs duty and $3.9 million in GST. BCF applied for and received remission from the Federal Government in respect of the customs duty. BCF claimed ITCs of $3.9 million because it claimed that the Northern Adventure was imported primarily for use in its commercial activities on the basis that, pursuant to the allocation method calculation, over 50 percent of the vessel’s space was used in the making of its taxable supplies. The Minister’s position was that this vessel was imported for use primarily in the provision of exempt ferry transportation services and therefore no ITCs could be claimed.
The Evidence [26] BCF relied on the testimony of James Murray, its Comptroller, and Mark Collins, its Vice-President of Engineering. Both individuals have held these positions since 2004. The Respondent relied on the testimony of Richard Young and Annette Coles, the auditors responsible for the audits of the First Period and Second Period, respectively.
[27] Mr. Murray explained that BCF’s conversion from a Crown corporation was meant to address the manner in which BCF undertook capital expenditures in the ferry transportation system. As a Crown corporation, it was not conducive to expanding its capital spending as it was competing for funding with other provincial priorities, such as health care, which were considered more pressing matters for government to address. Throughout the Periods under appeal, revenue had increased, with much of it attributable to the ancillary services. For example, revenue from retail sales in the fiscal year ending March 31, 2006 grew to $68.8 million from $63.2 million in 2004 (Exhibit A-1, Tab 4). The significant role that ancillary services played in BCF’s operations is reflected in the number of staff dedicated to the provision of these services. “In any given year, approximately one-half of the total number of crew members on the vessels deployed on substantial commercial routes, are engaged directly and exclusively in the provision of commercial services.” (Exhibit A-4, Tab 8).
[28] Mr. Murray explained the nexus between propulsion of the vessels and their commercial activities carried out onboard in the following manner:
If the ship does not move customers will not come. We will not sell anything on board our ships or at our terminals.
(Transcript, Volume 1, page 95)
Essentially, the movement of vessels on the routes provides BCF with a high customer turnover, creating a captive market on board the vessels while they are sailing. These factors boost sales of ancillary services that are offered on some vessels. As a consequence of this nexus, BCF’s allocation method categorized all infrastructure decks as common, although Mr. Murray acknowledged that no commercial activities actually occurred on those decks (Transcript, Volume 2, page 193).
[29] According to Mr. Murray, this nexus between propulsion of the vessel and commercial activity was also the reason BCF claimed ITCs on fuel and lubricants, BCF’s largest input cost for operating its vessels, apart from wages:
Well, we’ve – we’ve claimed input tax credits and fuel and lubricants because of the importance of the – of the - the fact that the vessel moves from Point A to Point B. Without that movement no customers. Without that movement we do not sell.
(Transcript, Volume 1, page 92)
[30] On cross-examination, however, Mr. Murray conceded that the primary use of the fuel was to propel the ferries (Transcript, Volume 2, page 201).
[31] In respect to the stateroom rentals, Mr. Murray testified that they were not part of the ferrying services and were not charged to passengers as part of the cost of basic service for ferrying:
… It’s an extra charge. Those charges are not regulated by the ferry’s commissioner so it’s not part of core ferry services, its ancillary service.
… the purchase of a cabin is totally optional.
(Transcript, Volume 1, page 96)
[32] The testimony of Mark Collins was largely technical. He stated that the design and operation of the BCF vessels in issue are inextricably linked to the level of ancillary services on board each vessel. Ancillary services make the design and operation of a vessel exponentially more complex. Invariably, vessels get larger, heavier and their systems more complex in order to accommodate ancillary commercial services. For example, the water and electrical systems on a vessel with significant ancillary services will be much larger and heavier than the same systems on those vessels without commercial activities. Consequently, more fuel will be consumed on vessels with ancillary operations because such activities consume more energy.
[33] However, Mr. Collins acknowledged that individual fuel consumption of a particular component or system within the engine room would be difficult to determine. No breakdown method exists that can be used in the calculation of how much fuel might be consumed by ancillary services.
[34] On cross-examination, Mr. Collins admitted that the primary use of the infrastructure decks was to provide transportation. Nevertheless, his evidence established that, to some extent, those decks do play a role in supporting the ancillary services aboard each vessel.
[35] Richard Young, the auditor for the First Period, testified that the infrastructure decks are properly characterized as exempt because the entire infrastructure would exist regardless of the vessel’s commercial activity. Annette Coles was the auditor for the Second Period and specifically in respect to the importation of the Northern Adventure. It was her position that this vessel had been acquired to satisfy the terms of the Contract, that is, the provision of ferry services, even though taxable activities occurred on the vessel.
The Issues [36] The first issue is whether BCF used a fair and reasonable method to allocate ITCs between its taxable and exempt supplies in respect to its infrastructure decks for the First Period. This issue involves a determination of whether infrastructure decks should be characterized as common in that they provide both taxable and exempt supplies. In addition, it must be determined if rental of the staterooms can be characterized as taxable. If they are taxable, then as a sub issue to the stateroom characterization, the Respondent has taken the position that any claim by BCF for ITCs should be offset by the GST that BCF failed to collect.
[37] The next issue is whether BCF is entitled to ITCs in respect to fuel and lubricants consumed in the operation of the vessels in respect to the First Period. A determination respecting fuel and lubricants is dependant on whether “substantially all” of the fuel and lubricants was acquired and consumed by BCF to provide only an exempt supply or to provide both taxable and exempt supplies.
[38] The final issue is whether BCF is entitled to ITCs in respect to the acquisition and importation of the Northern Adventure vessel. This involves a determination of whether that vessel was imported for use “primarily” for commercial activities, as quantitatively calculated by BCF’s “deck by deck” allocation method, or imported for use primarily in providing exempt ferry transportation services.
Analysis A. Statutory Framework and Caselaw [39] The issues in these appeals are governed primarily according to the application of the following provisions of the Excise Tax Act (the “Act”): subsection 169(1), section 141, section 141.01 and paragraph 199(2)(a). As well, the definitions of “commercial activity”, “exempt supply” and “short term accommodation”, contained in section 123, are also relevant. The Appellant also relied on Schedule V, Part VIII, paragraph 1 in respect to its position on the acquisition of the Northern Adventure vessel.
[40] There are a number of provisions contained in the CFA that are also applicable to the issues.
[41] The GST is considered to be a consumption tax which is meant to be paid by the end consumer of the goods and services. Subsection 165(1) is the key liability provision in this regard. In CIBC World Markets Inc. v The Queen, 2011 FCA 270, [2011] FCJ No. 1378, at paragraphs 7 to 15, the Court provided a review of the general scheme and purpose of the GST provision contained in the Act:
(2) The key liability provision: subsection 165(1) of the Act
[7] Subsection 165(1) of the Act sets out a general rule: those who receive services or property, such as goods, in the course of a commercial activity (known under the Act as a “taxable supply”) are liable to pay GST.
(3) Who is subject to GST
[8] The general rule in subsection 165(1) of the Act applies to all, even those who are not final consumers.
[9] In particular, each recipient of taxable goods and services is potentially liable to pay GST, even if it, as an intermediary, ultimately delivers those goods and services to others. For example, a wholesaler may supply goods to a retailer who supplies them to a consumer. The retailer is liable to pay GST under the general rule in subsection 165(1).
[10] Were the matter left there, the GST would lose its character as a consumption tax imposed on the final consumers of goods and services. It would attach, full force, to each party in a chain of transactions culminating in the final receipt by consumers.
(4) Input tax credits: the general concept
[11] One way in which the Act prevents this consequence is by giving parties credits for “inputs” that they receive.
[12] For example, for the purpose of the selling of goods to consumers, a retailer might receive “inputs,” such as inventory. That “input” to the retailer is necessary in order for it to make a supply of the goods to the consumer. Depending on the particular business, there may be all sorts of necessary “inputs.”
[13] Obviously, if, in the example above, the retailer were not given credit for the GST paid on inputs needed for the making of a taxable supply of goods to a consumer, the GST would be imposed full force on it and, for that matter, on every intermediary in the chain of distribution. If that happened, the GST would lose its character as a consumption tax imposed on the final consumer of goods and services.
[14] To achieve the purpose of taxing the final consumers of goods and services, the Act allows tax credits for inputs received by parties to make an onward taxable supply. These credits are called input tax credits.
[15] The input tax credits, as explained above, ensure that the fundamental character of the GST as a consumption tax on final consumers is maintained. In the words of the Minister: (Canada Revenue Agency, GST Memorandum 8.1 - General Eligibility Rules (May 2005) at paragraph 1)
A fundamental principle underlying the GST/HST is that no tax should be included in the cost of property and services acquired, imported or brought into a participating province by a registrant to make taxable supplies … in the course of the commercial activities of the registrant. To ensure that a property or service consumed, used or supplied in the course of commercial activities effectively bears no GST/HST, registrants are generally eligible to claim an input tax credit (ITC) for the GST/HST paid or payable on such property or service. Consequently, the ITC enables each registrant to recover the tax incurred in that registrant’s stage of the production and distribution process.
[42] The general rule contained in subsection 165(1) applies to all registrants, even to intermediaries who are not the final consumers. For example, a wholesaler may supply goods to a retailer, who is liable to pay GST, but who in turn will be supplying those goods to a consumer. To retain the character of the GST as a consumption tax in respect to the final consumer of the product or service, the Act allows tax credits for “inputs” received by parties in order to make an onward supply. The general rule for calculation of ITCs is contained in subsection 169(1) of the Act. Essentially, if a registrant supplies only taxable services, that registrant will be entitled to 100 percent of ITCs used or consumed in the provision of that supply. If only exempt supplies are made, ITCs cannot be claimed.
[43] The additional scenario that may arise is the case of a registrant that makes both a taxable and exempt supply. Since a claim may still be made for ITCs in respect to those goods and services required and used for making the taxable supply portion, the Act allows a registrant to adopt an apportionment or allocation method. This means that any part of a business that consists of making exempt supplies must be “notionally severed” for GST purposes. Subsection 141.01(5) allows registrants to freely adopt a method provided it is “fair and reasonable” and “used consistently by the person throughout the year.” Although the Act does not offer any guidelines in respect to choosing an allocation method, it is clear that not all methods will be acceptable depending on the circumstances, including the intent and purpose for which the input was acquired. This clearly comes down to a question of fact.
[44] There are also two deeming provisions in respect to claims for ITCs that are relevant. First, pursuant to section 141, if substantially all of the consumption of property or a service is used or intended to be used in a particular activity, taxable or exempt, then the Act deems all of the property to be in the course of those activities. The view of the Canada Revenue Agency (“CRA”) is that the term “substantially all” means 90 percent or more. Generally, if 90 percent is used or intended to be used in either taxable or exempt activities, then it will be deemed to be used in 100 percent of that activity. Second, subsection 199(2) overrides subsection 169(1) in respect of ITCs claimed for the acquisition or importation of capital property. If such property is acquired or imported “primarily” for use in commercial activity, the registrant is entitled to claim all of the ITCs. If not, the registrant will be entitled to none. “Primarily” has been interpreted to mean either “more than 50 percent” or “first in importance.”
[45] In Magog (City of) v The Queen, 2001 FCA 210, [2001] FCJ No. 1259, Noël J. held that, although the Act does not specify a specific allocation method in respect to subsection 141.01(5), a registrant will be permitted to select a method to allocate ITCs provided it is fair and reasonable. At paragraph 17, the following comments were made:
[17] It is important in this regard to note that the Act does not require the appellant to establish the type of accounting systems that would enable it to separate out each property or service that is consumed or used in the context of its mixed activities. Parliament was aware that such a requirement could result in compliance expenses that would exceed the tax yielded. So it left it to the taxpayer to select an appropriate method, while requiring that the method chosen be “fair and reasonable”.
[46] The only prerequisite is that the chosen method be fair and reasonable having regard to all of the circumstances. However, there is no requirement that a registrant pick the “best” available allocation method. These principles were discussed in detail in Bay Ferries Limited v The Queen, 2004 TCC 663, [2004] TCJ No. 507. In that case, the appellant maintained a ferry operation similar, but not identical, to the vessels in the present appeals. The Court in Bay Ferries made the following comments, at paragraphs 39 to 41:
[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.
[47] In concluding in Bay Ferries that the appellant’s method of allocating between taxable and exempt activities was fair and reasonable, four guiding principles for such a determination were established. First, whether a particular allocation method chosen by a registrant will be fair and reasonable is a question of fact (paragraph 6). Second, and relying on the Magog decision, the Court does not have to decide whether the best or most appropriate method has been chosen by the Minister or the taxpayer, but simply whether the method chosen by the taxpayer is fair and reasonable (paragraph 37). Third, a degree of deference is to be accorded to the taxpayer in choosing a method that is fair and reasonable as well as consistent (paragraph 39). Fourth, regardless of such deference, a registrant must always be able to satisfactorily substantiate that the chosen method is, in fact, fair, reasonable and consistent. The chosen method must reasonably reflect the actual use of the property and services and the manner in which it conducts its business activities generally (paragraph 40).
[48] The Court, in Îles-de-la-Madeleine (Municipalité régionale de comté) v The Queen, 2006 TCC 235, [2006] TCJ No. 166, relied on the reasoning in Magog and Bay Ferries in concluding that a chosen method need not be a perfect one and that it cannot be rejected solely on the ground that it is not the ideal method. The Court also noted that the assessment of the fairness and reasonableness of a method involves a “subjective dimension” (paragraph 78).
B. Infrastructure Decks [49] In respect to the appeals before me, the question is whether BCF’s categorization of the infrastructure decks is fair and reasonable. A fair and reasonable allocation method should realistically reflect the actual use of the property and services and the manner in which BCF conducts its business generally. Both the Appellant and Respondent agreed that the “deck by deck” method chosen by BCF is fair and reasonable. However, the parties disagreed on the classification of some of the decks, that is, whether it is fair and reasonable to consider the infrastructure decks, used for propulsion and steering, on those vessels providing commercial activities, as inputs in the provision of both taxable supplies and exempt supplies.
[50] BCF characterized the infrastructure decks as common and argued that there is a direct nexus between the propulsion activity and the commercial operations on each vessel. BCF’s view is that its operations are fully integrated but that the method it employed to apportion the supplies and claim ITCs resulted in a notional severance of the exempt portions that is both fair and reasonable in the resulting allocation. The propulsion of these vessels, therefore, does not occur in isolation from the commercial activities in which it engages.
[51] BCF conceded that it will not be entitled to ITCs on vessels where propulsion occurs in isolation from commercial activities. However, with respect to the vessels at issue, there exists this direct nexus between the ferrying transportation services and its taxable supplies.
[52] The Respondent submitted that BCF’s allocation method does not reasonably reflect the actual use of these infrastructure decks. Therefore, claims for ITCs in respect to these decks do not reasonably reflect their actual use or the manner in which BCF conducted its business operations. Mr. Murray agreed, on cross-examination, that no commercial activities were actually taking place on those particular infrastructure decks. Consequently, the Respondent submitted that they do not contribute to those activities and that their inclusion distorts the financial reality of those activities.
[53] BCF, on the other hand, relied on the evidence of Mr. Murray, who testified that the propulsion and steering support the onboard commercial activities by creating a high volume of customer turnover and a captive market. On that basis, BCF categorized all infrastructure decks on those vessels as common to both taxable and exempt activities because they are essential to move the commercial areas onboard.
[54] Subsection 141.01(5) addresses the allocation between taxable and exempt supplies for a registrant who engages in both activities. It is connected to subsection 169(1), which allows ITCs only to the extent that they were acquired for the consumption or use in the course of commercial activity. A method must be chosen that fairly, reasonably and consistently restricts the ITCs that are claimed to reflect those goods and services acquired for or used in the making of taxable supplies. That method must reasonably reflect the actual use of the property and services and the manner in which the business is conducted. In addition, it should not distort the financial reality of the commercial activity (Bay Ferries, at paragraph 40).
[55] An input, therefore, must contribute to the ultimate production of the taxable supply. The decision in Midland Hutterian Brethren v The Queen, [2000] FCJ No. 2098, dealt with the threshold level of contribution. The issue was whether a religious colony could claim an ITC for 50 percent of the GST incurred on cloth that was allocated to its members in order to make both church clothing and work clothing used in the colony’s commercial farming activities. The Federal Court of Appeal, in allowing the colony to claim an ITC for the work cloth, framed the issue, at paragraph 2, as follows:
… There is no dispute that the applicant carries on a commercial activity, that is farming, and produces non-exempt supplies. The disagreement is about whether the cloth was used in the course of commercial activities. The issue is one of remoteness. How closely tied to an output does an expense have to be before it qualifies for an ITC? (Emphasis added)
[56] Once it is determined that an item is acquired and used in connection with a commercial activity of a GST registrant and that item directly or indirectly contributes to the production of articles or the provision of services that are taxable supplies, then an ITC will be available using a formula in accordance with subsection 141.01(5) of the Act.
[57] While I agree with the Respondent that the primary use of those decks is for the propulsion of the vessels and that they support and are connected, therefore, to exempt services, the evidence was clear and uncontradicted that some portion of those decks is indirectly connected and necessary to BCF’s commercial activities conducted onboard the vessels. The evidence supports a conclusion that there is a nexus between the propulsion, steering and infrastructure decks and BCF’s commercial activities. The ancillary services onboard could not occur without the support of the equipment and systems located on the infrastructure decks. The uncontradicted evidence, of both Mr. Murray and Mr. Collins, established that the decks in issue support the entire vessel and not just the act of propulsion. Most of the decks in issue are located below the passenger decks on each vessel. While these decks on all vessels will contain water, sewer and heating systems, the evidence supports that, on those vessels where commercial activities occur, those systems are specially designed and scaled in size and weight to support the additional requirements of those operations. Such vessels are either specifically built or purchased with these particular structural designations in place so that the commercial activities can be properly supported. The greater the scale of commercial activities on a vessel, the greater the requirement will be for it