Services or Rentals of Goods ?   Substance over Form in Ontario RST.

(As originally published in GST & Commodity Tax Journal, July 2005)

In an interesting Ontario retail sales tax (“RST”) case, the Ontario Courts have dealt with the troubling line between the provision of taxable personal property (“TPP”), and the provision of non-taxable services, and in doing so, has demonstrated that the “substance over form” approach to tax interpretation is alive and well in Ontario .

By way of background, where there is a rental of TPP in Ontario , the vendor is required to charge and collect Ontario tax from its customers, based on the full fair value of the charges for the goods.  ( Ontario generally takes that as the full contract price, including many incidental charges that most persons might view as escaping taxation).  Where equipment comes with a skilled operator, the issue becomes whether there is still a taxable rental, or whether what is being acquired is really a non-taxable service, with the vendor being relieved from collecting any RST (but required to self-assess RST in respect of the cost of that TPP).  Generally speaking, it is advantageous to position a contract as a provision of “non-taxable services”, since the total RST burden on the transaction would be minimized (and held to the cost value, to the vendor, of the required equipment).  

This tension was in place in the recent case of Spie Construction Inc. v. Ontario (Minister of Finance, [2005] O.J. No. 2291 (Ont. Sup. Ct. Jus.).

In the case, the purchaser was Spie Construction, and was engaged in pipeline construction.  It acquired the services and related equipment of qualified welders and journeymen (“Welders”), by entering into separate labour and rental agreements with the Welders, signing an “Employee Sign On” form and Equipment Rental Agreement respectively.  Not having being charged any RST by the Welders, Spie self-assessed and remitted RST on amounts paid to Welders for the equipment acquired (apparently on the basis that the Welders ought to have charged that RST to Spie, and as the “purchaser” of the same, Spie was lawfully liable to pay that RST.)  Spie later concluded that it had made a mistake and applied for a refund of that RST, totaling some $200,000.

Ontario disagreed, taking the position that since Spie treated the Welders as employees, and had separate Equipment Rental Agreements, Spie could not be purchasing non-taxable services; it was acquiring taxable TPP, and had correctly self-assessed the RST.  (In doing so, Ontario seemed to go against its well-established policy that where one acquired equipment “with an operator”, one is really acquiring a non-taxable service, with the supply of the TPP/equipment being incidental to the provision of the services.  Ontario , however, seemed to be relying on the actual agreements in place between the parties.)

The Ontario Superior Court ultimately found in Spie’s favour, basing a significant portion of its analysis on the fact that the ‘separate agreements approach’ was due to  union requirements (Spie being forced to adhere to the collective agreement between the Pipeline Contractors Association of Canada, of which it was a member, and the Plumbing and Pipefitting Industry of the United States and Canada, and practice within the inductry), and concluding that in substance, the agreements ought to be characterized somewhat differently. 

Specifically, the Court found that the Welders were independent contractors regardless of how they were labeled for internal accounting purposes: each was hired on a project by project basis; the contracts were short term; there was no guarantee of being hired for the next project; the welders were free to quit at any time; the welders owned their equipment which was worth a substantial sum ($75,000 approx.), and the welder was responsible for its financing, repair, fuel, licensing and insurance; the welder had discretion over the make and model of equipment, its repair and maintenance; Spie only told the welders what work to do and not how to do it, as long as their product met the standards of workmanlike manner; the welders supplied their own work clothing; and ran the risk of profit/loss as evidenced by their ability to negotiate performance bonuses based on timely completion or bare the cost of transporting their equipment to the site if they failed the initial welding test or failed to remain on the project for an initial number days.

Next, the Court concluded that there also could not have been a “rental” of equipment since the Welders brought their own equipment, and maintained exclusive control over it.  They could also part with their equipment at any time; would not have provided equipment to Spie without their services being engaged as well; and would not have allowed use by any other welder or employee of Spie of their equipment. Thus, the essential element of exclusive possession, use, and quiet enjoyment by Spie did not exist and it was never Spie’s intention to rent equipment, but rather to have welding completed.

By way of commentary, there seems to be a definite tension between the results of the case, and commentary in the Supreme Court (in cases like Shell) which suggests that once a taxpayer makes a choice as to the legal relationships that it would like to create, those legal relationships are the ones that will govern the application of applicable taxes.  Thus, if Spie wanted to separate out the services from the equipment, why should it not pay tax ? 

The Minister in fact made this argument, arguing that “a taxpayer cannot structure its affairs in one manner and then argue that it is entitled to a tax benefit if it had structured its affairs in a different manner” – perhaps a bit of the latin doctrine verba chartarum fortius accipiuntur contra proferentem (essentially, ‘The words of written documents are construed more forcibly against the party using them.’)

The other side of the coin, however, which is ably reflected in the Court’s conclusions (and other comments) is that in some instances, taxpayers may simply be incapable of creating the legal relationships it intends to; thus Spie was incapable, given the actual facts of the situation, of creating an “employment” relationship with the Welders, or of “renting” their equipment.  The Spie case thus stands as an excellent example of the “substance over form” concept in action.

The one area not addressed by the Court is the ultimate application of the RST to the equipment in question.  It does not go simply un-taxed.  In all likelihood, it will be the poor Welders that are left to purchase the equipment on a taxable basis, and incur that RST burden themselves.  There is also an open question as to whether the results of the case left the poor Welders holding the tax-bag, since it is conceivable that most would have purchased the equipment on an exempt basis, in the view that they would be re-selling it (by way or rental) to Spie.  The result of the Spie decision seems to be to clarify that the initial acquisition of the equipment by the Welders is in fact a taxable event, and RST is payable on those transactions by the Welders ... who are thus left holding the bag.

Author:

Robert G. Kreklewetz

Millar Kreklewetz LLP

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