Subsection 141.01(2) of the Excise Tax Act (“ETA”) deems a property or service acquired for use in a business to be for use in commercial activities only to the extent that it is used in the making of taxable or zero-rated supplies. On the other hand, subsection 141.1(3) provides that any action of a person in connection with the acquisition, establishment, disposition, or termination of a commercial activity is deemed to occur in the course of commercial activities. An apparent conflict therefore exists where a property or service is acquired by a registrant in connection with the acquisition, establishment, disposition or termination of a commercial activity, but where taxable supplies have not yet been made or have ceased: a registrant is deemed to have incurred the property or service in the course of commercial activities by subsection 141.1(3), but also deemed to have incurred same in the course of non-commercial activities by subsection 141.01(2).

The Federal Court of Appeal (“FCA”) resolved the aforementioned conflict in ONEnergy Inc. v. Canada, 2018 FCA 54 (“ONEnergy”). In that case, the Registrant carried on a telecommunications business until 2009 when it sold its spectrum and CRTC broadcast licence (the “Sale”). This effectively terminated the Registrant’s telecommunications business and its making of taxable supplies for GST/HST purposes.

In July 2011, after part of the Sale proceeds were used to cancel share options and share appreciation rights and pay bonuses to select directors, executives, shareholders, and employees (the “Former Executives”), the Registrant, on its shareholder’s behalf, filed a lawsuit for breach of fiduciary duty and misappropriation of the proceeds against the Former Executives. This led to considerable litigation costs in respect of which the Registrant was charged GST/HST and claimed input tax credits (“ITCs”).

After a dispute arose with the CRA over whether the litigation costs were incurred in the course of a commercial activity (as required to claim ITCs under subsection 169(1)), a rule 58 motion was brought before the Tax Court of Canada (“TCC”) to determine whether the litigation costs were incurred in the course of a commercial activity per paragraph 141.1(3)(a).

The TCC (2016 TCC 230) found the litigation costs were “personal” and not incurred in the course of a commercial activity per paragraph 141.1(3)(a)

On the appeal, the FCA disagreed with the TCC’s characterization of the litigation costs as “personal”. On the contrary, the FCA viewed the litigation costs as “a claim for overpaid remuneration” that were not “personal” since the remuneration would have been paid for services rendered as part of the Registrant’s commercial activities or the termination thereof.

In regards to the conflict between subsection 141.01(2) and subsection 141.1(3), the FCA found that as a more specific provision, the latter overrode the former. As such, while subsection 141.01(2) applies generally, the FCA held that where a property or service is acquired in a scenario where subsection 141.1(3) applies, a registrant “will not lose the entitlement to claim an input tax credit solely because that person is not making any taxable supplies at the time that such property or service is acquired”.

The FCA ultimately found a sufficient connection between the litigation costs and termination of commercial activity to permit ITCs to be claimed. In particular, it held that since the litigation was in respect of overpaid remuneration for services rendered by the Former Executives while the Registrant was still making taxable supplies, there was a clear connection between the litigation and the termination of commercial activity.

The FCA’s conclusion that where subsection 141(1)(3) applies a “person will not lose the entitlement to claim ITCs solely because that person is not making any taxable supplies at the time that such property or service is acquired” is important as ensures that Canadian businesses, particularly start-ups, are treated fairly and not subject to cascading tax (which would, for example, occur if ITCs were delayed at the start-up of a business).

Do you require assistance in this area? If so, contact us here.

Want a PDF copy of this blog?