When is an allocation of costs amongst supplies “fair and reasonable” for calculating input tax credits (“ITCs”)? In Marine Atlantic Inc. v The King (2023 TCC 95), the Tax Court confirmed that a “fair and reasonable” allocation:
- is based on the facts and supported by evidence;
- accurately reflects the economic realities of the business; and
- focusses on the activities that consume or use the taxable inputs to make supplies.
ITCs are available for properties and services acquired to be used or consumed in a registrant’s business, except if that business is making exempt supplies. For registrants in the business of making both taxable and exempt supplies, like the appellant in Marine Atlantic, costs must be allocated between supplies to identify which amounts are eligible for ITCs.
The Excise Tax Act (the “ETA”) recognizes that analyzing every cost item individually would be prohibitively complex and expensive for many businesses. Sections 141 and 141.01 of the ETA thus allow registrants to estimate the allocation as long as their chosen method is “fair and reasonable” and consistently applied. In Marine Atlantic, the appellant’s allocation was put to the test.
During the years at issue, Marine Atlantic Inc. operated ferries between Nova Scotia and Newfoundland. The ferry services were exempt supplies, but Marine Atlantic also offered upgrades and amenities – including private cabins, dining, shopping, and amusement machines. These were taxable supplies. Marine Atlantic was thus faced with the task of developing a “fair and reasonable” methodology for allocating the costs of its operation between exempt and taxable supplies.
To that end, Marine Atlantic retained a respected accounting firm that conducted a study to develop an allocation based on use of space. Specifically, each space on every vessel was categorized as a taxable area, exempt area, or common area depending on its function. This way, Marine Atlantic could calculate what percentage of its vessels were used to make taxable supplies, and then use that percentage to estimate what percent of its total input costs were eligible for ITCs. The Court noted that “input” methods like this are preferable to “output” methods because they trace inputs to actual supplies.
The Canada Revenue Agency (“CRA”) wanted Marine Atlantic to hire experts and engineers to support its calculations. The Court, however, found that forcing registrants to incur exorbitant costs to support ITC claims would frustrate the purpose of subsection 141.01(5), which only requires a “fair and reasonable” allocation not a perfect one.
The TCC ultimately determined that Marine Atlantic’s allocation was “fair and reasonable” because it:
- was consistent with the facts and supported by detailed evidence supplied at trial – for example, evidence about the business, how the ferries worked, the allocation methodology, how space was categorized, and different cost inputs;
- accurately reflected the economic realities of the business – for example, it was reasonable to apply the same percentage to fuel costs as to other inputs because the added services consumed more electricity, required additional staff, and took up more space, making the vessels bigger and heavier than they would have been if there were no taxable supplies; and
- focused on the activities that consumed or used inputs to make supplies – for example, Marine Atlantic treated its on-land terminals as “common” areas that did not affect the calculation because, although the terminals were very large, almost no supplies (taxable or exempt) were made there and thus including the terminals would have skewed the outcome due to their sheer size (which would have been unreasonable since all the costs incurred at the terminals were to support supplies made on the vessels).
Marine Atlantic affirms that the “fair and reasonable” test is a matter of common sense and judgment. A registrant is entitled to find an allocation method that makes sense for its business, as long as the method complies with the ETA. In short, the CRA cannot simply impose its own methodology.