Subsection 141.01(2) of the Excise Tax Act deems a property or service acquired for use in a business to be for use in commercial activities only to the extent that the property or service 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.
Conceptually, in situations where a registrant acquires a property or service in connection with the acquisition, establishment, disposition or termination of a commercial activity, but has not yet made or has ceased making taxable supplies, there is an apparent conflict between subsection 141.1(3) and subsection 141.01(2). In this scenario a registrant would be deemed to have incurred the property or service in the course of commercial activities by subsection 141.1(3), but would also be deemed to have incurred the property or service in the course of non-commercial activities pursuant to subsection 141.01(2).
In ONEnergy Inc. v Canada, 2018 FCA 54, the Federal Court of Appeal resolved this apparent conflict by holding that subsection 141.1(3), as the more specific provision, overrides subsection 141.01(2).
In ONEnergy, the appellant/registrant had carried on a telecommunications business under the name Look Communications Inc. While carrying on this telecommunications business, the registrant offered a share option plan and a share appreciation plan to certain employees, directors, and consultants. When exercised, the SAR plan entitled rights holders to be paid an amount equal to the difference between the fair market value of shares when the rights were exercised and when the rights were awarded.
In 2009, Look sold its telecommunications spectrum and its CRTC broadcast licence for net proceeds of $64 million. This effectively terminated the telecommunications business and its making of taxable supplies for GST purposes. Part of the proceeds of the spectrum and licence sales were used to pay for the cancellation of the share options and SARs and for bonuses to rights holders, which included directors, executives, shareholders and employees (collectively the “former executives”).
In July 2011, Look, on behalf of its shareholders, filed a lawsuit for breach of fiduciary duty and misappropriation of the spectrum and licence sale proceeds against the former executives as it alleged that $14.7 million of excess payments had been made. This inevitably resulted in considerable legal fees and other expenses in respect of which Look was charged and paid GST.
A rule 58 motion was subsequently brought before the Tax Court of Canada seeking a determination of a question of law as to whether or not the litigation costs were incurred in the course of a commercial activity pursuant to paragraph 141.1(3)(a) of the ETA.
The TCC ruled that the litigation costs were personal and thus not incurred in the course of a commercial activity pursuant to paragraph 141.1(3)(a).
On the appeal, the FCA held that the TCC erred in finding that the litigation costs were personal. The FCA viewed the litigation costs as “a claim for overpaid remuneration” against the former executives. Since this remuneration would have been paid for services rendered as part of the commercial activities of Look or the termination of those activities, the FCA found that the litigation costs were not personal.
That said, the FCA noted that because Look ceased making taxable supplies before the legal expenses were incurred, there was an apparent conflict between the deeming rules in subsection 141.01(2) and subsection 141.1(3) of the ETA because, “it may be difficult to argue that any expense incurred after a registrant has ceased making taxable supplies is made for the purpose of making taxable supplies even though the expenditure is made in connection with the termination of the commercial activity.”
The FCA resolved this conflict by finding that as a more specific provision subsection 141.1(3) overrode subsection 141.01(2) based on the “implied exception” rule of statutory interpretation which states that a general provision cannot be applied to override a more specific provision. As such, the FCA held that while subsection 141.01(2) applies generally, where a registrant is acquiring a property or service, in circumstances where subsection 141.1(3) applies (i.e., in connection with the acquisition, establishment, disposition or termination of a commercial activity), 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.”
Having concluded that the fact that Look was no longer making taxable supplies was not, in and of itself, a reason to deny its entitlement to claim ITCs related to the litigation costs, the FCA found that there was a clear connection between the litigation and the termination of Look’s commercial activity because the overpaid remuneration was in respect of services rendered by the former executives while Look was still making taxable supplies. On this basis, the FCA held that there was a sufficient connection between the termination of Look’s commercial activities and the litigation costs to permit Look to claim ITCs.
The FCA therefore allowed the appeal and confirmed that the litigation costs paid by Look were incurred in the course of a commercial activity pursuant to paragraph 141.1(3)(a) of the ETA.
The FCA decision in ONEnergy is certainly a welcome victory for taxpayers. More importantly, the FCA’s conclusion that where subsection 141.1(3) applies a “person 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” is significant because it ensures that Canadian businesses, especially start-ups, are treated fairly and not subject to cascading tax concerns (which would for example occur if ITCs were delayed at the start-up of a business).
Robert G. Kreklewetz and Steven Raphael are with Millar Kreklewetz LLP