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Input Tax Credits: Establishing a Fair and Reasonable Methodology


The Canada Revenue Agency (CRA) and the University of Calgary (U of C) recently had a showdown in court regarding Input Tax Credits (ITC). The case at hand regarded the volume of ITCs U of C was attempting to claim – the CRA claimed that the school’s method was faulty in providing a fair and reasonable estimate of the extent to which it used certain U of C parcels of land in its commercial activities.

The CRA’s aim was to substitute U of C’s methodology with their own. Now, when the CRA goes after a claim like this, you can bet it’s because the credits at hand are not a small amount – millions of dollars were at stake. Here’s how it played out – and what other post-secondary institutions should take away in assessing their own properties and ITC allocations.

The Claim

U of C filed elections on three separate parcels of land under section 211 of the Excise Tax Act. They elected to make the real property taxable like a normal commercial business. The effect is to get access to some ITCs they were not otherwise entitled to on the real property and some operating expenses. This was filed in 2006, with ITC claims being made from 2006 to 2009. They then established an ITC allocation method to determine the ITCs that could be claimed based on the useable floor space in the buildings. Anyone familiar with a typical university layout knows there is plenty of open / free use space on campus. It was only a matter of time before CRA was going to run at the large tract of external space and try to bring that in at 100% exempt to grind the ITC ratio down.

University of Calgary’s Approach

U of C’s methodology to determine their ITC claims involved looking at the buildings on the parcel of land, determining the internal use of the buildings in terms of establishing the extent of commercial use and exemption of the entire parcel of land. The common areas inside the building take on a weighting of the direct use of the used space so they are ignored (the formula becomes taxable / taxable + exempt).

The University is running a business. The land and buildings are either used directly in taxable activities, directly in exempt activities or to some degree, in both taxable and exempt activities. CRA took the view if the property is not used directly in taxable activities, the default becomes directly in exempt activity. This is exactly how they approached the external common area space on the basis they did not view it as having any direct link to taxable activities. Thankfully, the legislation doesn’t allow this conclusion.

The use of the space in the buildings was very measurable. This was indicative of the entire use of the property. The U of C applied their established weighting to both internal and external common areas for the same reason. The common area is not a direct use in taxable or exempt activity, so it must indirectly adopt a weighting of use as opposed to being a direct use.

Canada Revenue Agency Approach

The CRA took a novel approach to reduce the allocation percentages and reduce the ITCs claimed. The parties came to an agreement on the use of the internal space in the buildings. CRA then took the position that ALL external common areas must be used 100% in exempt activities because they did not get used directly in commercial activities. CRA agreed that internally a hallway or a bathroom, for example, has a link to exempt and commercial use within a building. However, walking outside between one building and the next apparently has no ‘link’ to commercial use and therefore must be entirely exempt use. This is from some internal CRA roadmap document the auditor referred to in their testimony.

The next creative approach CRA used was to take the replacement cost for each parcel of land, including buildings, to ‘index’ the extent of use in commercial activities. In addition to shifting all of the external common area square footage to being 100% exempt use, they calculated all of the taxable and exempt square footage into a cost allocation using current costs per square footage of the land and buildings. The allocation is now using dollar amounts (taxable cost / taxable cost plus exempt cost) as opposed to square footage. This reduced the usage in commercial activities significantly thereby reducing the eligible ITCs. The problem is the use of the space remains the same regardless of what cost was used. Shifting to a cost base simply skewed the taxable proportion downward but did not demonstrate how the use in activities was different.

The University is only required to determine the extent of use in taxable and exempt activities in a fair, reasonable and consistent manner. CRA was trying to substitute this approach with their own method and somehow factor in current costs as a better means to arriving at a methodology. There were lots of shortcomings to their approach, considering we are also dealing with GST paid in 2006 but using 2011 valuations. They changed the dynamics of the ratio by shifting to a cost base from square footage. The use of the space hadn’t changed, but the allocation now become less? That doesn’t make fundamental sense.

The Verdict

Ultimately, the courts didn’t buy the CRA’s logic. They concluded that U of C established a fair and reasonable ITC method and ruled that CRA cannot substitute a sound methodology of their own. U of C has in turn avoided the ITC reduction of a cool $3.9 million by not having to adopt CRA’s methodology.

Having used a similar approach when assisting other post-secondary institutions in determining their ITCs, it’s reassuring to see the courts have upheld U of C’s methodology and shut down the CRA’s attempts to squeeze the school’s tax credits.

To learn more about input tax credits for your post-secondary institution, contact Jeff Harrison, CPA, CMA, at 306.751.7998 or [email protected], or your local MNP Tax Advisor.