Memorandum 8-3 - "Calculating Input Tax Credits"

46. … If a particular method accurately reflects the purpose for which the property or service was acquired, the method would be fair and reasonable.

Example 1

A public institution has a mandate to provide exempt supplies. The public institution's revenues are as follows:

• 95% government funding (that is not consideration for a supply) to assist in its mandate;
• 0.5% consideration charged to persons who receive exempt supplies; and
• 4.5% consideration for taxable supplies which are made to provide additional funding to support its mandate.

The public institution used a revenue-based ITC allocation method (i.e., an output-based method) which did not include the amount of government funding in the calculation and claimed ITCs equal to 90% (4.5%/5%) of the GST/HST paid or payable on taxable inputs.

If the public institution claimed ITCs based on the purpose for which it acquired its inputs it would claim ITCs equivalent to 2.18% (2% + 0.18%) of the tax paid or payable on all taxable inputs based on:

• 2% of taxable inputs are for use exclusively for the purpose of making taxable supplies for consideration;
• 88% of taxable inputs are for use exclusively for the purpose of making exempt supplies; and
• 10% of taxable inputs are for use both for the purpose of making taxable supplies for consideration and for either the purpose of making exempt supplies or for a purpose other than making supplies:
  • 85% of the mixed-use inputs are for use less than 10% in commercial activities and are not eligible for ITCs;
  • 15% of the mixed-use inputs are for use 12% for the purpose of making taxable supplies for consideration and 88% for the purpose of making exempt supplies and for purposes other than making supplies.

...If a revenue-based ITC allocation method is appropriate in the circumstances, excluding the government funding revenue from the denominator in the calculation would not be fair and reasonable because government funding may be the greatest source of revenue for the public institution and that revenue is used to purchase inputs, including taxable inputs that are used in making exempt supplies. In this example, as 88% of taxable inputs are used exclusively for the purpose of making exempt supplies, a method that results in the public institution claiming 90% of the GST/HST paid or payable on those inputs as ITCs is not a fair and reasonable allocation method for those inputs.

First-order v. second-order supplies

27. Where inputs are acquired, imported or brought into a participating province for consumption or use for the purpose of making a particular supply (the first-order supply), and the first-order supply is made for the purpose of making another supply (the secondary supply), it is the tax status of the first-order supply that determines whether the inputs are for consumption or use in a commercial activity.

Direct allocation method

49. The method that allocates inputs directly to activities should yield fair and reasonable results. Specifically, where it is possible to record the actual consumption or use of a particular input in making taxable supplies for consideration and otherwise, this is a reasonable method to apply. Where this is not possible, allocation factors could be applicable under the direct allocation method.

50. Where an allocation factor is used, it should directly approximate the use of the particular input in making taxable supplies for consideration and otherwise using a systematic approach and an appropriate allocation base. [Then gives example of snow removal costs being allocated between exempt and commercial real estate properties on relative square footage of cleared driveways for each property type].

Input-based method

52. An input-based method may be used to apportion ITCs for those inputs that cannot be allocated… using the direct allocation method. For this method to be considered fair and reasonable by the CRA, property and services that can be attributed using the direct allocation method must represent a significant part of the registrant's overall inputs.

53. The input-based allocation method is the use of an input-based formula to allocate those remaining inputs that cannot be allocated using the direct allocation method (e.g., the ratio of taxable inputs allocated to taxable activities using the direct allocation method as compared to total inputs allocated using the direct allocation method).

Output-based method

54. An output-based method is only appropriate when an analysis shows that the outputs generated by a person will give a reasonable approximation of the use of inputs in those activities. The method can use such items as:

• the number of transactions processed (e.g., purchase orders and sales orders);
• the number of telephone enquiries;
• revenues; or
• some other reasonable measure relating to the outputs of the registrant.

55. An output-based method can be used if the registrant can substantiate that:

• the method is fair and reasonable in the circumstances; and
• the method reasonably reflects the use or intended use of the inputs.

Revenue-based method

56. A revenue-based method uses the ratio of revenue from making taxable supplies for consideration to total revenues to determine the ITC eligibility. …

57. A revenue-based method should be used with caution

ITC determined on a billing period by billing period basis

74. Under subsection 136.1(2), ongoing services will be treated as a series of separate supplies of services, one for each period (referred to as a "billing period") to which a particular payment is attributable and during which the service is rendered under the agreement. For each billing period, the supplier is deemed to have made, and the recipient is deemed to have received, a separate supply of the service on the earliest of:

• the first day of the billing period;

• the day the payment for that billing period becomes due; and

• the day the payment attributable to the billing period is made.

75. The payment attributable to the billing period is deemed to be consideration payable for the supply of the service for that billing period.

76. For purposes of claiming an ITC, the formula in subsection 169(1) applies separately to each amount of tax that becomes payable or is paid without having become payable with respect to each taxable supply. Therefore, the person may not be entitled to claim an ITC to the same extent for each of these amounts of tax since the use of the service in the course of the person's commercial activities as determined through the application of section 141.01 may change for each billing period.

Example of allocation between improvements and repairs (para. 65)

Example

In March 2014, a landlord … engages a contractor to make improvements and repairs to an apartment building, 20% of which is leased as commercial retail space. Those improvements and repairs will cost $10,000 plus $500 GST. Of the contractor's services, 60% are considered to be improvements to capital property and are included in determining the adjusted cost base of the property under the ITA. The remaining 40% of the services are not improvements to capital property, and are to be expensed for income tax purposes.

…

Therefore, the GST deemed payable for the improvements to the apartment building is $300 (i.e., $500 × 60%).

The ITC available on the improvement is calculated in accordance with subsection 169(1) and paragraph (b) of element B of the formula in that subsection, and is equal to $60 (i.e., $300 × 20%).

Non-improvement

The GST deemed payable on the part of the services that is not for use in improving the property (i.e., the repair services) is determined in accordance with paragraph 169(1.1)(c) and is equal to

$500 - 300 = $200

If the repair services were for consumption or use exclusively in the landlord's commercial activity (i.e., in its retail space), then an ITC of $200 in respect of this part could be claimed. Conversely, if the repair services were for consumption or use exclusively on the residential portion of the building, no additional ITC could be claimed. However, if the repair services were partly (e.g., 20%) for consumption or use in commercial activities and partly (e.g., 80%) for consumption or use in non-commercial activities, an ITC of $40 (i.e., $200 × 20%) could be claimed in accordance with subsection 169(1) and paragraph (c) of element B of the formula in that subsection.

Soft costs included in ACB (para. 62)

Under section 54 of the Income Tax Act, the capital cost (or adjusted cost base) of capital property is determined for income tax purposes under Subdivision c of Part I of the Income Tax Act. Examples of expenses incurred by a taxpayer that increase the adjusted cost base of capital property that is depreciable property would be the costs for the construction, alteration or modification of the property. Soft costs (e.g., interest, legal and accounting fees, and property taxes) incurred in respect of the construction, renovation or alteration of a building are also added to the adjusted cost base of the property. In most cases, the adjusted cost base of capital property is the purchase price of the property adjusted for amounts incurred to prepare the property for use (e.g., delivery expenses, installation and legal fees). In addition, the cost of repairs made in anticipation of a sale of the property is included in the adjusted cost base of the property.