On July 11, 2017, in its much-anticipated decision in Club Intrawest v. The Queen1, the Federal Court of Appeal ("FCA") set aside a judgment of the Tax Court of Canada and ruled that GST/HST is exigible only on that portion of annual resort fees paid to the appellant, Club Intrawest ("Intrawest"), for services it provided in relation to "timeshare" vacation homes located within Canada. The ruling also establishes that the portion of the annual resort fees attributable to services related to Intrawest vacation homes located outside Canada is not subject to tax.

In the Tax Court decision2, Justice Steven K. D'Arcy rejected a favourable Canada Revenue Agency ("CRA") administrative policy and determined that GST/HST was applicable on the entirety of the annual resort fees invoiced by Intrawest, even though some of the underlying timeshare properties were situated in the U.S. and Mexico.

The FCA decision, authored by Justice Eleanor R. Dawson, now represents the state of the law regarding the application of the so-called "made-in-Canada" rules in section 142 of the Excise Tax Act ("ETA").

Facts

The background to the litigation can be summarized as follows:

  • Intrawest is a Canadian resident non-profit, non-stock Delaware corporation established to facilitate the administration and operation of vacation homes in connection with a timeshare ownership program ("Intrawest Program").

  • Members of the Intrawest Program hold timeshare points ("Points") that entitle them to stay at vacation homes owned by Intrawest. The vacation homes are located in Canada, the U.S. and Mexico.

  • Members of the Intrawest Program pay annual resort fees ("Annual Resort Fees") to cover such costs as property taxes, insurance coverage and salaries and benefits of Intrawest's employees. The amount of the Annual Resort Fees depends on the number of Points that a member holds.

  • Intrawest never collected GST/HST on the Annual Resort Fees on the ground that it was merely acting as agent on behalf of its members when it acquired the various goods and services in connection with the Intrawest Program. As such, Intrawest viewed the Annual Resort Fees as simply being a reimbursement of the expenses incurred by Intrawest and, therefore, not as a consideration for a taxable supply.

The dispute arose when the CRA took a different view and reassessed Intrawest for uncollected GST/HST in connection with the Annual Resort Fees for its monthly periods between 2002 and 2007. Intrawest appealed this reassessment principally on the basis of the agency analysis. Intrawest also argued in the alternative that, to the extent that it might be found to have made a supply to the members, the Annual Resort Fees should then be allocated between taxable supplies made within Canada (subject to GST/HST) and taxable supplies made outside of Canada (not subject to GST/HST) based on the Points issued with respect to Canadian vs. non-Canadian Intrawest vacation homes.

Tax Court decision

The agency issue

In reply to Intrawest's "agency" analysis, the CRA argued that the Annual Resort Fees were in fact consideration for a taxable supply of intangible personal property on the part of Intrawest. In deciding this issue, the Tax Court considered the three generally accepted components of an agency relationship:

  1. The consent of both principal and agent;
  2. A grant of authority to the agent by the principal, allowing the former to affect the latter's legal position; and
  3. Control by the principal of the agent's actions.

The Tax Court concluded that Intrawest was not acting as an agent on behalf of its members. It followed that the Annual Resort Fees paid by the members were not a reimbursement of expenses incurred by Intrawest and were instead consideration paid for a supply that could be subject to GST/HST under the ETA.

The GST/HST issue

Intrawest accepted the proposition that to the extent it made a supply, it was a taxable supply. However, it disagreed with the CRA with respect to the application of the "made-in-Canada" rules under section 142 of the ETA.

The Tax Court began by stating that, by using the Annual Resort Fees to fund its operations, Intrawest had made a single supply of services because it could only continue to operate the Intrawest Program if it incurred all of the costs associated with the program3 It then noted that section 142 contains an internal inconsistency inasmuch as a plain reading of its provisions can, in certain circumstances, deem two mutually-exclusive events to occur. This was one of those circumstances, because in Intrawest's case (i) a plain reading of para. 142(1)(d) deemed the single supply of the services by Intrawest to be made in Canada since the services related to real property situated in Canada, and (ii) a plain reading of para. 142(2)(d) deemed the single supply of the services to be made outside Canada since the services also related to real property situated outside Canada.

To resolve the ambiguity, the parties specifically asked the Tax Court to interpret the inconsistency in such a manner that the GST/HST would be applicable to only a portion of the Annual Resort Fees attributable to vacation homes located in Canada. However, the Tax Court rejected that reasonable approach. For the Tax Court, subsection 165(1) of the ETA - the provision that imposes the tax on taxable supplies that are made in Canada - contains no ambiguity and clearly imposes the tax on the full consideration for the taxable supply.

The Tax Court also decided that paras. 142(1)(d) and 142(2)(d) of the ETA did not apply because:

"the words 'a service in relation to real property' in paragraphs 142(1)(d) and 142(2)(d) should be interpreted to mean that these paragraphs only apply if the single supply of a service relates solely to real property."4

However, a number of services performed by Intrawest in the administration of the Intrawest Program did not relate directly to real property. Therefore, the exception provided for in paras. 142(1)(d) and 142(2)(d) was not applicable and as the services were, in part, performed in Canada, the Tax Court concluded that the residual rule under para. 142(1)(g) was applicable (it deemed the supply to be made in Canada because the service was performed at least partially in Canada) and that as a result, GST/HST applied to 100% of the Annual Resort Fees paid by Intrawest's members.5

Federal Court of Appeal decision

The agency issue

Although Intrawest acknowledged that the Tax Court correctly formulated the three generally accepted components of an agency relationship, it argued that the Tax Court erred in law in the factual application of the test as it did not give effect to the appropriate legal and accounting documents. The FCA rejected this argument, citing Supreme Court of Canada authority to the effect that "absent an extricable error of law, the appellant must demonstrate a palpable and overriding error of fact or mixed fact and law".6 In the FCA's view, the Tax Court had considered the agency issue carefully and had not made any palpable and overriding errors in doing so.

In a parallel conclusion, the FCA also stated that the Tax Court had not erred in determining that Intrawest, and not its members, held a beneficial interest in the vacation homes. Intrawest tried to argue that if Intrawest acquired goods and services for maintaining vacation homes beneficially owned by its own members, it could only do so as an agent.7

The GST/HST issue

Intrawest agreed that to the extent there had been no agency relationship with its members when it incurred the costs of operating the vacation homes, it had supplied a service to its members. However, Intrawest argued that the Tax Court made an error in law when it failed "to characterize the predominant element of the service."9 Intrawest submitted that, by correctly characterizing the predominant element, the Tax Court "would have found there to be a single supply: the operation of each resort property."9 In other words, Intrawest agreed that there was a single supply with respect to each individual vacation property, because "the services in respect of each individual resort property are interdependent and inextricably intertwined"10, but not that there was a single supply with respect to the vacation properties as a collectivity. As Intrawest pointed out, resorts were added and removed from its list of properties without destroying the fabric of its overall timeshare business.

Prior to reaching a conclusion on the single vs. multiple supplies question, the FCA determined whether the Tax Court failed to correctly apply the place-of-supply rules when it concluded that paras. 142(1)(d) and 142(2)(d) of the ETA did not apply because such paragraphs are only relevant if the single supply of a service relates solely to real property (which was not the case from a factual standpoint). Because the services were at least partly performed in Canada, the Tax Court concluded that the residual rule for services (i.e. para. 142(1)(g)) was applicable and that the whole supply was deemed to be made in Canada.

The FCA came to the conclusion that the Tax Court erred in applying subsections 142(1) and 142(2) of the ETA "when it broke down the single supply into its constituent elements for the purpose of determining whether each constituent element related directly and solely to real property".11 The FCA stated:

"More recently, in Global Cash Access,12 this Court looked to the commercial efficacy of an arrangement in order to determine the predominant element of a single supply. As that predominant element fell within the statutory definition of "financial service" in subsection 123(1) of the Act, and did not fall within any statutory exception, the consideration received by the taxpayer in exchange for the supply was not subject to GST.
What I take from Global Cash Access is that when applying the Act regard must be had to the predominant element of a single supply. It is an error of law to apply the Act having regard to services that do not form the predominant element of a single supply (see also: Great-West Life Assurance Company v. Her Majesty The Queen, 2016 FCA 316, [2016] F.C.J. No. 1408, at paragraph 43)."13

In the case at hand, the FCA argued that while the administrative services formed an integral part of the operation of the Intrawest Program, they were not the predominant element of the supply - the predominant element being the operation of vacation homes. Because the Intrawest Program operates vacation homes located both in Canada and outside Canada, it follows that the predominant element of the supply was therefore in relation to real property situated both in Canada and outside Canada.

That conclusion brought the FCA back to the "legislative inconsistency" between paragraphs 142(1)(d) and 142(2)(d) of the ETA that was described above. That inconsistency, the FCA suggested, existed "because Parliament, when drafting the place-of-supply rules, appears not to have contemplated that a single supply could be made in respect of multiple real properties, some inside Canada and others outside Canada."14

The FCA considered various approaches to resolving the inconsistency. It rejected the pragmatic approach submitted by the parties that tax should be levied on a portion of the consideration of the single taxable supply. Like the Tax Court, the FCA noted that "the Act contemplates that a single supply will either be subject to tax on the whole of the consideration paid for the supply or be not subject to tax at all."15 However, the FCA also rejected the Tax Court's approach in connection with the legislative inconsistency between the two paragraphs for two main reasons:

  1. Even though it correctly found that the words "in relation to", as used in the two paragraphs, are given a wide scope under Canadian law,16 the Tax Court wrongly inferred that:
    • the relevant paragraphs "only apply to services performed by the Appellant that relate directly to real property"; and
    • the relevant paragraphs only apply if the single supply of a service relates solely to real property.17
  2. The Tax Court's interpretation would give paragraph 142(1)(g) the status of a "default provision" applicable for all services performed both inside and outside Canada. According to the FCA, this was not Parliament's intent.

To resolve the legislative conflict, the FCA took a "common sense" approach, relying on the exact same jurisprudence quoted by the Tax Court, by essentially splitting up the supply of services and by concluding that there were in fact multiple supplies (i.e. two supplies: the services relating to the operation of the vacation homes located in Canada and the services relating to the operation of the vacation homes located outside Canada) and not a single supply as stated by the Tax Court:

"Generally, as explained above, a single supply of services is a supply of services that are inextricably intertwined. If such services are partially consumed in Canada they will be deemed to be supplied wholly in Canada under the general place-of-supply rule.
In this circumstance, I see no reason in principle that precludes splitting up the supply so that the supply is treated as two supplies in order to recognize that ultimately the services are inherently distinct in one important respect: the services relating to the operation of the vacation homes located in Canada are services in relation to real property situated in Canada and hence are a taxable supply - the services relating to the operation of the Intrawest vacation homes situated outside of Canada are services related to real property situated outside of Canada and hence are a non-taxable supply."18 (our emphasis)

In this respect, the FCA decided that the Tax Court had been mistaken in rejecting this approach on the ground that it would entail that Intrawest made separate supplies in respect of the other three groups of activities that did not relate directly to real property. In fact, the FCA's approach simply acknowledges the fact that the intertwined bundle of services (comprising all groups of activities) are supplied on a property-by-property basis. In fact, based on the FCA's conclusion that only two supplies were rendered by Intrawest, the bundle of services (comprising all groups of activities) were not really supplied on a property-by-property basis but rather on a Canadian properties vs. non-Canadian properties basis.

As a result of this "common sense" approach, the FCA then indicated that it would be necessary to quantify the portion of the Annual Resort Fees that can be viewed as a consideration paid for the services provided in relation to real property situated in Canada. As a consequence, this would mean that the balance of the consideration paid to Intrawest was in respect of a non-taxable supply.

As the method of quantification must be fair and reasonable according to the FCA, Intrawest proposed that the Annual Resort Fees should be allocated based on the ratio of membership costs associated with the operation of the vacation homes in resorts situated in Canada to the total membership costs for all resorts. The FCA agreed that such allocation was fair and reasonable and stated that "the consideration paid for the taxable supply should be calculated on this basis."

Conclusion

Even though this decision represents a better outcome for Intrawest, it is still expected that a significant number of timeshare members with vacation homes in Canada will be negatively affected by its economic consequences as they will end up paying taxes on the supply of services in Canada related to vacation homes situated in Canada. We also understand that many timeshare members assume that they have a direct beneficial ownership interest in their vacation homes - a belief that now appears unfounded, at least with respect to the Intrawest Program.

Many tax practitioners would agree that the FCA arrived at a fair and reasonable conclusion as regards the parties in this particular case, at least regarding the "made-in-Canada" rules. However, they might not necessarily agree with the legal foundations of the Court's "common-sense" approach. In particular, it will be interesting to see how this decision affects the notions of single supply and multiple supplies given that it now appears that one can split up a particular supply into multiple supplies simply based on one's generous application of common sense.