Canada: Federal Court Of Appeal Confirms Orthodontists' Right To Claim GST/HST Input Tax Credits: The "O.A. Brown" Test Takes A Back Seat To Parliamentary Intent

In its April 12, 2023 decision in Canada v. Dr. Kevin L. Davis Dentistry Professional Corporation, the Federal Court of Appeal ("FCA") has affirmed a 2021 Tax Court of Canada decision allowing GST/HST input tax credits ("ITCs") to be claimed by an orthodontic practice in connection with taxable expenses incurred for purposes of supplying orthodontic appliances to patients. The Minister of National Revenue had disallowed these ITC claims, which dated from 2015 and 2016.

Summary

• Subsection 169(1) of the Excise Tax Act (Canada) ("ETA") establishes a GST/HST registrant's ability to claim ITCs with respect to expenses incurred for consumption, use or supply in the course of commercial activities. However, the definition of "commercial activity" excludes the making of exempt supplies, thereby limiting a registrant's right to claim ITCs to recover GST/HST paid or payable on taxable supplies of property and services acquired to make such exempt supplies.
• Noting the absence of a fee breakdown on the patient receipts produced by the orthodontic practice ("the Orthodontist"), the Minister argued that the Orthodontist had not followed the strict documentation requirements under its longstanding administrative position relating to supplies of orthodontic treatments (the "CRA Administrative Position").¹ As a consequence, the Minister was of the view that the Orthodontist's supplies of exempt and zero-rated orthodontic appliances constituted a "single supply" of exempt orthodontic services. The Minister accordingly denied the ITCs claimed by the Orthodontist for taxable expenses related to the making of supplies of orthodontic appliances.
• Based on a detailed textual, contextual and purposive interpretation of the ETA, the Tax Court concluded that Parliamentary intent was to clearly classify a conventional orthodontic practice as involving the making of multiple supplies of both exempt professional services and zero-rated orthodontic appliances. The Tax Court therefore decided that there was no need to apply the common law test (developed in its 1995 ruling in A. Brown v. The Queen) that is routinely used to resolve cases involving supplies made up of multiple components.
• While the Minister's appeal to the FCA was limited to determining whether the supply of orthodontic services and the supply of orthodontic appliances constituted multiple components of a single supply or two distinct supplies, the FCA's affirmation of the Tax Court decision cements a departure in approach from a myriad of earlier cases that had relied on the O.A. Brown test (including the Hurd case discussed below).

Facts

The Orthodontist carried on a conventional orthodontic practice and was a GST/HST registrant under Part IX of the ETA. The practice consisted of providing orthodontic treatments, comprised of orthodontic services and orthodontic appliances, such as braces, removable aligners, retainers, bite plates, and growth modifiers.

During the relevant period, the CRA Administrative Position allowed orthodontists to claim ITCs by using 35% of the patient's total treatment cost as an estimate of the consideration payable for supplies of orthodontic appliance(s). Orthodontists were then required to reconcile their ITC claims estimate with their actual taxable supplies when such information became available (e.g., at year end).

Thus, in accordance with the CRA Administrative Position, the Orthodontist took the filing position that it was making multiple supplies of both exempt orthodontic services (included in section 5 of Part II of Schedule V to the ETA), and zero-rated orthodontic appliances pursuant to section 11.1 of Part II of Schedule VI to the ETA ("Section VI-II-11.1"). Accordingly, ITCs could therefore be claimed for the portion of the Orthodontist's expenses that related to the making of zero-rated supplies.

However, according to the Minister, the Orthodontist did not provide a fee breakdown clearly differentiating the exempt services supplied to patients from the zero-rated appliances on the patient receipts issued by it. Therefore, the Minister denied the ITCs claimed by the Orthodontist on the basis that a specific requirement of the CRA Administrative Position, to the effect that the consideration payable for orthodontic appliances should always be separately identified on patient invoices, had not been met.

On appeal to the Tax Court, the Minister made two additional arguments:

• that the orthodontic appliances are either an integral or incidental part of a single overall supply of tax-exempt orthodontic treatment; and
• that even if the appliances are a separate supply, they are still tax-exempt, with the result that the appellant cannot claim ITCs.

Tax Court Decision

Statutory interpretation

In analyzing the taxable nature of supplies of orthodontic appliances, the Tax Court (per Wong J.) noted that orthodontic appliances (to the extent not related to cosmetic services) are zero-rated under Part II of Schedule VI to the ETA ("Part II-VI"). Adopting a modern statutory interpretation approach "founded on the basis that the words of an Act should be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament", Wong J. focused on the legislative history and amendments to Part II-VI, noting that prior to 1997, orthopedic braces were zero-rated pursuant to section 23 of Part II-VI, and pursuant to a 1997 amendment, orthodontic appliances were unconditionally zero-rated with the introduction of new section 11.1 of Part II-VI (Section VI-II-11.1).

Drawing on the Goods and Services Tax Technical Paper issued by the Minister of Finance in 1989 and explanatory notes from the Department of Finance accompanying the enactment of new Section VI-II-11.1 in 1997, Wong J. concluded that Parliamentary intent, from the inception of the GST, was to zero-rate orthodontic appliances, emphasizing the following excerpts:

Based on the foregoing statements, the Tax Court concluded that Parliament clearly intended that orthodontic appliances, which were moved from section 23 to newly enacted Section VI-II-11.1, should be unconditionally zero-rated.

Single supply vs. multiple supplies

After determining that the ETA provides for an unconditional zero-rating treatment of orthodontic appliance supplies, the Tax Court stated that there was no need to apply the common law test developed in O.A. Brown for determining whether a conventional orthodontic practice is involved in a single supply or multiple supplies, thereby dismissing the Minister's argument that the Orthodontist was making a single supply of exempt services:

In essence, one can conclude that the Tax Court's position is that the O.A. Brown test may be disregarded to the extent that a statutory interpretation of the ETA provisions (as confirmed by Parliamentary intent) supports the conclusion that a certain specific supply of a good or service (where such supply is consistently combined with another supply that has a different tax status) should have a distinct treatment from a GST/HST standpoint (i.e., taxable, exempt, or zero-rated).

Documentary requirements

The Minister also argued that the patient invoices provided by the Orthodontist did not sufficiently differentiate the fees attributable to the orthodontic services from those attributable to the orthodontic appliances, in contravention of the CRA Administrative Position. While Wong J. acknowledged that the Tax Court lacks jurisdiction to resolve the ITC issue in terms of the CRA Administrative Position, she also noted that the statutory basis of the CRA Administrative Position lies in subsection 169(5) of the ETA, which gives the Minister the discretion to exempt registrants, or classes of registrants, from the statutory requirements in subsection 169(4) that the amount of the ITC be determined prior to claiming a credit. Wong J. therefore felt it appropriate to state, in a general way, that she was "mindful of the Minister's administrative policy" and that, in her opinion, the Orthodontist appeared to have adhered to it. It followed that this issue could not affect the outcome of the case, which was in favour of the taxpayer.

With respect, it is difficult to comprehend the rationale behind such analysis pertaining to the documentary requirements for claiming ITCs. The factual background of the case does not suggest any issues with the invoices or documents received by the Orthodontist for the expenses related to the denied ITC claims. The issue was rather related to the apportionment of inputs in an orthodontic practice between zero-rated and exempt supplies and it appears that an analysis under section 141.01 of the ETA would have been more appropriate.

Federal Court of Appeal Ruling

The Minister appealed to the FCA on the single ground that the O.A. Brown test should have been applied. Pursuant to this "common law" test, the Minister argued, the orthodontic services and appliances supplied in the context of the Orthodontist's conventional orthodontic practice are sufficiently intertwined to constitute a single supply of exempt services.

In 2017, this line of reasoning had been explicitly adopted by the Tax Court in Dr. Brian Hurd Dentistry Professional Corp. v. The Queen, an informal procedure decision involving similar facts. The Tax Court in that case presumed the applicability of the O.A. Brown test without first undertaking a distinct "textual, contextual and purposive interpretation of the relevant provisions of the ETA", as was done by the trial judge in the case at hand. (However, as this is an informal procedure decision, it cannot, in theory, be used as a precedent for any other case, although the tax authorities had envisaged changing the CRA Administrative Position in response to it).

Despite a comprehensive consideration of the background of the O.A. Brown test as a judicial doctrine, the FCA indicated that the present case differs from other GST/HST cases, thereby putting into question its application. The central premise of the FCA's argument was that, despite the routine application of the O.A. Brown test, Parliamentary intent must override the applicability of the common law test where such intent is clear and unambiguous:

As the FCA noted, by codifying the zero-rating of orthodontic appliances in a standalone provision, Parliament clearly confirmed its unequivocal intent for these supplies to be zero-rated. Furthermore, as conceded by the Minister, barring certain rare exceptions, orthodontic appliances are invariably accompanied by orthodontic services. Taken together, these arguments suggest that the legislature intended for conventional orthodontic practices to make multiple supplies of exempt services and zero-rated appliances. The only other alternative that could give effect to Section VI-II-11.1, considering the reality of a conventional orthodontic practice, would be, as advanced by the Minister, if the provision were intended to apply to sales by manufacturers of orthodontic appliances.

The FCA rejected the Minister's argument by relying on the findings of the trial judge, particularly with respect to the Department of Finance explanatory notes, which provided a clear indication that the zero-rating of orthodontic appliances was meant to apply to supplies made to patients. As such, the FCA endorsed the Tax Court's conclusion that a conventional orthodontic practice consists of the making of multiple supplies of exempt services and zero-rated appliances – rendering the O.A. Brown test inapplicable in this context.

Key Takeaways

Orthodontists involved in a conventional orthodontic practice should welcome this decision, since the TCC's line of reasoning in Hurd clearly has been set aside by the FCA. Subject to further appeal, it is likely that the CRA Administrative Position, which was on hold pending the outcome of this decision, will be reinstated.

GST/HST practitioners should be fully cognizant of this major judicial development in the "single versus multiple supplies" doctrine, noting the following in particular:

• While the Tax Court and the FCA have seemingly simplified the picture for orthodontists, the determination as to whether a particular supply of multiple elements constitutes a single supply or multiple supplies has been complexified from a legal standpoint. Going forward, a two-stage approach may be required, in which a court first takes a purposive and contextual approach to the legislation and its drafting (including consideration of Parliamentary intent). Only if the issue fails to be resolved at that stage should they then move on to the "common law" A. Brown test.
• Both the Tax Court and the FCA decided that the A. Brown test was inapplicable based on their appreciation of Parliament's intention to characterize supplies of orthodontic appliances as separate zero-rated supplies in the context of a conventional orthodontic practice. However, this conclusion was drawn from a practical consideration of the realities of such practice in which orthodontic appliances are virtually always accompanied by orthodontic services. Thus, there appears to be an implicit underlying conclusion that, if the O.A. Brown test were to apply, the supply of orthodontic appliances would virtually always form an integral part of a single supply of exempt services.

Critically, the FCA ruling should not be seen as necessarily overruling other similar cases not specifically related to conventional orthodontic practices, such as the recent TCC decision Axelrod v. The King, which involved a dentist carrying on a prosthodontic practice. In Axelrod, which we discussed in a January 2023 post, the application of the O.A. Brown test resulted in the conclusion that the supplies of zero-rated artificial teeth were part of a single supply of exempt dental services. Although the supply of artificial teeth is also unconditionally zero-rated under section 11 of Part II of Schedule VI to the ETA (to the extent the supply is not for cosmetic purposes), it might be difficult to argue that Parliament's intent was to restrict the zero-rating status of artificial teeth "at the wholesale level" only as stated by the FCA in the present case. Contrary to most orthodontic appliances (although the FCA conceded that certain appliances could be purchased directly by a patient), customers can purchase dentures directly from a manufacturer, laboratory, or denturist. In other words, supplies of zero-rated artificial teeth to customers are not always combined with the supply of exempt dental services in the context of a dentist prosthodontic practice involving, notably, the supplies of crowns and bridges, which are included in the definition of artificial teeth.

The authors would like to acknowledge the support and assistance of  Josh Laxer, stagiaire.

Footnote

1. See, notably, GST/HST Ruling RITS 56427 dated December 1, 2004—Eligibility by an Orthodontist for Input Tax Credits.

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