Draft Advanced Income Tax Ruling Example

The following provides an example of an Advanced Income Tax Ruling

1b) Draft application: (consent of taxpayer for Appendix A of IC 70-6R5 is not provided)

The following example concerns employee deductions for required Consumable Supplies:

Issue: Whether the a) cost of a Blackberry unit, b) the monthly connection charges for a blackberry unit, c) an initial connection charge for high speed internet service, and d) monthly internet charges, are deductible for an employee under s 8(1)(i)(iii) of the ITA where i) the listed charges are paid by the employees, ii) the purchase of these items are an employment requirement, iii) the employees specialize in research, sales or design, and are paid through a salary or bonus, but are not compensated through commission.

Facts:

1. Apple Communications Inc. (Apple) conducts market research and creates print and television ads for Canadian and foreign clients. Apple emphasizes a corporate culture based on team work, and rapid response to client requests. This culture is key to Apple’s success.

2. Apple believes that the maintenance of its competitive edge can only be sustained if they have 24-hour access to most of its employees, who must be able to work together from any location at any time. To this end, Apple would like to implement a new policy requiring employees to use a Blackberry wireless handheld device, and to maintain high speed internet access at their homes.

3. Apple’s employees specialize in research, sales or design, and are paid through a salary or bonus, but are not compensated through commission.
Proposed Transactions:

4. Apple would like their employees to bare the costs of; purchasing a Blackberry unit, the monthly connection charges for the Blackberry, the initial connection charge for high speed internet service, and monthly high speed internet charges.

5. Apple employees would then deduct these expenses under s. 8(1)(i)(iii) of the ITA.
Purpose of the Proposed Transactions:

6. Apple wants to implement their policy, as seen in ¶3, to minimize their operational costs. The implementation of this new policy is unlikely if the employees cannot deduct these expenses.

Law and Analysis:

7. Law: S. 8(1)(i)(iii) states that an employee can deduct the cost of supplies consumed directly in the performance of their employment duties, and where the employee is required to supply and pay for these supplies by virtue of their contract. The impending amendment to s. 8(1)(i),[1] applicable on Royal Assent, clarifies the position that an expense paid (normally the employer) on an employee’s behalf is deductible by the employee if the amount paid is required to be included in computing the employee’s income.

8. S. 8(2) does not allow an employee to deduct an expense unless it is permitted under s. 8.

9. The historical understanding by the courts regarding ‘supplies that were consumed’ are supplies must be used up during the taxpayer’s employment, and be unfit for later use.[2] Items not used up are equipment, and are not consumable supplies; for example, the gasoline used in a blowtorch is a consumed supply, but the blowtorch is not.[3]

10. The meaning of ‘supplies’ has expanded to include items not directly consumed in the course of employment. For example, a book supplied by a professor for the preparation of his class, [4] the payment of a basic monthly telephone service and a monthly rental fee for a pager[5] were considered to be supplies, despite the fact they were not consumed.

11. CRA’s approach to ‘supplies that were consumed’ is consistent with the above case law. CRA treats “supplies,” under s. 8(1)(i)(iii), to mean materials are used up directly in the performance of the duties of employment,[6] and includes items like the cost of gasoline and oil used for power saws, or long-distance telephone calls or cell phone air time. Supplies do not include monthly phone service charges, or fees to connect or license a cell phone.[7]

12. CRA does not permit an employee to deduct the cost of acquiring a cell phone from employment income,[8] and considers items like cell phones, fax machines and computers to have capital cost attached to them.[9] CRA disallows basic telephone fees because they are personal.[10]

13. However, recent cases have bucked this trend, and recognized that interpreting the ITA in its classical sense would be patently absurd.[11] The Tax Court of Canada (TCC) has stated that the monthly cost of a cell phone and pager are supplies that are consumable, and can be deducted for the purposes of s. 8(1)(i)(iii), as the distinction drawn under Interpretation Bulletin IT-352R2 between consumable and non-consumable supplies is nonsensical.[12] The TCC has gone even further and ruled that computer software, which by its very nature, does not wear down, is a consumable supply that can be deducted by an employee under s. 8(1)(i)(iii) if the employee implicitly required updated software for their employment.[13]

14. The recent case law should be followed as opposed to historical jurisprudence regarding what are and what are not consumable supplies in s. 8(1)(i)(iii). A dynamic understanding of the ITA is needed in our society, as this allows the spirit of the ITA to change and reflect the modern needs and practices of society, and permits the evolution of language and understanding by all those who try to adhere to the ITA. It is irrational to expect members of society to know what a judge thought was the meaning of a phrase in 1950, and then apply it to today’s circumstances.

15. Analysis: Therefore, the recent case law states Apple employees can deduct the expenses under s. 8(1)(i)(iii) where they pay; for a Blackberry unit, the monthly connection charges for the Blackberry, the initial connection charge for high speed internet service, and monthly high speed internet charges, and this payment is required by employment.

16. The cost of a Blackberry unit is similar to the cost of acquiring new software in Glen. Due to the constant innovations in technology, people are constantly updating the items they use, and not allowing for items that may have once been considered capital in nature, to depreciate. Current business cycle trends dictate how pertinent it is to update technological supplies.

17. The monthly connection charges of a Blackberry are analogous to the monthly cost of a cell phone, as both require a flat fee for memory sent or air time, and the consumer pays an extra amount where they send more memory, or use extra air time.

18. The initial connection and monthly internet charges are similar to connecting and paying for a telephone landline. These expenses are deductible under s. 8(1)(i)(iii) as Fardeau states that paying for services, like the monthly cost of a cell phone, is as much a cost of a service that is supplied as is cellular telephone airtime.[14] Like the payment of a monthly cell phone service, the initial connection and monthly internet charges are a cost of a service that is supplied.

FOOTNOTES

[1] “Department of Finance, Explanatory Notes to clause 4 of Legislative Proposals and Explanatory NotesRelating to Income Tax – 20 December 2002,” 14 March 2005, (obtained on CCH online).
[2] Martyn v. M.N.R., 64 DTC 461 (TAB), at 465.
[3] Luks v. M.N.R., [No. 2], 58 DTC 1194, at 1198.
[4] Carson v. M.N.R., 66 DTC 425, at 425.
[5] Cuddie v. The Queen, 98 DTC 1822, at para. 11.
[6] M.N.R., Interpretation Bulletin IT-352R2, “Employee’s Expenses, Including Work Space in Home Expenses” (26 August 1994, modified on 1 January 1995), at para. 9.
[7] Ibid. at para. 10.
[8] Deductibility of the cost of acquiring a cellular telephone from employment income, Technical Interpretation, September 22, 1989, CRA Document No. 5-8450. (TaxFind)
[9] Employment Expense — fax machine, cell phone etc., Technical Interpretation, December 20, 1994, CRA Document No. 9430840. (TaxFind)
[10] Employee's Internet Fees, Technical Interpretation, Business and Publications Division, September 28, 1998, CRA Document No. 9816945. (TaxFind)
[11] Sword v. M.N.R., 90 DTC 1798, at 1802. (Sword)
[12] Fardeau v The Queen, [2002] 3 CTC 2169 (TCC), at para. 16-18. (Fardeau)
[13] Glen v. Canada [2003] TCJ No. 667 (TCC), at para. 11. (Glen)
[14] Supra. note 12, at para. 18.