Zero-rated supplies: Do not forget the burden of proof!

The burden of proof in tax matters is a topic frequently addressed by commentators and dealt with in provincial and federal case law. However, the concept itself is sometimes confused with other tax concepts. For example, many taxpayers consider the concept of the burden of proof and that of compliance with legislative and regulatory consumption-tax requirements to be identical, whereas they are actually two distinct concepts, albeit interconnected in law.

The requirements under sales tax statutes and regulations are prescribed by the actual wording of a statute and/or regulation and must be met in order for a legal right or obligation to apply. The burden of proof, on the other hand, is a concept denoting the taxpayer’s obligation to show that it has met the conditions imposed under applicable consumption-tax laws and regulations. These two concepts can be easily confused, as was the case in the Contact Lens King[1] decision of the Federal Court of Appeal.

Contact Lens King Inc. v. Canada

The taxpayer, Contact Lens King Inc. (“Contact Lens”), sold contact lenses through an online e-commerce platform. To place an order, customers had to enter their biometric information during the ordering process but was not required to provide Contact Lens with a copy of their prescription. Contact Lens did not collect GST on sales made to customers in Canada because, in its view, the contact lenses sold constituted a zero-rated supply under section 9 of Part II of Schedule VI of the Excise Tax Act (“Section 9”).

Under Section 9, the supply of contact lenses is zero-rated provided they are supplied under the authority of, inter alia, a prescription prepared by an authorized person. According to the Canada Revenue Agency’s (the “CRA”) interpretation, this meant that Contact Lens at a minimum had to prove the existence of a valid prescription in order for the sale of the lenses to be zero-rated. This was not the case, as it had not verified in any way whether its customers had a prescription. The CRA was therefore of the view that Contact Lens’s sales of the lenses at issue were taxable. As for Contact Lens, it maintained that no action was required on its part for the sales of its lenses to be zero-rated, as the specificity of the biometric information required to order the contact lenses necessarily meant that the customer had a prescription.

The courts thus had to determine whether or not Section 9 required Contact Lens to obtain and retain a copy of its customers’ prescriptions at the time of purchase in order for its sales to be zero-rated.

The Tax Court of Canada ruled at first instance that it was clear from Section 9 that the taxpayer had to obtain a prescription from its customers, as this was the only way to ensure that the lenses were prescribed for the treatment or correction of a defect of vision (legal requirement). The trial judge also indicated that even if he accepted the argument that obtaining the prescriptions was not an essential condition, Contact Lens had in any event not produced any reasonable proof that its customers had a prescription when they placed their order. The taxpayer, not having satisfied one of the conditions for zero-rating or discharged its burden of proof, was required to collect GST on the sale of contact lenses to its customers.

Questions at issue

At the Federal Court of Appeal, the following two questions were at issue:

• 1. did the Tax Court of Canada err in concluding that Contact Lens had to obtain and retain each customer’s prescription in order for the supply of contact lenses to be considered zero-rated under Section 9?
  2. did the Tax Court of Canada err in finding that Contact Lens had not succeeded in providing reasonable proof of the existence of prescriptions in connection with its sales of contact lenses?

Decision of the Court of Appeal

In its decision, the Court of Appeal found partly in the taxpayer’s favour in deciding that obtaining evidence of the prescription was not a condition (legal requirement) under Section 9. The wording of that provision does not explicitly create an obligation to obtain and retain a copy of the prescription, and interpreting it otherwise would be tantamount to adding wording to the section. In addition, this interpretation is more in line with the purpose of the section on zero-rating, which is to ease the economic burden on individuals with a handicap or impairment.

The Court specified however that it was up to Contact Lens to provide “sufficient and credible” evidence that the lenses sold were or were to be “supplied under the authority of a prescription” in order for zero-rating to apply. However, given that Contact Lens made no attempt to verify the existence and validity of its customers’ prescriptions, its evidence on file was deficient and based solely on hypotheses and deductions. The Court thus sided with the tax authorities and dismissed the appeal:

[86] [TRANSLATION] Nor is there any evidence that the appellant made random checks or invited customers disposed to do so to send it a copy of their Prescription. While not obliged to provide them to the Minister, nothing prevented it from doing so of its own volition, in keeping with the best-evidence principle.

Overview

The Contact Lens decision is interesting because it emphasizes the importance for taxpayers to understand the conditions for zero?rating under consumption-tax laws and regulations as well as the concept of the burden of proof, and to obtain and retain supporting documents so as to be able to adduce the best evidence in the event of a challenge by the tax authorities.

If you have any questions about this decision or the GST/QST, our Sales, Commodity and Indirect Tax team is available to discuss them with you.

[1]Contact Lens King Inc. v. Canada, 2022 CAF 154