The evolution of GST/HST and orthodontists

Orthodontists have faced difficulties in complying with the Goods and Services Tax (GST)¹ since it was introduced on January 1, 1991.

The difficulties trace back to the origins of the GST system itself. In August 1989, The Finance Minister at the time, the Honourable Michael Wilson, introduced a paper titled “Goods and Services Tax: An Overview.” The paper was the foundation of the soon-to-be-implemented GST system, and introduced the two concepts “tax free” and “tax exempt.” On the surface these concepts appear similar. In reality they differ significantly:

• Tax free (i.e. zero rated) – Vendors may sell products or services without charging GST to the purchaser. They may also recover any GST paid on inputs used in making the tax-free good or service. As such, the good or service is completely free of any GST costs that would normally be absorbed into the purchase price.
• Tax exempt – Vendors may sell products or services without charging GST to the purchaser, but they may not recover GST paid on inputs. 

How does this apply to orthodontists? Orthodontists provide treatment to correct problems related to patients’ irregular alignment of teeth, and problems with the jaw and occlusion. These treatments consist of the manufacture, installation and adjustment of an orthodontic appliance, along with the professional services of the orthodontist. The problem for orthodontists lies with the design of the GST system: medical devices fall under the tax-free category, whereas orthodontic services fall under the tax-exempt category.

The system was designed so that the GST would not cause a direct or indirect increase in the cost of medical devices to the end consumer, which is why vendors have the ability to recover any GST on inputs used in making the medical device. This cost-neutral aspect of the tax-free category was not afforded to the services of medical practitioners. Virtually all health and dental care services fall under the tax-exempt category. The tax-exempt status allowed medical practitioners to provide services to their patients without charging GST on the value of the service provided, but it did not allow for a cost-neutral situation. The 1989 paper did not provide any explanation why health and dental care services were tax exempt rather than tax free. One possible explanation is that a medical practitioner’s time accounts for the majority of the direct costs associated with delivering health care and dental services, and a medical practitioner’s time does not create GST costs. 

Why do we care that orthodontic treatments fall under two separate categories: tax free and tax exempt? We care because orthodontists have the ability to claim, as input tax credits (ITCs), any GST paid on expenses directly or indirectly related to the production, manufacture and installation of the orthodontic appliance,² including any part, accessory or attachment.³ But orthodontists may not claim ITCs for GST paid on expenses related to services of a medical practitioner, which are considered tax exempt.

The Canada Revenue Agency (CRA) collaborated with the Canadian Dental Association and the Canadian Association of Orthodontists to develop practical guidelines to allow orthodontists to estimate the split between a tax-free medical appliance and a tax-exempt medical service. The CRA has published the guidelines in a number of technical interpretations since 1998,⁴ leading to the most comprehensive interpretation issued December 1, 2004.⁵ In that interpretation, the CRA developed an administrative policy to allow an estimate of 35 per cent of the cost to the patient of the orthodontic treatment to represent the consideration for the supply of the orthodontic appliance. The CRA’s guidelines for this policy stated that the orthodontist had to show the supplies separately and reconcile the estimate at year-end based on actual results.

This interpretation opened the door for orthodontists to assume that 35 per cent of their revenue related to the orthodontic appliance. Consequently, all GST on expenses directly related to the appliance, and 35 per cent of GST on expenses indirectly related to the appliance, were claimed as ITCs. 

The CRA’s guidelines remained unchallenged for several years until 2006, when the CRA challenged Dr. James Singer Inc. for claiming ITCs on the installation of artificial teeth,⁶ which is also zero rated.⁷ The dispute was heard by the Tax Court of Canada (informal procedure) and the challenge by the CRA was appealed by the taxpayer (Dr. James Singer Inc.), but Singer’s appeal was dismissed by the court due to inadequate evidence. Justice Bowman did however provide comments regarding the zero-rated status of installing artificial teeth. Justice Bowman stated (in obiter dictum) that the services of installing a zero-rated supply would also be considered zero rated. While neither the case nor Justice Bowman’s comments related directly to orthodontists, they did appear to validate the CRA’s policy.

Eleven years later, orthodontists face a new challenge: the 2017 decision of the Tax Court of Canada in Dr. Brian Hurd Dentistry Professional Corporation v. Her Majesty the Queen.⁸ Concerns with the outcome of this case focus on Justice Campbell’s conclusion that the orthodontic treatment provided by Dr. Hurd was a single supply of an exempt medical service. As discussed above, an exempt supply does not allow the recovery of GST paid on expenses. Therefore, any GST paid on expenses related to the orthodontic appliance could not be recovered by the appellant in the case.  

Several other important aspects stand out in the case:

• Justice Campbell disagreed with the CRA’s policy, calling it misleading;
• Dr. Hurd’s dentistry practice executed the orthodontic treatments as a single supply;
• Justice Campbell concluded emphatically that both the appliance and the services are indispensable components of the single supply of an orthodontic treatment to a patient; and
• if the supplies could be considered two separate supplies, then the orthodontic appliance would be zero rated, and the medical service would be exempt.

The case is problematic for orthodontists. On one hand, Justice Campbell concludes that the orthodontic treatment is a single supply, which seems inconsistent with the original intentions of Parliament that medical devices are to be tax free and medical services are to be tax exempt. On the other hand, Justice Campbell concludes that, if there were two actual supplies, then the legislation is designed to zero rate the orthodontic appliance while exempting the medical service. It would have been helpful if Justice Campbell had provided some concluding remarks to clarify whether there was anything Dr. Hurd could have done differently to create two supplies rather than one. Without such clarification, practitioners are left to guess whether the case is applicable to all orthodontists or only those who execute orthodontic treatments as a single supply.

This case provides uncertainty regarding the CRA’s long-standing policy for orthodontists. Is the policy at risk of being withdrawn, or will the CRA treat this taxpayer situation as an isolated incident due to poor documentation and specific circumstances? To date, the CRA has not commented on the outcome of the case or the specific comments made by Justice Campbell in relation to the policy. Consequently, orthodontists are left to decide between multiple courses of action: 

• they may continue operating as normal, relying on Parliament’s original intentions and continuing to follow the CRA’s administrative policy on claiming ITCs;
• they may stop claiming ITCs and pass the GST costs on to their patients, which would be inconsistent with Parliament’s original intentions;
• they may modify operations to ensure documentation and procedures indicate two separate supplies (one supply of an orthodontic appliance and a separate supply of a medical service); or
• they may reorganize their practices to provide the two separate supplies out of two separate entities (i.e. an appliance company and a separate medical services company).

Your Collins Barrow advisor can help you consider the tax landscape and decide on the course of action that is most appropriate for your orthodontic practice.