GST/HST and Damage Payments: What Tax Litigators Need to Know

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1 Osler, Hoskin & Harcourt LLP GST/HST and Damage Payments: What Tax Litigators Need to Know D Arcy Schieman March 2017

2 Overview of GST/HST and Provincial Sales Taxes GST value added tax that applies to most supplies of goods and services made in, or imported into, Canada, including most supplies of legal services. current rate is 5%. Ontario, Prince Edward Island, Newfoundland, Nova Scotia and New Brunswick all have harmonized sales taxes with the GST to form HST HST for Ontario: 13% HST in other participating provinces: 15% Both taxes are imposed under the Excise Tax Act ( ETA ) and they both typically have the same rules. One registration number covers both. Quebec has a 9.975% QST generally applies in the same manner as GST/HST but a separate registration is required. Manitoba, Saskatchewan and British Columbia each have provincial sales taxes ( PST ) that generally only apply to sales of tangible personal property and certain taxable services (including, generally, legal services). Each has its own registration and filing requirements, separate from the GST/HST. 2

3 Section 182 of the ETA and the Application of GST/HST to Payments for Damages Generally, a damage payment would not be consideration for a supply, as it is compensatory or punitive in nature and is not given in exchange for a supply of property or services by another party. GST/HST would typically not apply even if the payee agreed to release the payer from further liability. This applies whether the damage payment is made from a court judgment or from a settlement that was concluded to avoid a court judgment. Absent section 182, most payments for damages are generally not subject to GST/HST. 3

4 Section 182 of the ETA and the Application of GST/HST to Payments for Damages Under section 182 of the ETA, where an amount is paid to a GST/HST registered supplier as a result of the breach, modification or termination of an agreement for the making of a taxable supply (other than a zero rated supply) by the supplier, the payment is deemed to include GST/HST. Example: Assume a GST/HST registered supplier enters into an agreement to sell widgets in Ontario to a purchaser for a price of $1,000 plus $130 of HST, the purchaser terminates the agreement, and the purchaser agrees to pay the supplier $500 as damages for the breach of the agreement. In these circumstances, section 182 of the ETA would apply, and the payment of the $500 would be deemed to be inclusive of tax. As such, the purchaser would be deemed to have paid $ of consideration (100/113 * $500), and to have paid $57.52 of HST (13/113 * $500). The GST/HST registered supplier is deemed to have collected the $57.52 of HST, and must include this amount in its net tax calculation of the GST/HST it must remit to the CRA for the taxation period in which the payment is made. The GST/HST included will depend on the particular province in which the supply is considered to be made. If section 182 applies, the supplier would be required to remit the amount set out regardless of whether the payment was made to the supplier in respect of a court ordered payment or out ofcourt settlement. 4

5 Technical Requirements for the Deeming Rule in Section 182 of the ETA For s. 182 to apply, the following conditions must be satisfied: there was an agreement (although it need not have been in writing) for the making of a taxable supply (other than a zero rated supply) in Canada; the supplier is a GST/HST registrant; the agreement is breached, modified or terminated; an amount is paid or forfeited to the GST/HST registered supplier by the purchaser otherwise than as consideration for the supply or a debt or other obligation of the supplier is reduced without payment on account of the debt or obligation; if the amount was paid as consideration for a taxable supply, taxable under the normal rules; the amount paid or forfeited is not a late payment charge, as contemplated by s. 161 of the ETA; the amount paid or forfeited is neither for demurrage nor an inter railway rolling stock penalty for failure to return rolling stock, as contemplated by s of the ETA. 5

6 Circumstances under which Section 182 does not Apply See CRA Policy Statement P 218R, P 218 Tax Status of Damage Payments, Whether or not Within Section 182 of the Excise Tax Act, 2007 An award of judicial costs is not subject to s. 182 even if the award purports to say GST inclusive or HST inclusive, as no supply of legal services is being made by the successful party to the unsuccessful party. If award is GST/HST inclusive, generally the paying party must reimburse the other party for any unrecoverable GST/HST paid on the legal fees by the party receiving the award. Where a payment for non fulfillment of a provision is made pursuant to an indemnity clause in a contract, like a provision specifically providing for liquidated damages, it is arguable that since the contract provides for payment, it is not made as a consequence of the breach, termination or modification of the agreement. Section 182 generally does not apply to payments for claims in tort o underlying taxable supply. 6

7 Effect of Section 182 If section 182 applies, paragraph 182(1)(a) provides that the recipient is deemed to have paid consideration for the supply equal to 100/105 of the amount paid or forfeited in a GST province. In an HST province (with an HST rate of 13%), the recipient is deemed to have paid consideration for the supply equal to 100/113 of the amount paid or forfeited. Paragraph 182(1)(b) then provides that the recipient is deemed to have paid GST/HST on the amount paid or forfeited, and the supplier is deemed to have collected the same amount of tax. In effect, the total amount paid or forfeited is treated as tax included for both parties. The recipient may be able to claim an input tax credit (ITC) if the original property or service would have been acquired for use in the course of the recipient s commercial activities. 7

8 Examples Agreement between Aco and Bco Bco, a GST/HST registrant, was to make a taxable supply of custom software to Aco. Before the scheduled delivery date, Aco cancelled the order, but agreed to pay an amount to Bco to compensate for the cancellation. Is the payment subject to GST/HST under s. 182? The payment is subject to GST/HST since all the requirements for the application of s. 182 have been met. The payment is an amount other than for consideration for the supply under the agreement, and the payment is made as a consequence of the breach or termination of an agreement for the making of a taxable supply by a GST/HST registrant. Agreement between Cco and Dco Dco, a GST/HST registrant, would supply 1,000 widgets per month to Cco for a period of six months (for a total of 6,000 widgets). After 3 months and 3,000 widgets were delivered, Cco requests that the remaining portion of the order be modified to 1,500 widgets instead of 3,000. Cco agreed to pay Dco an additional amount as consideration for the modification. Is this payment for the modification subject to GST/HST under s. 182? Yes, as all the requirements have been met. The payment is an amount other than as consideration for the supply, it is made as a consequence of the modification of the agreement, and the payment is made to the GST/HST registered supplier. 8

9 Examples Agreement between Eco and Fco Fco would design and install a new software program by a certain date. Fco was unable to fulfil its obligations under the contract by the deadline, and Eco incurred additional expenses as a result of the non delivery of the software by the date. Pursuant to negotiations, Eco agreed to release Fco from the contract in exchange for a settlement. Is the payment subject to GST/HST? The payment is not subject to GST/HST as it is in essence compensatory with respect to the additional expenses incurred by Eco, rather than consideration for a taxable supply. It is meant to restore Eco to the position it was in prior to the damage occurring. Further, subsection 182(1) does not apply as the payment is being made by the supplier and not to the supplier. Truck owned by Gco causes damage to property owned by Hco. Hco sues Gco for $100,000 for the damage caused by Gco s truck. Gco agrees to settle the claim for a payment of $80,000. Is the payment subject to GST/HST? The payment is not subject to GST/HST as the payment is to compensate Gco for its losses. Further, section 182 does not apply as there was no agreement for a taxable supply between Gco and Hco. 9