GST Considerations for Suppliers and Their Creditors in a Downturned Economy
From the Editor's Pen is monthly feature focusing on current issues in commodity taxation, edited by Steven K. D'Arcy of Bennett Jones LLP, Michael Firth of PricewaterhouseCoopers LLP, and Brent F. Murray of Wilson & Partners LLP. This article first appeared in CCH's Canadian GST Monitor newsletter No. 243 dated December 2008.
With all of the doom and gloom associated with today's economy, it is important for Canadian businesses and their creditors to understand that there may be some significant GST implications resulting from their actions. Some of the GST implications may be beneficial, such as the ability of GST-registered suppliers (and certain of their agents) to obtain a net tax deduction on account of the GST component of a bad debt; whereas others may result in potential GST liabilities, such as the requirement for a mortgagee to remit GST on attorned rents and the requirement for creditors to collect GST on the sale of a debtor's property that was seized or repossessed. The purpose of this article is to provide a brief summary on some of the issues that GST registrants and their creditors may wish to consider in a flailing economy.
Bad Debt Relief for Suppliers and Certain of Their Agents
GST registrants are required to remit GST that is collectible on a taxable supply with their GST return for the reporting period in which the tax was collectible, irrespective of whether or not the customer actually pays the tax. In situations where the recipient fails to pay all or part of the consideration for the supply and the GST that is collectible on the consideration, section 231 of the Excise Tax Act (the "ETA") allows the supplier to take a net tax deduction for the GST component of the account receivable that is written off as a bad debt.
Bad debt relief is only available to the supplier or to a "reporting entity" who made an election under subsection177(1.1) of the ETA. Persons who merely receive an assignment of accounts receivable are not entitled to bad debt relief; however, as explained in Policy Statement P-029R, where accounts receivable are assigned on a recourse basis and the supplier reacquires the receivables, then the supplier may still be entitled to bad debt relief. With respect to taxable supplies that a debtor makes on a prospective basis, creditors who are entitled to receive payments directly from the debtor's customer should consider becoming the billing agent of the respective debtor so that they can make the requisite subsection 177(1.1) election and obtain GST relief with respect to any bad debts that are written off. By making the election, however, the creditor will be the person responsible for reporting the GST that is collectible on the supplies that the debtor makes. Alternatively, in the course of monitoring the accounts receivable that they have been assigned, creditors should consider transferring the uncollectible accounts back to the supplier so that the supplier/debtor can obtain bad debt relief for the GST component of the receivables.
GST Remittance Obligation for Creditors Who Receive GST
Paragraph 225(1)(a) of the ETA stipulates a person's "net tax" calculation includes amounts that are collected "as or on account of tax" under Division II of the ETA. As a result, the CRA has stated in Policy Statement P-131R that a third party "other than the supplier" is required to remit GST in situations where he or she receives payment of the GST:
Where a person other than the supplier collects an amount as or on account of tax under Division II, the provisions of the ETA for the calculation of net tax require that person to include the amount collected in its own net tax calculation.
As a result, both the supplier and the person who collected the amount as or on account of tax are required, under the ETA, to account for the GST/HST in their net tax calculations.
For example, a mortgagee that attorns rents of a commercial landlord is required to include the GST that he or she collects in his or her net tax calculation. Similarly, a person receiving an assignment of a future stream of lease payments may also have a remittance obligation for the GST component of the lease payment.Note1 Any failure on the part of the person receiving GST to remit the tax directly to the Receiver General could result in the person being assessed for the non-remittance of tax. Moreover, based on the Tax Court's reasoning in Sun Life Trust Co.,Note2 the attornment of rents could also constitute a seizure or repossession such that deeming rules in section 183 may apply. Pursuant to subsection 183(2) of the ETA, the mortgagee seizing or repossessing the mortgagor's property through attorning rents would be deemed to be the supplier of the leased property and, as such, would have an obligation to collect and remit GST by virtue of being the supplier.
As discussed in the September 2006 issue of the Canadian GST Monitor (Issue No. 216),Note3 by virtue of the deeming rules in section 182 of the ETA, amounts paid or forfeited as a consequence of the breach, modification, or termination of an agreement for a taxable supply may be deemed to be inclusive of GST. For the person receiving a damages payment, section 182 has the economic effect of reducing the damages payment by 5/105 (or 13/113 for payments that relate to agreements for taxable supplies made in the harmonized provinces). When negotiating and agreeing on a damages payment, the GST implications should be considered in advance and consideration should be given towards grossing up the damages payment on account of any unanticipated application of section 182.
ITCs Relating to Ceasing Commercial Activities
Subsection 141.1(3) of the ETA confirms that anything undertaken in connection with terminating a commercial activity is being undertaken in the course of a commercial activity. Accordingly, GST registrants are entitled to claim input tax credits ("ITCs") relating to winding down their respective business activities that constituted a "commercial activity". To the extent a particular business is no longer operating, there may be some concern as to whether the sale of the assets can qualify for a section 167 election. At the March 9, 2006 Canadian Bar Association's GST Round Table Meeting, the CRA expressed some concern as to whether it could be said that a "business" or "part of a business" is being sold when the assets of a defunct business are being transferred.
Purchaser Assessments for Non-Payment of Tax
Pursuant to paragraph 296(1)(b) of the ETA, the CRA may assess any GST payable by a person under the ETA. In Policy Statement P-112R, "Assessment of Tax Payable Where a Purchaser is Insolvent", the CRA has set out its administrative position concerning the assessment of insolvent purchasers who have claimed ITCs for GST that was payable to a supplier but not paid:
Section 296 of the ETA allows the Minister to assess any tax payable by a person under Division II as well as Division IV or IV.1. The [CRA] will not generally intervene to assess the tax payable by the purchaser under section 165. However, in circumstances of potential revenue loss, the Minister may exercise its authority under paragraph 296(1)(b) of the ETA and assess a purchaser who is insolvent or bankrupt in respect of the GST/HST not paid to the supplier.
For example, an assessment of tax payable may be made where a purchaser has claimed input tax credits (ITCs) in respect of a taxable purchase, for which payment to the supplier remains outstanding, and the supplier is entitled to a bad debt deduction in calculating its net tax. Under these circumstances, an assessment of tax payable addresses the net revenue loss position that would occur if the supplier deducts the bad debt adjustment in its net tax calculation.
Assessing the recipient of a supply for its failure to pay GST in a bankruptcy situation, where the recipient had claimed and received an ITC for the GST payable (but not paid), was the approach taken by the CRA in Paper Mill Recycling.Note4
1.By virtue of section 222.1, the person receiving an assignment of a debt that is an account receivable would not have a remittance obligation as the GST component of the receivable is deemed not to be an amount collected as or on account of tax.
2.Sun Life Trust Co. v. The Queen, 98 GTC 2162.
3.Brent Murray, GST and Damage Payments (Part II), No. 216, September 2006.
4.Paper Mill Recycling Inc. v. The Queen, 2004 GTC 461 (TCC).