7 April 2005 External T.I. 2005-0109721E5 - GST Penalty in a Wash Transaction

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: A GST registrant failed to collect GST on the sale of a depreciable property. Whether the 4% GST penalty paid by the vendor in a "wash transaction" can be deducted as a current expense or, alternatively, deducted from the proceeds of sale of depreciable property..

Position: The reduced GST penalty payable in a wash transaction on the disposition of a depreciable property is in the nature of capital which is deducted from the proceeds and is, therefore, not deductible as a current expensse.

Reasons: The decrease to a taxpayer's UCC of a particular class includes for each disposition of a depreciable property of the class that has occurred before the time of the UCC calculation the lesser of the following two amounts: the proceeds of the property's disposition minus any related disposition costs of the taxpayer; and the taxpayer's capital cost of the property.

XXXXXXXXXX 2005-010972
Kathryn McCarthy, CA
April 7, 2005

Dear XXXXXXXXXX:

GST Penalty in a Wash Transaction

This is in reply to your facsimile dated January 1, 2005, concerning the above noted subject matter.

You described a situation where a Goods and Services Tax (GST) registrant failed to collect GST on the sale of a depreciable property. A GST "wash transaction" occurs when a supply that is taxable at 7% or 15% is made and the supplier has not remitted an amount of net tax by virtue of not having correctly charged and collected the tax from the recipient who is a registrant who would have been entitled to claim a full input tax credit if the tax had been correctly applied. You enquired as to whether the 4% GST penalty paid by the vendor in a "wash transaction" can be deducted as a current expense or, alternatively, deducted from the proceeds of sale of depreciable property under the Income Tax Act (the Act).

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. We are, however, prepared to offer the following general comments.

Pursuant to new section 67.6 of the Act, as proposed in the September 16, 2004 draft legislation:

In computing income, no deduction shall be made in respect of any amount that is a...penalty (other than a prescribed...penalty) imposed under a law of a country...

Paragraph (a) of draft section 7309 of the Income Tax Regulations (Regulation) states that, for the purposes of section 67.6 of the Act, an amount paid or payable under paragraph 280(1)(a) of the Excise Tax Act (ETA) is a prescribed penalty. New section 67.6 applies to penalties imposed after March 22, 2004.

Pursuant to subsection 281.1(2) of the ETA, the Minister may waive or cancel penalties payable by a person under section 280 of the ETA. For a wash transaction, the Minister will consider waiving or cancelling the portion of the penalty payable at the time of assessment that is in excess of 4% of the GST not properly collected by the supplier. For more information, see GST/HST Memoranda Series, 16.3.1. Reduction of Penalty and Interest in Wash Transaction Situations, which is available on our website at http://www.cra-arc.gc.ca/E/pub/gm/16-3-1/README.html. A 4% penalty applied to a GST wash transaction is, therefore, a prescribed penalty pursuant to draft Regulation 7309 and is generally deductible as a current expense pursuant to draft section 67.6 of the Act.

However, the decrease to a taxpayer's undepreciated capital cost (UCC) of a particular class includes for each disposition of a depreciable property of the class that has occurred before the time of the UCC calculation, the lesser of the following two amounts:

? the proceeds of the property's disposition minus any related disposition costs of the taxpayer, and
? the taxpayer's capital cost of the property;

In our opinion the reduced GST penalty payable in a wash transaction on the disposition of a depreciable property is in the nature of capital which is deducted from the proceeds and is, therefore, not deductible as a current expense. For further information, please contact our GST general inquiries line at 1-800-959-5525.

We trust these comments are helpful.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch