CRA assimilates a loan to a royalty agreement and finds that the principal advanced in fact was subject to GST/HST

CRA considered a situation in which a financing of a company with product sales was bifurcated into a non-interest-bearing loan and a royalty agreement. The loan was repaid on a quarterly basis to the extent of x% of product sales in each quarter, with the balance of the loan to be repaid on a specified date, if the revenues prior to then were insufficient to repay the loan. The second component was styled as a royalty agreement and contemplated that in consideration for a stipulated amount advanced to the company (which was labeled as an “interest free loan”), the company was to start paying a percentage of its product sales to the investor after a stipulated level of payments had been made under the loan agreement.

CRA found that the company had made a single supply under the two (loan and royalty) agreements. What it supplied to the investors was a “contingent right to be paid money” rather than the exempt supply of a debt security. Accordingly, there was a taxable supply by the company to the investors, and the “principal amount” advanced by them under their “loan” to the company was the up-front consideration charged to them for this taxable supply. Accordingly, the company was required to charge GST/HST on that principal amount.

CRA also ruled that a more straight-up royalty arrangement (somewhat similar to that described in 162056) was subject to GST/HST on the amount advanced by the investor.

Neal Armstrong. Summary of 10 May 2019 GST/HST Ruling 167225 under ETA s. 123(1) – debt security.