Please note that the following document, although correct at the time of issue, may not represent the current position of the Canada Revenue Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence du revenu du Canada.
Excise and GST/HST Rulings Directorate
Place de Ville, Tower A, 15th floor
320 Queen Street
Ottawa ON K1A 0L5
[Addressee]
Case Number: 162056
Business Number: […]
February 10, 2017
Dear [Client]:
Subject: GST/HST RULING
GST/HST - Application of the GST/HST to an investment transaction
Thank you for your letter addressed to our […] Regional Office concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to the operations of […] ([…][the Investor]). We apologize for the delay in responding to your letter.
The HST applies in the participating provinces at the following rates: 13% in Ontario; and 15% in New Brunswick, Newfoundland and Labrador, Nova Scotia and Prince Edward Island. The GST applies in the rest of Canada at the rate of 5%.
All legislative references are to the Excise Tax Act (ETA) unless otherwise specified.
We reviewed the following documents in connection with your request:
* […][Agreement 1] dated [mm/dd/yyyy] […] between [the Investor] and […](Corporation 1); and
* […][Agreement 2] dated [mm/dd/yyyy] […] between [the Investor] and a non-resident corporation (Corporation 2).
STATEMENT OF FACTS
Based on your submission, [Agreement 1], [Agreement 2] and […], we understand the following:
1. [The Investor] is a GST/HST registrant; […].
2. [The Investor’s] only place of business is in […][City A], Canada. [The Investor] does not have any subsidiaries or place of business in the United States.
3. [The Investor] buys royalty interests in the revenue generated by small and medium sized businesses operating across a wide range of industry sectors and does not acquire any interest in any assets of those businesses.
[Agreement 1]
4. Under [Agreement 1], [the Investor] pays a Royalty Acquisition Amount of $[…] to Corporation 1, in return for a monthly Royalty Payment that is calculated as a percentage of certain intellectual property (IP) related revenue streams of Corporation 1.
5. Corporation 1 is a Canadian resident and a GST/HST registrant.
6. In return for the Royalty Acquisition Amount, [the Investor] is not entitled to receive a minimum monthly amount.
7. [Agreement 1] includes the following key provisions:
Recital
“The Purchaser [[…][the Investor]] wishes to acquire from the Corporation, […], a gross sales royalty […] on the terms and conditions contained herein.”
[…] Gross Sales Royalty
“As consideration for the payment by the Purchaser of the Royalty Acquisition Amount, and subject to the terms hereof, the Corporation […] agrees to pay to the Purchaser a royalty payment ([…] a “Royalty Payment”) equal to […]% of monthly IP Revenue earned by the Corporation during each calendar month, […].”
[…] Buyout Option
“[…] the Corporation shall have the right to purchase and extinguish, fully and not in part, all amounts owing to the Purchaser […], in accordance with the following (the “Buyout Option”): …”
[…] No Interest
The Purchaser is not granted interest in any assets or Business IP of the Corporation. The only interest being granted to the Purchaser by the Corporation under [Agreement 1] is the Gross Sales Royalty.
[…]
[Agreement 2]
8. Under [Agreement 2], [the Investor] pays an amount referred to as the Initial Installment and, if applicable, the Second Instalment to Corporation 2, in return for a monthly Royalty Payment that is calculated as a percentage of certain IP related revenue […].
9. [Agreement 2] contains a provision […] entitling [the Investor] to receive a minimum monthly amount from Corporation 2.
10. [Agreement 2] includes the following key provisions:
Recitals
“[…] the Purchaser wishes to acquire from the Corporation, […] a gross sales royalty […].”
[…] Gross Sales Royalty
“As consideration for, […], the payment by the Purchaser of the Initial Installment and, if applicable, the Second Installment, […], the Corporation […] agrees to pay to the Purchaser a royalty amount ([…] a “Royalty Payment”) equal to […]% of monthly IP Revenue […] (the “Gross Sales Royalty”). […].”
[…] Minimum Royalties
“[…] [No] Royalty Payment in respect of a calendar month will be less than $[…], […] referred to as the “Minimum Monthly Amounts”. […].”
[…] Buyout Option
[…], the Corporation may […] purchase and extinguish […]% […] of all amounts owing or to become owing to the Purchaser […]
[…] Acknowledgements of the Purchaser
“The Purchaser acknowledges and agrees that:
…
(b) this Agreement and the royalties paid or payable […] do not confer on the Purchaser any right, title, or interest in any assets […] other than the rights to receive the payments set out herein.”
[…]
RULINGS REQUESTED
In relation to [Agreement 1], you would like to know:
1. Is the Royalty Acquisition Amount paid by [the Investor] to Corporation 1 not a “debt security” and is it a taxable supply?
2. Are the Royalty Payments received by [the Investor] from Corporation 1 not a “debt security” and are the payments taxable supplies?
3. Does subsection 182(1) apply to the payments made by Corporation 1 pursuant to the Buyout Option in [Agreement 1]?
In relation to [Agreement 2], you would like to know:
4. Are the […][installment payments] paid by [the Investor] not a “debt security” and are the payments taxable supplies?
5. Are the Royalty Payments received by [the Investor] from Corporation 2 not a “debt security” and are the payments taxable supplies?
6. Are the Minimum Monthly Amounts received by [the Investor] from Corporation 2 taxable supplies irrespective whether these amounts continue to perpetuity or are in effect for only a specified period of time?
7. Does subsection 182(1) apply to the payments made by Corporation 2 pursuant to the Buyout Option in [Agreement 2]?
RULINGS GIVEN
Based on the facts set out above, we rule that:
Under [Agreement 1]:
1. The Royalty Acquisition Amount paid by [the Investor] to Corporation 1 is consideration for a taxable supply made by Corporation 1 of intangible personal property (a right to be paid money, that is, the Royalty Payments). This right is not a “debt security” because [the Investor’s] right to be paid money is contingent on Corporation 1 earning IP Revenue (that is, there is no minimum amount guaranteed to [the Investor]).
2. The Royalty Payments received by [the Investor] from Corporation 1 are not consideration for a taxable supply made by [the Investor] to Corporation 1.
3. Subsection 182(1) of the ETA does not apply to the payments made by Corporation 1 pursuant to the Buyout Option in [Agreement 1].
Under [Agreement 2]:
4. The Installments paid by [the Investor] are consideration for an exempt supply of a financial service made by Corporation 2 to [the Investor]. [The Investor’s] right to be paid money (Royalty Payments) is not contingent and is therefore a "debt security" (that is, there is a minimum amount guaranteed to be paid to [the Investor] in the form of Minimum Monthly Amounts).
5. The Royalty Payments received by [the Investor] from Corporation 2 are not consideration for a taxable supply made by [the Investor] to Corporation 2.
6. The Minimum Monthly Amounts received by [the Investor] from Corporation 2 are not consideration for a taxable supply made by [the Investor] to Corporation 2.
7. Subsection 182(1) of the ETA does not apply to the payments made by Corporation 2 pursuant to the Buyout Option in [Agreement 2].
EXPLANATION
As set out in paragraph 8 of GST/HST Memorandum 17.1, Definition of “Financial Instrument”, a “debt security” does not include a contingent right. A right to be paid money is a possibility but not a certainty where a contingent right is involved. The payment is conditional upon the occurrence or non-occurrence of some future event that may never happen.
Under [Agreement 1]
Pursuant to the supply by Corporation 1 of the right to the Royalty Payments, the recipient (that is, [the Investor]) receives a contingent right to receive payments of money based on the IP Revenue earned by Corporation 1. The right is contingent since [the Investor’s] right to be paid money is a possibility but not a certainty being contingent on Corporation 1 earning IP Revenue (that is, there is no minimum amount guaranteed to [the Investor]). Therefore, this supply of the right to receive the Royalty Payments is a supply of intangible personal property made to [the Investor] by Corporation 1 and is taxable. The consideration for this supply is the Royalty Acquisition Amount paid by [the Investor] to Corporation 1.
When Corporation 1 makes the subsequent Royalty Payments to [the Investor] pursuant to the right that it has acquired, we do not consider [the Investor] to be making a taxable supply in exchange for these payments of money. Accordingly, the Royalty Payments are not subject to GST/HST.
Input tax credits (ITCs) are generally available to GST/HST registrants for GST/HST paid or payable on property or services to the extent that they are acquired or imported for consumption, use or supply in the course of a commercial activity. A person is generally not entitled to claim ITCs for GST/HST paid or payable on property or services acquired exclusively for consumption or use for the purpose of making supplies that are not taxable supplies for consideration (for example, making exempt supplies) or for a purpose other than the making of supplies. Since [the Investor] is not making supplies under [Agreement 1], it would not be entitled to claim ITCs for GST/HST paid or payable on related inputs.
Generally, subsection 182(1) applies where, at any time, as a consequence of the breach, modification or termination of an agreement for the making of a taxable (other than zero-rated) supply of property or a service in Canada by a registrant to a person, an amount is paid or forfeited to the registrant otherwise than as consideration for the supply or a debt or other obligation of the registrant is reduced or extinguished without payment on account of the debt or obligation. The registrant making the taxable supply under [Agreement 1] is Corporation 1 and the payment made pursuant to the Buyout Option is paid to [the Investor] and not to Corporation 1. As such, subsection 182(1) will not apply when the Buyout Option is exercised.
Under [Agreement 2]
Under [Agreement 2], pursuant to the supply by Corporation 2 of the right to the greater of Royalty Payments and the Minimum Monthly Amounts, the recipient (that is, [the Investor]) receives a non-contingent right to receive payments of money. The right is not contingent since [the Investor’s] right to be paid money is a certainty not being contingent on the Corporation earning IP Revenue (that is, there is a minimum amount guaranteed to [the Investor] in the form of Minimum Monthly Amounts). Therefore, the right to receive the Royalty Payments is a debt security and is a financial instrument. The transfer of the financial instrument under [Agreement 2] is a supply of an exempt financial service made to [the Investor] by Corporation 2. The consideration for this supply consists of the Installments paid by [the Investor] to Corporation 2.
When Corporation 2 makes the subsequent Royalty Payments or the Minimum Monthly Amounts (whichever are applicable) to [the Investor] pursuant to the right that it has acquired, we do not consider [the Investor] to be making a taxable supply in exchange for these payments of money. In other words, the Royalty Payments or the Minimum Monthly Amounts made by the Corporation to [the Investor] are not consideration for a taxable supply. Accordingly, the Royalty Payments or the Minimum Monthly Amounts are not subject to GST/HST.
Since [the Investor] is not making supplies under [Agreement 2], it would not be entitled to claim ITCs for GST/HST paid or payable on related inputs, for similar reasons as discussed above in the context of [Agreement 1].
Since Corporation 2 is making an exempt supply to [the Investor] under [Agreement 2], subsection 182(1) would not apply when the Buyout Option is exercised.
We are unable to provide any comments with respect to any potential application of Division IV of the ETA or other provisions pertaining to non-residents in the context of [Agreement 2], since we were not provided with sufficient information in this regard.
In accordance with the qualifications and guidelines set out in GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service, the Canada Revenue Agency (CRA) is bound by the rulings given in this letter provided that: none of the issues discussed in the rulings are currently under audit, objection, or appeal; no future changes to the ETA, regulations or the CRA’s interpretative policy affect its validity; and all relevant facts and transactions have been fully and accurately disclosed. The interpretations given in this letter, including any additional information, are not rulings and do not bind the CRA with respect to a particular situation. Future changes to the ETA, regulations, or the CRA's interpretative policy could affect the interpretations or the additional information provided herein.
For your convenience, find enclosed a copy of GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service.
If you require clarification with respect to any of the issues discussed in this letter, please call me directly at (778) 374-8360 or my manager, Luba Baran, at (613) 952-9206. Should you have additional questions on the interpretation and application of GST/HST, please contact a GST/HST Rulings officer at 1-800-959-8287.
Yours truly,
Marjorie Stevens
Financial Services Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate
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