May 1995
XXXXX
Dear Sir:
This is in reply to your letter of March 13, 1995 requesting our interpretation of the eligibility of XXXXX to claim input tax credits with respect to litigation costs incurred in respect of a claim of misconduct and breach of contract of certain of its officers, directors, and "others".
Our understanding of the situation is as follows:
1. XXXXX was appointed liquidator of the XXXXX on January 20, 1986.
2. In its capacity as liquidator, XXXXX has commenced a law suit against former officers and directors of XXXXX as well as certain "accommodation parties" for breach of contractual obligations owed to the XXXXX and for misconduct on their part which resulted in the XXXXX suffering damages of approximately $ XXXXX .
3. The specific allegations of misconduct engaged in by former officers and directors include, "entering into transactions, the true purpose of which was to conceal the XXXXX true financial condition or to artificially increase its income". The misconduct took the form of entering into agreements with "accommodation parties", e.g. loan agreements with accommodation parties or numbered companies owned by accommodation parties which enabled the parties to enter into certain real estate transactions thus concealing the XXXXX true financial condition.
4. The transactions in question involve the purchase and sale of real property by accommodation parties and numbered companies owned by accommodation parties at inflated values which enabled the XXXXX to rid itself of real property on which it otherwise would have taken a loss, i.e. real property held as security on XXXXX , and by doing so artificially inflate its revenues.
These transactions also enabled the XXXXX to minimize the recognition of XXXXX .
XXXXX Position
1. All the litigation costs which are the subject of the current claim for an input tax credit are related to the XXXXX dealing in real property on its own account. In virtually every transaction in respect of which the XXXXX is suing certain officers, directors and other persons, the XXXXX was the effective owner of the real property in question and was the party purchasing or selling the property.
2. The law suit is wholly unrelated to the XXXXX t XXXXX and wholly unconnected to the liquidation of the XXXXX . There were no XXXXX taken. The transactions engaged in by the former officers and directors were sham transactions, the true purpose of which was to conceal the XXXXX true financial condition.
3. The litigation costs incurred by the XXXXX fall within the XXXXX commercial activities, within the meaning of subsection 123(1) of the Excise Tax Act, specifically paragraph (c) of the definition of: "commercial activity", i.e., "the making of a supply (other than an exempt supply) by the person of real property of the person, including anything done by the person in the course of or in connection with the making of the supply".
4. No officer, director, or any other person who is a defendant in the legal action is a borrower in any of the transactions. These parties were all agents or other persona of the XXXXX often numbered companies. XXXXX
5. In no case did any "borrower" put in any of its own money. The "borrowers" had no risk, held all the future profits and ultimately when the XXXXX was put in liquidation, the borrowers gave the XXXXX quit claims indicating that the XXXXX had owned the property at all material times.
6. In some cases, the XXXXX would package several properties that had been acquired as described above, and sell that package to another company. The numbered companies who "owned" the property were not paid for the property by the XXXXX when it was sold as part of a package to a third party. None of the numbered companies had any interest whether or not the XXXXX sold the properties, indicating that the XXXXX , in effect, was the owner of the properties.
7. The individuals who owned the numbered corporations typically took their profit through the charging of management fees.
8. The XXXXX was at all times supplying real property or providing management services in respect of real property and/or engaging in other transactions in the course of or in connection with the supply of real property as defined by the term "commercial activity" in section 123 of the Act. To the extent that any supply or any dealing in real property is a "commercial activity", and to the extent that the XXXXX is now suing certain officers, directors and accommodation parties in respect of commercial activities, the XXXXX is entitled to inputs tax credits which relate to the litigation costs associated with this lawsuit.
Department's Position
Based on the information submitted in your letters of February 3, 1995 and March 13, 1995 and conversations with yourself, XXXXX , it is our view that the lawsuit with respect to misconduct and breach of contractual obligations on the part of certain officers and directors as well as the other parties named in the Statement of Claim relates to the making of exempt supplies and, to the extent that the XXXXX is realizing on its loan security by selling real property which it has seized, some taxable supplies.
The services of the officers and directors are inputs into the XXXXX operations. Given the level of these persons within the organization, i.e., president, vice-presidents, members of the Audit Committee of the Board of Directors, their services could be classified as "overhead" since the services relate to the overall operations of the XXXXX and not to any specific transaction. As a result, the services of these persons would generally not be directly or wholly attributable to any particular supply, i.e., taxable or exempt.
The lawsuit is with respect to the breach of the fiduciary duties of the officers and directors in their obligations pursuant to their contracts and their failure to act honestly and in good faith with a view to the best interests of the XXXXX and in discharging their duties. To the extent that the lawsuit involves the breach of any duty with respect to the taxable sale of real property that was disposed of as a result of the realization of the XXXXX security interest, input tax credits are claimable. However, to the extent that lawsuit involves the breach of any duty with respect to the attempt by the officers and directors to conceal the true nature and value of the XXXXX the lawsuit is in respect of exempt supplies of the XXXXX and no input tax credits are claimable.
In this particular case there are two aspects to consider. One aspect is the sale of real property which, as noted above, can be considered in the course of the commercial activities of the XXXXX . The other aspect is the XXXXX concealing the true nature of its XXXXX . XXXXX .
As with the officers and directors, the accommodation parties are also inputs acquired by the XXXXX to make certain supplies. Some of these supplies involve the sale of real property and some of these supplies involve financial services as noted above.
XXXXX were engaged by the XXXXX as consultants to assist in the management of the XXXXX XXXXX . To the extent that the lawsuit is with respect to the breach of their fiduciary and contractual duties to the XXXXX , input tax credits are not claimable since their services were inputs acquired by the XXXXX to make exempt supplies, i.e. XXXXX .
An allocation of the GST incurred on the legal and other fees with respect to the lawsuit will be required for purposes of claiming input tax credits. To the extent that the lawsuit relates to the disposal of real property as a result of realization of the XXXXX security interest in the property, input tax credits are claimable. To the extent it relates to the operation of the XXXXX XXXXX input tax credits are denied.
Subsection 141.01(5) requires that the allocation method or methods chosen must be fair and reasonable and used consistently throughout the year.
The foregoing comments represent our general views with respect to the subject matter of your letter. Unannounced proposed or future amendments to the legislation may result in changes to our interpretation. These comments are not rulings and, in accordance with the guidelines set out in GST Memorandum 100-3, do not bind the Department with respect to a particular situation.
If you have any questions, please contact P. Roach at (613) 952-9214 or R. Osudar at 952-9220.
Yours truly,
J. Sitka
A/Director
Financial Institutions/Corporate Reorganizations
GST Rulings and Interpretations
| c.c.: |
XXXXX
Tax Services Office - XXXXX |
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