25 April 1996 GST/HST Interpretation 11710-1[2] - Compensation for Damages to Property - Case

                                                                        File: 11710-1(lhk)

                                                                        Leg. Ref: s. 123(1) - supply, consideration

I refer to your letters of December 8, 1994 and February 14, 1995, concerning the application of the GST to compensation paid by the City of XXXXX to the XXXXX for damaging the latter's property.

Please accept our apologies for the delay in responding to you in writing. As you are probably aware, the issue of the application of the GST to payments of damages has been under policy review for some time. Although the policies encompassing these issues have already been drafted, they are still under consideration by our Directorate's Policy Review Committee. Therefore, until such time as these policies are finalized the opinions expressed in this letter must be regarded as reflecting the interim policy position of the Department.

Background

Attached to your letter were copies of letters issued by Policy and Legislation and District Tax Services offices with respect to the application of GST to compensatory payments made for damaging the property of utility companies (e.g. hydro plants, cable television lines), municipal property, etc.

The general approach taken in these letters is that the payments of damages are not consideration for a supply. Rather, the payments have been viewed as penalties, restitutionary payments or financial indemnities. The only exception noted is where an agreement exists requiring one party to do something in order for the other party to make a payment. For example, where an agreement has been reached by a municipality (who had damaged the property of a cable company) with the cable company to pay the repair costs incurred by the latter.

Case Specifics

I understand from the information you have provided on the phone to Lalith Kottachchi of my staff, that the case of XXXXX is similar to the situations addressed in the above mentioned letters. In this case, XXXXX (the "City") who had damaged XXXXX property is refusing to pay the GST on compensation for damages claimed by XXXXX. Apparently, XXXXX has been charging GST on all invoices issued by XXXXX claiming compensation for damages to their property. It is our understanding that the damages to the property of XXXXX have not arisen as a consequence of a breach, etc. of an agreement for the making of a taxable supply by XXXXX. Simply put, the payment is not related to a previous supply made by XXXXX (i.e. a supply made prior to the damages).

After discussing the issue with my staff, you have contacted XXXXX and advised them that the policy position of the Department with respect to such payments is different from that of the opinions expressed in the letters referred to earlier and therefore, the amount invoiced to the City as compensation for damages is taxable at 7 per cent. However, the City is waiting for a confirmation of the Department's policy on the application of the GST to payments of property damages.

Interpretation Requested

In light of the views expressed in previous letters by Policy and Legislation and District Tax Services offices, you request a confirmation and/or a policy update on the issue of the application of the GST to compensation paid to a utility company, etc. for damaging their property.

Interpretation Given

When someone causes damages to the property of a utility company, the utility company may either request the person to repair (or replace) the property, or may do the repairs (or replacement) themselves and subsequently demand that the person who caused the damages pay compensation. While there can be situations where the damages are captured by a supply already being made by the utility company (e.g. damages to a water heater supplied by a gas company, or damages to telephone equipment supplied by a phone company), the situation addressed here is when the payment would not be in respect of a previous supply (i.e. a supply made before the damages to the property).

Since the damages to the property of XXXXX have not arisen as a consequence of a breach, etc. of an agreement for the making of a taxable supply by XXXXX, the payments would not fall within the scope of section 182. Also, given the fact that the payment is not in respect of a previous supply, it would not be consideration for a previous supply. The question then is whether the payment could still fall under the general provisions of the Act and, if so, what are the tax consequences of applying the general provisions of the Act to these payments?

Whether a payment falls within the general provisions of the Act would depend upon the question of whether it can be regarded as "consideration for a supply". The key question, therefore, is whether XXXXX is making a supply to the City for which the compensation is the consideration. As defined in subsection 123(1) of the Act, the term "supply" generally means "provision of property or a service in any manner". Since the words "property" and "service" are statutorily defined, the phrase "provision of" (or the word "provide" in the case of section 133 which is the overriding yet supplementary provision to the general meaning of "supply") would essentially determine the scope of the general meaning of "supply".

As explained in the draft policy "Meaning of the phrase 'provision of' in the definition of 'supply'", it is the policy position of the Department that, for there to be a "provision of" something and a possible supply, there must be a conferring of a value in the thing that is given/rendered and the conferring must be by one "person" (as that term defined in the Act) to another. There are two persons (XXXXX and the City) involved in the case at hand. Thus, the question is whether there is a property or a service of value being conferred upon the City by XXXXX in return for the payment?

The answer to the above question would most likely be yes. The reason the City is paying compensation to XXXXX is to obtain a "release" from XXXXX stating that the City had met the obligations created by damages. The "release", in this case, may or may not be manifested in a written form (e.g. release document) meaning that a release is only implied in the settlement agreement reached by the parties.

The term "release" is defined in Black's Law Dictionary, (1979), as "the relinquishment, concession, or giving up of a right, claim or privilege, by the person on whom it exists or to whom it accrues, to the person against whom it might have been demanded or enforced." Similarly, The Random House College Dictionary, (1982), defines the word "release" as "to free from obligation; to give up, relinquish a right, claim, etc.; the surrender of a right or the like to another. ..."

One might argue that the relinquishment, giving up or disposition of rights, in whole or in part, would not result in a supply. The argument is that the rights that one is giving up or relinquishing have already existed (in some cases) as natural rights and therefore, were never transferred to the person who already held those rights. Since there was no initial transfer (supply) there cannot be a retransfer (a "re-supply"). For example, in this case, XXXXX always had pre-existing rights to the property (e.g. peaceful enjoyment of the property) that was damaged. It is important to note, however, that the issuance of a release will have no effect on those pre-existing rights. The point is that the damages caused to the property had given XXXXX "a right of claim" (i.e. a chose of action) against the City (a particular party) and that right will be reduced, extinguished or disposed of (i.e. released) by the payment. As a general rule, a supply would exist where a right or claim is surrendered, relinquished, disposed of, etc. because there is a "release" of property (i.e. right) occurring at that time.

The question of a "release" constituting a "supply" is discussed in more detail in the draft policies "Meaning of the phrase 'provision of' in the definition of 'supply'" and "The application of general provisions of the Act to payments of damages where section 182 does not apply". Although, technically, a supply exists in almost all cases where there is a release of a right (constituting a value) from one person to another, administratively, the Department may look beyond the "release" itself. Consequently, the policy position taken with respect to a "release" is that, before making a final determination as to the existence of a supply one must look at the underlying cause of action for the release to assure oneself that it involves "property" or a "service". In the case of XXXXX the underlying cause of action for release involves property and related services. The underlying cause of action would most likely be the repairs to (or replacement of) the property. Since the release relates to property and services, it will constitute a supply.

Thus, compensation paid to XXXXX for damaging their property would fall within the general provisions of the Act. As in the case of any other payment, the tax status of such compensation would depend upon the question of whether XXXXX is issuing the release in the course of its commercial activities. Apparently, in this case, XXXXX is making the supply of release in the course of their commercial activities and thus correctly charging 7 per cent tax on payments of compensation.

You have already advised XXXXX that they should not rely on opinions, interpretations, etc. given by the Department to other parties on specific fact situations regardless of whether such situations are similar to the ones encountered by XXXXX[.]

Notwithstanding, I am cognizant of the fact that the policies we have developed in the series of "Meaning of Supply", "Meaning of Consideration", and "Damages" would necessitate the Department to revisit some other policies, amend some of the rulings and interpretations issued by the Department in the past, etc. I must emphasize that one of the main objectives of developing these policies is to establish the parameters for interpreting the terms "supply", "consideration", etc., thus enabling the Department to provide consistent interpretations and rulings on matters such as the application of the GST to compensation for property damages, in a more timely fashion.

I hope the above rationale for our position on the issue will be of assistance to you. If you have any questions or require additional information, please contact Lalith Kottachchi at (613) 952-9588 or one of the other members of the Imposition Team in the Taxing Provisions Unit. They are: Serge Bernier (613) 952-9580, Gerry O'Reilley (613) 952-9589 and Anny Roy (613) 954-2560.

Yours truly,

H.L. Jones
Director
General Applications Division
GST Rulings and Interpretations        1019(REG)