31 January 1997 GST/HST Interpretation 11585-26 - Input Tax Credit Claims in Respect of an Obligation Under a Performance Bond

This is in reply to the letter of July 11, 1995 from XXXXX, concerning the input tax credit claims in respect of an obligation under a performance bond of the above-noted registrant.

Our understanding of the situation is based on a memorandum of April 5, 1993 from XXXXX as follows:

XXXXX as the general contractor for the construction of XXXXX situated in XXXXX entered into a contract with XXXXX dated XXXXX, 19XX for the completion of glass and door work on XXXXX and XXXXX have indemnified XXXXX by way of a performance bond, ("the Performance Bond") dated XXXXX, 19XX in the amount of $XXXXX. No GST was charged by XXXXX to XXXXX on the supply of the performance bond. XXXXX has treated all supplies of performance bonds as exempt financial services. XXXXX is required to undertake completion of responsibilities by virtue of the performance bond;

3. On XXXXX, 19XX was declared bankrupt. At that point in time XXXXX had not completely fulfilled its obligations under its contract with XXXXX[;]

4. As a consequence of the bankruptcy of XXXXX has called on the performance bond, such that XXXXX has been required to comply with the default provisions of the performance bond;

5. XXXXX owed money to XXXXX[.] The unpaid amounts were paid by XXXXX to XXXXX[.] On these unpaid amounts, the GST portion was remitted by XXXXX[;]

6. XXXXX, in compliance with the terms of the performance bond, has attempted to complete the contract between XXXXX and XXXXX by directly engaging other subcontractors to complete the glass and door work on the XXXXX[.] In doing so, the subcontractors have invoiced XXXXX including GST, for their services rendered;

7. The completion contract is between XXXXX and XXXXX XXXXX[;]

8. XXXXX has paid some of the subcontractor's invoices, including the GST component. Certain of the invoices have been issued but not yet been paid. To date, XXXXX has claimed input tax credits for the GST it has been invoiced; and

9. XXXXX has invoiced XXXXX for work performed to complete the contract, and has charged GST on these invoices.

With respect to fact # 5 above, we believe that accounts receivable of a bankrupt person are collected by the trustee in bankruptcy and normal rules apply. However, as we believe that these funds are not amounts paid under the bond, we have not pursued this issue further.

There are two options in settling the claim in the performance bond. They are as follows:

(1) the surety shall complete the construction contract; or

(2) the surety shall re-tender the construction contract so that a new contractor enters into a contract with the obligee.

According to the facts, XXXXX took over the construction work and fulfilled its obligation under the performance bond to complete the construction contract.

It is our view that the issuing of a bond and the action taken to fulfill the bond's obligation are part of the same activity related to the supply of a financial service. The premium paid for the bond is the consideration for the supply of an exempt financial service which includes the fulfillment of the obligation under the bond by the bonding company. This interpretation is further supported in the Notice of Ways and Means Motion to amend the Excise Tax Act, tabled on April 23, 1996 which, by amending the definition of insurance policy, clarified that a performance bond issued in respect of a construction contract is treated as an insurance policy. Any consideration received by XXXXX from XXXXX with respect to the completion of the construction contract under the performance bond is not subject to GST.

In summary, there is no commercial activity when XXXXX undertakes to fulfill its obligations under the performance bond to complete the construction contract. As the subcontractors have been hired by XXXXX to supply work and materials, XXXXX is a recipient of taxable supplies. GST is applicable to the consideration for the taxable supplies made by the subcontractors to XXXXX[.] However, XXXXX is not entitled to claim ITCs on these supplies as it is not acquiring them for consumption, use or supply in the course of a commercial activity.

It on the other hand, XXXXX proceeds under option (2), the new contractor will complete the construction work and invoice either XXXXX or XXXXX as follows:

XXXXX agrees to pay the new contractor for the supplies of construction provided to the obligee. The new contractor invoices XXXXX for the construction work. XXXXX is the recipient of taxable supplies and it is required to pay GST to the new contractor; or

XXXXX agrees to pay, on behalf of the obligee, the new contractor for the supplies of construction work. The new contractor invoices XXXXX for the construction work. XXXXX is the recipient of taxable supplies and is required to pay GST to the new contractor. In some cases, XXXXX may be entitled to claim an input tax credit or a tax rebate. XXXXX may apply the Net-of GST approach described in GST Memorandum 700-5-10 GST Treatment of Insurance Claims.

Should you have any further questions, please do not hesitate to contact Roy Osudar at (613) 952 -9220 or Pierre Bertrand at (613)952-9219.

Ginette Bouchard-Forgues
Policy Officer
Financial Institutions and
Real Property Division
GST Rulings and Interpretations