30 November 1998 GST/HST Interpretation HQR00001238 - Overriding Royalty Payments

Further to our telecon of July 29, 1998, and in view of the fact that XXXXX have asked for an interpretation based on very limited facts, my response will similarly be of a general nature.

Facts

An individual (engineer), who is a registrant, provided his services for the design of a small water powered electric production facility. The recipient of the engineer's services was a producer of electricity (utility). The utility is a registrant under the Excise Tax Act[.] 11 The utility and the engineer, who are not related persons for the purposes of the Act, entered into a contract whereby the engineer would be paid annually, in perpetuity, a royalty of XXXXX of the net value of all electricity generated from this facility. Subsequent to the engineer providing the services the contract entitling the engineer to the royalty payment was sold at arm's length to a third party. Finally, the agreement is silent with respect to the application of tax.

The tax practitioner has represented the payments made under the contract as "royalty" payments. It is further contended that the contract between the engineer and the utility is within the ambit of subsection 162(1) and hence it is deemed not to be a supply.

Response

•   The provision of the engineering service is not within the ambit of subsection 162(1) and is therefor a taxable supply;

•   The time of supply is deemed to be at the time the contract is entered into;

•   Tax is due at the earlier of the day the consideration is paid or becomes due;

•   The provision of subsection 168(2) is operative such that tax becomes payable on each payment.

Analysis

While it may be the case that the utility is exploiting a water resource, the engineer is a contractor to the utility and hence para. 162(1)(a) is not operative. Our position is that the payment referred to in the section, is in relation to the person who holds the right to explore or exploit the natural resource. The engineer is not a party to the agreement to explore or exploit the resource but rather is acting in the capacity of a contractor to the party who has the right to the resource. Although the determination of the quantum to be paid for the engineer's services is expressed in relation to the value of electricity generated this is not relevant to section 162 since the engineer does not possess a right to, in this case, the water. In fact, the engineer is providing a service to the utility, which under the normal scheme of the Act would be a taxable supply.

Since we are now dealing with a taxable supply the issue then becomes, when does the tax become exigible?

Subsection 168(2) applies to the situation and tax is due at the earlier of the day the consideration is paid or becomes due. From the available facts, it appears that the contract is for engineering services and does not involve the physical construction of real property on the part of the engineer. In other words, the role of the engineer is to provide a service that is only in relation to what may become real property (i.e. the generating equipment and possibly the dam if one is involved). As such, subpara. 168(3)(c)(i) is inoperative. The contract is not for the sale of real property therefore subsection 168(5) does not apply. Although the taxpayer may attempt to invoke subsection 168(6) this subsection provides only for situations where the value is not ascertainable under subsections 168(3) or (5). Therefore tax becomes payable in accordance with the general rules contained in subsections 168(1) and (2).

Liability to Remit Tax

The engineer, as a registrant, is liable for the tax. Since the contract is silent on the application of tax, you may wish to refer to POLICY NUMBER P-116: COLLECTION OF GST, BY A SUPPLIER, WHERE THE INVOICE IS SILENT ON THE TAX PAYABLE.

In this unique set of circumstances, the liability to collect and remit tax is not conveyed to the purchaser of the "financial instrument" who is understood to be an unrelated third party. Unlike the sale of a lease agreement, underlying property is not conveyed. The supply has been completed by the engineer and it is our view that this situation is more appropriately analogous to factoring accounts receivable.

Should you have any further questions, please do not hesitate to contact me at 613-954-7931.

David Crawford
General Operations Unit
General Operations & Border Issues Division

1. Incoming from XXXXX, dated Jun 26/98

2. Record of Peer Consultation

3. Research

•   Letter of XXXXX

•   P-128

•   P-110

•   Explanatory notes

4. Carlson & Associates Advertising Ltd v The Queen