8 October 1998 GST/HST Interpretation HQR0000994 - Reimbursed Amounts & Termination Penalty Fees

This memorandum is in response to your request for an interpretation as to whether or not a technically accurate response has been given in your draft application ruling to XXXXX[.] A Goods and Services Tax (GST) ruling has been requested on the tax status of several different types of reimbursed amounts and a termination penalty fee charged by XXXXX to a lease operator.

Statement of Facts:

Although there are seven different types of reimbursed amounts and termination penalty fees upon which you have made an application ruling, you have asked us to specifically review your response concerning the GST implications of four specific types of reimbursed amounts (i.e., identified in your ruling as 1, 4, 5, and 7) and in the case of a termination penalty fee (i.e., 8). The five situations (with the corresponding number as it appears in your letter) are described below:

1. A lease operator has incurred a violation or parking ticket due to negligence on his/her part. XXXXX is charged with the violation as the registered plate holder. XXXXX charges back the cost of the ticket to the lease operator involved.

4. A Canadian load (i.e., one that is picked up at a Canadian location and delivered to a Canadian location) has been damaged. In cases where negligence is involved on the part of the lease operator, XXXXX is unable to make a claim through its insurance company. XXXXX pays its customer for the damage claim for the load. In turn, XXXXX charges back the amount paid to settle the claim for the load to the negligent lease operator.

5. A U.S. load (i.e., one that is picked up at a Canadian location and delivered to a U.S. location or vice versa) has been damaged. In cases where negligence is involved on the part of the lease operator, XXXXX is unable to make a claim through its insurance company. XXXXX pays the damage claim for the load and charges back to the negligent lease operator the amount paid to the customer to settle the claim.

7. It is mandatory for XXXXX to pay a Heavy Use Tax to the United States Revenue Service to operate in the United States. Upon payment of the tax by XXXXX, one permit is issued to cover all of the vehicles operating under XXXXX name. XXXXX charges the lease operator for a proportionate share of the cost of the permit.

8. In accordance with the terms of a signed agreement, XXXXX charges the lease operator a penalty fee for quitting without notice, and another penalty fee if the lease operator quits within six months of commencing employment.

Interpretation Given:

In each of the situations described above, you have asked for feedback as to the draft application ruling you have made with respect to whether or not these reimbursed amounts are subject to the GST. Since the supplies discussed here are taking place in a non-participating province, XXXXX, and no reference is made to HST in your draft application ruling, we will not address the HST implications in this response. To respond to the issue effectively, it is necessary to examine the reimbursed amounts and the termination penalty fee on an individual basis to determine their tax status.

Reimbursed Amounts for Violation or Parking Tickets (1):

Based upon the information provided, it is the Department's position that the payment by the lease operator to XXXXX for the amount equivalent to the violation or parking ticket fine is not consideration for a supply.

In general, subsection 165(1) of the ETA provides that the recipient of a taxable supply is required to pay tax equal to 7% (or 15% in a participating province) on the value of the consideration for the supply. In the context of the GST, "consideration" generally means the amount paid or payable to a supplier by the recipient of the supply. In all cases, in order to be consideration, the amount must be payable for a supply. Generally, a fine imposed by a municipality or provincial authority for a traffic violation is not subject to tax.

In the case at hand, it is not the tax status of a ticket issued directly to a recipient from a municipal or provincial authority that is at issue. It needs to be determined if a charged back amount would be subject to GST when XXXXX pays the ticket and charges the equivalent amount back to the lease operator. It is understood that trucking companies engage the services of lease operators who often provide their own equipment (e.g., truck tractor, trailer). In these situations the lease operator retains legal title to the tractor or trailer where applicable, but through the lease operator agreement, the trucking company becomes the registered owner of the vehicle for the purposes of registration, licensing, insurance and fleet permits. In the event that a violation or parking ticket is issued, XXXXX as the registered licensee would be the recipient of the ticket. When XXXXX seeks to be reimbursed by the lease operator for the amount of the ticket, it cannot be characterized merely as a "resupply" of a ticket. The ticket from the municipal or provincial authority has been issued to the registered plate holder (i.e., XXXXX and XXXXX is required by law to pay it. The fact that the ticket issued to XXXXX was not subject to tax has no bearing on the tax status of the subsequent amount charged back to the lease operator.

Under the terms of the XXXXX lease operator agreement, it is clearly stated that the lease operator must assume responsibility and pay when due "all costs and expenses incidental to the operation of the equipment" (e.g., both auxiliary equipment supplied by the operator and company owned equipment) which would include all violation and parking tickets. The agreement also states that XXXXX "may pay any of the costs or expenses for which the lease operator is liable hereunder and the company will be entitled to deduct any amounts so expended from monies otherwise owing to the lease operators."

XXXXX is seeking compensation from the lease operator for the payment of the violation ticket for which a signed agreement between the parties has made the lease operator contractually liable. By having signed this agreement, the lease operator has provided an indemnification under the terms of the lease operator agreement of the cost incurred by XXXXX to pay the violation or parking ticket. The lease operator failed to abide by either municipal or provincial regulations during the period under which the agreement was in effect, resulting in the issuance of a violation or parking ticket to the registered plate holder of the vehicle (i.e., XXXXX. It is our position that the lease operator's payment to XXXXX is strictly compensatory in nature and does not represent consideration for a taxable supply.

Reimbursed Amounts for Damages to American and Canadian Cargo Loads (4 & 5):

Under the agreement between XXXXX and the lease operator, XXXXX obtains cargo, tractor and trailer insurance in its name from an insurance company on behalf of the lease operator. The lease operator must bear the cost of said insurance. The agreement states that all claims for cargo damage caused by the lease operator or the lease operator's employees is not covered by the insurance. In these cases, XXXXX will pay its customers for the claims. However, under the lease operator agreement, the responsibility for reimbursing XXXXX for payment of these damage claims to Canadian or XXXXX loads rests with the lease operator.

In cases where the transport company pays for the cargo damages and seeks reimbursement of these expenses from the lease operator, the reimbursed amount by the lease operator to XXXXX does not represent consideration for a taxable supply made by the company to the lease operator. In order to come to this conclusion, it is necessary to look to the one directed to pay the charged back amount (i.e., the lease operator) and determine whether the nature and effect of the amount paid is to turn the lease operator into the recipient of taxable goods or services.

In this situation, the payment does not represent a monetary substitute for the lease operator's obligation to perform transportation services under contract. It is clear from the liability clause in the lease operator agreement that the lease operator has provided an indemnification under the terms of the agreement, of the cost incurred by XXXXX to pay the damages. While under the agreement with XXXXX the lease operator cannot be said to have received a supply of insurance or any other property or service for that matter in exchange for the payment. The reason for the compensation is clearly unrelated to the supply of the vehicle and transportation services from the lease operator to XXXXX under the lease operator agreement. The payment is compensatory and is not made in exchange for a supply of property or services by XXXXX. In addition, the acceptance of the payment does not result in the payment being consideration for a supply, in that it represents compensation for additional expenses paid by XXXXX in order to settle a cargo damage claim on behalf of its lease operator. The payment by the lease operator is meant to restore, to some degree, XXXXX to the same position the company was in prior to the cargo damage.

Reimbursed Amount for Heavy Use Tax (7):

Upon completion of an application with a fee for a Heavy Use Tax, the United States Revenue Service certifies the form effectively making it a permit and returns it to XXXXX[.] The payment of x [t]he Heavy Use Tax (herein after referred to as "the permit") allows the fleet of vehicles and equipment operating under the name of XXXXX to travel on highways in the United States XXXXX charges back the cost of the lease operator's proportionate share of the permit to the lease operator. In your interpretation, your response would have been more appropriate as an answer to the question of whether or not GST is applicable to the supply of intangible personal property (i.e., the permit) from XXXXX United States Revenue Service XXXXX[.] Pursuant to subparagraph 142(2)(c)(i) of the ETA, the supply of the permit directly from the United States Revenue Service to XXXXX would be deemed to be made outside Canada and thus not subject to GST. However, in the case at hand, the main issue is whether or not the charged back amount from XXXXX to the lease operator should be subject to the GST.

As stated previously, the permit is registered in the name of the transport company to cover the entire fleet operating under the XXXXX name (including those vehicles provided by the lease operator). XXXXX is not "resupplying" a permit to the lease operator as it has neither the authority to issue nor the right to transfer the permit to the lease operator. However, the responsibility for paying a proportionate amount of the permit fee lies with the lease operator in accordance with the lease operator agreement. In this particular situation, XXXXX is charging the lease operator for a supply of intangible personal property. By having paid for the supply, the lease operator is able to fulfill the specific contractual obligations under the lease operator agreement. In accordance with subparagraph 142(2)(c)(i) of the ETA, the supply is deemed to be made outside Canada. Consequently, the charged back amount from XXXXX to the lease operator is beyond the scope of the general imposition rules and is not subject to the GST.

Termination Penalty Fees (8):

Under the lease operator agreement, XXXXX charges a penalty fee of XXXXX to any lease operator who quits within six months of being hired and XXXXX in cases where the lease operator quits without notice. The penalty fees are outlined in the agreement and are considered necessary to cover the company's administrative costs. In this situation, upon receipt of the penalty fee, a formal release is neither issued to the lease operator nor required by the transport company. The payment is in respect of a fulfillment of an obligation that had been previously made by the lease operator to XXXXX[.] Since the payment is made to absolve the lease operator from the obligation to XXXXX it can also be regarded as a payment for a "release" explicitly or implicitly granted by XXXXX to the lease operator. The question is whether such a "release" constitutes a supply.

According to Black's Law Dictionary, a "release" is defined as:

"A writing or an oral statement manifesting an intention to discharge another from an existing or asserted duty. The relinquishment, concession, or giving up of a right, claim, or privilege, by the person in whom it exists or to whom it accrues, to the person against whom it might have been demanded or enforced. Abandonment of claim to the party against whom it exists, and is a surrender of a cause of action and may be gratuitous or for consideration."

In most circumstances, technically, a supply exists in many cases where there is a release of a right (constituting a value) from one person to another. Before a final determination can be made as to the existence of a supply, administratively, under certain circumstances, it may be necessary to look at the underlying cause of action for the release to determine whether or not it involves "property" or "service". It is the Department's position that a damage payment, to the extent that it is not a payment for a supply of property or a service, is not consideration for a supply even if the payee (i.e., XXXXX agrees to release the payer (i.e., lease operator) from further liability. With respect to the situation at hand, our position is that the termination penalty fees are essentially compensatory in nature, and are not made in exchange for a supply of property or services by XXXXX[.] Consequently, the amount paid by the lease operator to XXXXX as termination penalty fees is not consideration for a supply.

As stipulated in the lease operator agreement, the termination penalty fees are a fixed amount payable as a compensatory payment in the event that the agreement is terminated by a lease operator. The fact that XXXXX charges fixed fees does not change the result as the fees represent the company's administrative determination of what it will claim as being the amount of the total compensation. Either fee can be characterized more accurately as "liquidated damages" rather than as a penalty as the purpose of stipulating damages is, according to Black's Law Dictionary, "to fix the amount to be paid in lieu of performance." Both parties have recognized the right to compensation upon termination of the agreement in these circumstances and have fixed by agreement the company's "administrative costs" payable to the benefiting party in such an event. The payment in itself is not made in exchange for a supply of property or services by the other party (i.e., XXXXX[.] Furthermore, it cannot be said that either amount is paid to the registrant otherwise than as consideration for the supply as the fee is payable by the lease operator to XXXXX whereas the original lease operator agreement was for a supply of transportation services for which payment was made by XXXXX to the lease operator.

The payment represents compensation to XXXXX for additional expenses (i.e., administrative costs) incurred or that would be incurred as a result of the lease operator's termination of the lease operator agreement. As is the nature of a compensatory payment, the termination penalty fees are meant to restore, to some degree, XXXXX to the position it was in prior to the lease operator's action to terminate the lease operator agreement.

Additional Comments:

The case at hand is indicative of a situation where one or more of the requirements for the application of subsection 182(1) of the ETA have not been met. The reimbursed amounts and the termination penalty fees mentioned previously, are provided for in an agreement where one party binds itself to make a payment in order to compensate the other party under certain circumstances. The indemnifying person, in making the payment, is in fact performing its legal obligations under the contract. No cause of action (e.g., breach of contract) would arise, unless that person refused to fulfill the commitment to the undertaking. For example, the provisions for payment of amounts for cargo damages, violation tickets or parking tickets have been included in the lease operator agreement. In the event that the lease operator pays the reimbursed amount, it cannot be viewed as a situation where, subject to section 182 of the ETA, there has been "a breach, modification or termination of an agreement for the making of a taxable supply." Furthermore, in the case of the termination penalty fees, the payment is outside of the scope of section 182 of the ETA because the damages are paid by the supplier (i.e., lease operator) and not the recipient of the supply (i.e., XXXXX[).]

The interpretation with respect to the issue of the application of GST to the reimbursed amounts (where applicable) and termination penalty fees is in accordance with the draft policy on the "Tax Status of Damage Payments Not Within Section 182 of the Excise Tax Act (P-218)".

Should you have any further questions concerning the above matter, please do not hesitate to contact me at (613) 952-8806.