21 May 1998 GST/HST Interpretation HQR0000791 - Percentage Allowance in Lieu of Returning Defective Goods - Price Adjustments Subsequent Reductions in Consideration

                                                                        GST/HST Rulings and Interpretations
Directorate
Place Vanier, Tower C, 9th Floor
25 McArthur Road
Vanier, Ontario
 XXXXX                                                                                K1A 0L5              

Dear XXXXX

Thank you for your fax of July 29, 1997, addressed to Ms. Sara Nixon, formerly of our office, concerning the application of the Goods and Services Tax (GST) to your operations. I apologize for the delay in responding to this matter.

Background Information

•   A vendor provides XXXXX with a percentage allowance in lieu of returning defective goods ("% in lieu"). The "% in lieu" is an amount that is deducted from the price of the goods purchased by XXXXX in lieu of XXXXX returning the defective goods to the vendor for credit.

•   XXXXX purchases products from a vendor, net of the "% in lieu", and pays tax on the net amount. XXXXX records the inventory purchased from the vendor at its full value, and allocates the "% in lieu" to a separate account. XXXXX reviews the defective history of the inventory purchased on a monthly basis, and makes an adjustment to the "% in lieu" account based upon inventory levels, and actual defective returns.

•   On a quarterly basis, if the negotiated "% in lieu" rate is less than the actual defective rate, the vendor will adjust, refund, or credit the amount of the shortfall to XXXXX If the negotiated "% in lieu" rate exceeds the actual defective rate, XXXXX will pay, adjust, or credit an additional amount to the vendor. These amount are determined based upon the difference between the negotiated "% in lieu" rate and the actual defective rate, multiplied by the dollar value of actual inventory purchased from the vendor.

Interpretations Requested

•   XXXXX requested a ruling with respect to the application of the GST to the percentage allowance in lieu of returning defective goods it receives from a vendor.

•   XXXXX also enquired how it was to treat subsequent adjustments to the "% in lieu" (i.e., subsequent increases or reductions to the "% in lieu").

Interpretations Given

In your fax of July 29, 1997, you requested a ruling with respect to the application of the GST to the "% in lieu". On April 1, 1997, the Harmonized Sales Tax (HST) replaced the Goods and Services Tax (GST), and the Provincial Sales Tax (PST), in the three participating provinces of Nova Scotia, New Brunswick, and Newfoundland, with a harmonized tax rate of 15%. If XXXXX supplies goods that are delivered, or made available in a participating province, services to be performed in a participating province, or intangible personal property that may be used in a participating province, to the extent that they are taxable supplies, tax must be collected at the harmonized rate.

Since your questions do not relate to a clearly defined fact situation with a specific vendor, we are unable to issue a ruling on this matter at this time (please refer to paragraph 25 of the enclosed copy of section 1.4 of Chapter 1 of the GST Memoranda Series). However, we offer the following interpretation to assist XXXXX in fulfilling its obligations under the law.

It is the Department's position that where a vendor reduces the price of goods sold to XXXXX with the understanding that XXXXX will absorb the cost of the defective goods rather than shipping the goods back to the vendor, the "% in lieu" will be regarded as a price adjustment. When the "% in lieu" is deducted from the gross amount on the initial invoice, tax would be payable on the net amount on the invoice, after the price adjustment.

In examining the issue, XXXXX would not be regarded as having made a separate supply to the vendor (i.e., the action of not returning the goods to the vendor would not be regarded as a separate supply made by XXXXX to the vendor). As such, the "% in lieu" would not be regarded as consideration for a separate supply payable by the vendor to XXXXX when the negotiated "% in lieu" rate is less than the actual defective rate, and XXXXX is subsequently refunded, adjusted, or credited an amount for the shortfall by the vendor, the additional amount (i.e., subsequent increase to the "% in lieu") would be regarded as a subsequent reduction in consideration, to which subsection 232(2) of the ETA would apply.

Under subsection 232(2) of the ETA, where a vendor has charged to, or collected from XXXXX tax under Division II, calculated on the consideration, or a part thereof for a supply, and for any reason, the consideration or part is subsequently reduced (i.e., subsequent increase to the "% in lieu"), the vendor may, in or within four years after the end of the reporting period of the vendor, in which the consideration was so reduced, where tax calculated on the consideration or part was charged but not collected, adjust the amount of tax charged by subtracting the portion of the tax that was calculated on the amount by which the consideration, or part was so reduced.

The vendor may, in or within four years after the end of the reporting period of the vendor in which the consideration was so reduced, where the tax calculated on the consideration or part was collected, refund or credit to XXXXX the portion of the tax that was calculated on the amount by which the consideration or part was so reduced.

Under subsection 232(3) of the ETA, where a vendor adjusts, refunds or credits an amount in favour of, or to XXXXX in accordance with subsection 232(2) of the ETA, the vendor shall, within a reasonable time, issue to XXXXX a credit note, containing prescribed information, for the amount of the adjustment, refund or credit, unless XXXXX issues a debit note, containing prescribed information for the amount.

The amount of tax adjusted, refunded, or credited may be deducted in determining the net tax of the vendor for the reporting period of the vendor in which the credit note is issued to XXXXX or the debit note is received by the vendor, to the extent that the amount has been included in determining the net tax for the reporting period, or a preceding reporting period of the vendor.

The amount of tax adjusted, refunded, or credited shall be added in determining the net tax of XXXXX for the reporting period in which the debit note is issued by XXXXX to the vendor, or the credit note is received by XXXXX to the extent that the amount has been included in determining an input tax credit, claimed by XXXXX in a return filed for the reporting period, or a preceding reporting period of XXXXX As such, the Department is not in a position to say that the "% in lieu" would not be subject to tax.

Adjusting, refunding, or crediting the tax is not mandatory under subsection 232(2) of the ETA, rather, it is optional. Since XXXXX is a registrant, the vendor providing the "% in lieu" may choose not to adjust, refund, or credit the tax previously charged or collected. This may be desirable where the vendor of the defective goods has already accounted for the tax, and XXXXX has already claimed, or is entitled to claim a corresponding input tax credit.

A subsequent reduction to the "% in lieu" would occur when the negotiated "% in lieu" rate exceeds the actual defective rate. You advised that XXXXX would be required to pay, adjust or credit an additional amount to the vendor. This amount is determined based upon the difference between the negotiated "% in lieu" rate and the actual defective rate, multiplied by the dollar value of actual inventory purchased from the vendor. This amount would be regarded as additional consideration for the supply, and would be subject to the general imposition rules under the ETA.

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed amendments to the Excise Tax Act, if enacted, could have an effect on the interpretation provided herein. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST/HST Memoranda Series, do not bind the Department with respect to a particular situation.

For your convenience, find enclosed a copy of section 1.4 of Chapter 1 of the GST/HST Memoranda Series.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-9699.

Yours truly,

Douglas Wood
A/Rulings Officer
General Operations Unit
General Operations and Border Issues Division
GST/HST Rulings and Interpretations Directorate

Encl.: Section 1.4 of Chapter 1 of the GST Memoranda Series

Legislative References: Subsection 232(2), (3) of the ETA