5 January 1999 GST/HST Interpretation HQR01294 - A Purchase of Real Property

Dear XXXXX

This concerns your letter of July 28, 1998, regarding a purchase of real property by XXXXX, and a corollary agreement between XXXXX with respect to the supply of management services from XXXXX[.]

Facts

1. On March 1 XXXXX purchased an apartment building at XXXXX, in trust for the XXXXX. XXXXX. The transaction included any fixtures, improvements and appurtenances located on the property at the time of sale. The sale price was XXXXX.

2. The acceptance of the sales agreement by XXXXX. was conditional upon XXXXX signing another agreement with XXXXX XXXXX agreed to take over from the vendor a management contract to receive management services with respect to the building from XXXXX[.] If XXXXX did not sign the secondary agreement with XXXXX, the Agreement of Purchase and Sale between XXXXX was to be null and void.

3. Under Article IV - General, paragraph (c) of the agreement between XXXXX and XXXXX if the agreement was terminated for any reason. The paragraph specified that the XXXXX was to represent liquidated damages, rather than a penalty. The paragraph also stated that the XXXXX agreed that the amount was a reasonable estimate of the actual damages suffered by XXXXX and XXXXX waived any right to dispute recovery of this sum. This presumption of the amount of XXXXX as a reasonable estimate of actual damages was apparently to be considered true at any point in the remainder of the contract.

Interpretation Requested

1. Should the XXXXX payment from XXXXX to XXXXX be regarded as consideration for a taxable supply?

2. Does the answer depend in any way on whether the amount is characterized as a payment for liquidated damages, or whether it is characterized as a penalty payment?

3. Is the damage payment part of the capital cost of the building?

Interpretation Given

1. The XXXXX potential payment from XXXXX to XXXXX, if made, would be deemed to be consideration plus tax in respect of a taxable supply, under subsection 182(1) of the Excise Tax Act (ETA).

2. The answer does not depend on whether the amount is characterized as a payment for liquidated damages, or whether it is characterized as a penalty payment. What matters is whether the payment is consideration for a taxable supply.

3. The damage payment, if made, would not be part of the capital cost of the building.

Rationale

1. The XXXXX potential payment, if it is made, would be an additional amount paid in respect of the taxable supply of management services provided by XXXXX to XXXXX and not a payment made in respect of the supply of real property by XXXXX Canada Inc. to XXXXX[.] The agreement by XXXXX to take on the management services of XXXXX is a separate agreement from the sale of the real property, even though the sale of the real property is conditional on XXXXX agreeing to take on the contract for XXXXX management services.

Since the XXXXX payment, if it is made, would be an additional payment made by the recipient of a taxable supply, it would fall under subsection 182(1) of the ETA. Therefore, the XXXXX would be deemed to consist of consideration, in the amount of (100/107 x $XXXXX[)] and tax, in the amount of (7/107 x XXXXX[)].

2. The answer does not depend on whether the amount is characterized as a payment for liquidated damages, or whether it is characterized as a penalty payment. The tax status of the $XXXXX potential payment depends on whether the amount is to be consideration for a taxable supply, and whether it is paid by the recipient of the supply, or by the supplier. In this particular instance, the XXXXX payment would not be made in order to acquire a supply of property or a service, but to compensate XXXXX for its losses.

Therefore, the payment would not be consideration for supplies. However, because the payment would be an additional payment made by the recipient of the supply, it would be deemed to be consideration for a taxable supply under subsection 182(1).

3. The damage payment is not part of the capital cost of the building because it does not form part of the purchase price of the property. The XXXXX amount is merely a conditional amount that XXXXX would become obliged to pay in respect of the management contract in the event that XXXXX terminates the management agreement with XXXXX after purchasing the real property from XXXXX XXXXX[.]

However, if the XXXXX payment is made, it might be possible to capitalize the amount on some other basis. You can contact Mr. Stephen Tessler of Income Tax Rulings and Interpretations at (613) 954-1176 for more information on this specific issue, if the XXXXX payment is actually made.

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed or future amendments to the legislation may result in changes to our interpretation. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST Memoranda Series, do not bind the Department with respect to a particular situation.

If you require any further information concerning this matter, please contact the undersigned at (613) 952-9211.

Don Dawson
Tax Analyst
Financial Institutions and
Real Property
GST/HST Policy & Legislation

Note to File

Re Case #1294

Damages vs Penalty

Black's Law Library

Damages. A pecuniary compensation or indemnity, which may be recovered in the courts by any person who has suffered loss, detriment, or injury, whether to his person, property, or rights, through the unlawful act or omission or negligence of another. A sum of money awarded to a person injured by the tort of another.

Damages may be compensatory or punitive according to whether they are awarded as the measure of actual loss suffered or as punishment for outrageous conduct and to deter future transgressions. Nominal damages are awarded for the vindication of a right where no real loss or injury can be proved. Generally, punitive or exemplary damages are awarded only if compensatory or actual damages have been sustained.

Liquidated damages and penalties

The term is applicable when the amount of the damages has been ascertained by the judgement in the action, or when a specific sum of money has been expressly stipulated by the parties to a bond or other contract as the amount of damages to be recovered by either party for a breach of the agreement by the other. The purpose of a penalty is to secure performance, while the purpose of stipulating damages is the fix the amount to be paid in lieu of performance. The essence of a penalty is a stipulation as in terrorem while the essence of liquidated damages is a genuine covenanted pre-estimate of such damages.

Discussion With Stephen Tessler

I spoke to XXXXX who stated that the XXXXX would definitely not be part of the capital cost of the building, since it doesn't form part of the purchase price of the building. It is possible that the amount could be capitalized on some other basis, but Mr. Tessler did not want to provide an opinion unless the payment was actually incurred.