1 November 2000 GST/HST Interpretation 30441 - Section 222.1 of the Excise Tax Act

Dear XXXXX:

This letter is in response to the e-mail message of May 26, 2000, from XXXXX of your office, your facsimile transmission of August 25, 2000, and several telephone conversations we have had concerning the application of the Goods and Services Tax (GST) to the transactions of an alarm company which installs security systems.

Background Information:

XXXXX ("Alarm Company") a registrant supplier provides security equipment to residential and business customers (at no charge), and this is called the basic equipment package. This package is composed of the master panel, keypad, 2 door sensors and a motion sensor.

The Alarm Company provides the customer with a monthly monitoring service, pursuant to a four year agreement. The Alarm Company retains ownership of the "no-charge" security equipment until the four year agreement between the parties has been concluded, at which time, the customer can keep the equipment.

If a customer reneges on the four year contract, the security equipment is taken back by the Alarm Company. However, it is your understanding that if the customer reneges on the agreement before the four year period ends, the customer is still responsible for paying any remaining balance otherwise due under the agreement.

Once the equipment becomes the customer's property, the customer may then switch to another alarm company for services and still use the same equipment. However, some other companies use different equipment so the Alarm Company's equipment may not always be compatible with the systems of these other companies.

The customer may also acquire additional equipment which is not part of the basic package and that equipment would be considered "sold" to the customer. All of the contracts that are entered into include all equipment, whether at no charge or where additional charges are applicable, and the four year monitoring agreement. The total amount is recorded as an "account receivable" in the Alarm Company's books and records.

Credit application is made to the finance company, the XXXXX ("the Bank"), and if approved, the payment received from the Bank is applied to the "accounts receivable" and the balance, which represents the discounted portion of the "accounts receivable" is recorded to a loss account. The applications that are not approved by the finance company remain posted to the "accounts receivable" since the Alarm Company's own in-house accounts and payment programs are set up with those customers.

The reason that all of the GST has been remitted in advance is that the previous accountant recorded all amounts under the contract simultaneously as revenues and as receivables so that all the GST included in the receivables was remitted.

The GST portion of the monitoring agreement is not paid in advance by the customer (i.e., GST is not paid by the customer until each monthly payment is paid). Where the customer has purchased additional equipment for which there is a charge, the GST may be paid in full, or it can be spread out over the period of the four year agreement.

Questions and Answers:

Can the client claim a bad debt adjustment in respect of the discounted portion of the account receivable that is written off or can the client only claim a bad debt adjustment if it takes back the account receivable on a recourse basis and then established a bad debt for uncollectible amounts? If the registrant treats the 20% discounted amount as a "bad debt" when they sell the accounts receivable, can they then claim a bad debt adjustment for the GST included in that amount?

It is our position that a registrant would not be entitled to claim a net tax deduction under subsection 231(1) of the ETA in respect of the "discounted" portion of an accounts receivable sold without recourse since it is our understanding that the proper accounting treatment for such "discounts" is to recognize a loss on the sale of the accounts receivable, rather than to write-off an amount in the books and records as a "bad debt".

Where an account receivable is transferred with recourse, it is our understanding that for financial accounting purposes, the difference between the proceeds and the amount of the receivable is either treated as a loss on the sale of the account receivable, or as a financing cost (i.e., interest expense), depending upon the circumstances.

In either case, since no amount in respect of the account receivable would be written off, one of the conditions under subsection 231(1) of the ETA would not be satisfied. Consequently, the registrant would not be entitled to a deduction under subsection 231(1) of the ETA with respect to the "discounted" portion of an accounts receivable.

Based upon a review of the agreement with respect to the deferred payment and equal payment programs between the Alarm Company and the Bank, it is our understanding that the Alarm Company transfers its "sales drafts" to the XXXXX Bank at face value, and is charged a fee(s) by the Bank. In this situation, it is our view that the Alarm Company would not be entitled to a bad debt deduction under subsection 231(1) of the ETA in respect of the fee(s) since, in our view, the Alarm Company would not be entitled to write-off an amount in its books and records in accordance with Generally Accepted Accounting Principles (GAAP).

Where the Alarm Company agrees to buy or take back an account receivable, in whole or in part, that was previously transferred to the Bank, and later writes off the account receivable as a bad debt in its books and records, the Alarm Company may claim a bad debt deduction under section 231 of the ETA, in accordance with that provision.

If subsection 168(2) of the ETA applies to the monthly payments attributable to the monitoring portion of the agreement, but the supplier has remitted the GST in full, can the supplier claim a refund of the GST that has not yet been paid or become due from the recipient?

Where subsection 168(2) of the ETA applies to the monthly payments attributable to the monitoring portion of the agreement, but the Alarm Company has accounted for the GST in full in respect of amounts yet to be collectible, the Alarm Company would be in a position to claim a rebate in accordance with section 261 of the ETA to recover amounts remitted "as or on account of tax" that were not remittable.

When the registrant sells its "accounts receivable", will all of the GST payable for the entire four year agreement be considered to have been collected and would the registrant have to include that GST in its net tax calculation, even though, when the registrant has its own "in-house" accounts receivable that have not been sold to a third party, it would only have to account for the GST on the monthly payments that become due under the four year agreement pursuant to subsection 168(2) of the ETA?

After reviewing the facts of the case, there was some discussion as to whether or not the Alarm Company had indeed sold "accounts receivable" to the Bank. With respect to the monthly monitoring agreement, we are aware that some other alarm companies sell the right to receive a future stream of payments when they sell their monthly monitoring agreements. Section 222.1 of the ETA will not apply where a party sells the right to receive a future stream of payments rather than an "account receivable". As such, the Alarm Company will not be required to account for tax at the time the rights to a future stream of payments are sold to the Bank.

Where the Alarm Company sells an actual "account receivable" that has been established in accordance with GAAP, section 222.1 of the ETA would deem the Alarm Company to have collected, at the time of the sale, all tax not already collected on the original supply that gave rise to the debt. The tax so deemed to have been collected at the time of the sale of the debt is to be included in the amounts deemed under section 222 of the ETA to be held in trust by the Alarm Company from that time until the amounts are remitted or withdrawn.

Where the Alarm Company sells an "accounts receivable" to the Bank, the deemed tax collected under section 222.1 of the ETA will have to be taken into account when calculating its net tax, unless the amounts were previously included in its net tax.

In the March 2, 2000, written submission to your office, the Alarm Company enquired whether or not the Bank would be required to remit the GST in respect of amounts collected from customers where the Bank purchased an "account receivable" from the Alarm Company. The answer to that question would depend upon whether an "account receivable", established in accordance with GAAP, had actually been sold or assigned to the Bank.

In accordance with paragraph 222.1(b) of the ETA, where the Bank purchased an actual "account receivable" rather than the right to receive a future stream of payments, any amount collected by the Bank "on account of the tax payable" is deemed not to be an amount collected as or on account of tax, in accordance with paragraph 222.1(b) of the ETA. As such, the Bank would not be required to account for GST in respect of amounts collected where they have purchased the Alarm Company's "accounts receivable". However, where the Bank purchases the right to receive a future stream of payments, rather than an "account receivable", the CCRA's Third Party Remittance Policy would apply.

Subsection 221(1) of the ETA imposes an obligation on suppliers to collect the tax. However, subsection 225(1) of the ETA requires a third party, who actually collects the tax on a particular transaction instead of the original supplier, to include the tax collected in its net tax calculation. Furthermore, pursuant to subsection 222(1) of the ETA, the third party, in these circumstances, is deemed to hold the amount collected as or on account of tax in trust until the amount is remitted or withdrawn under subsection 222(2) of the ETA.

Subsection 225(1) of the ETA also requires a supplier to include amounts that became collectible in a particular reporting period, as or on account of tax under Division II, when determining their net tax for a reporting period. This is required whether or not the third party actually collects the tax.

It is not the CCRA's intention to collect the tax twice on the same supply. In the case at hand, where the Bank purchases the right to receive a stream of future payments, rather than an "account receivable", the Bank could account for the amount collected as or on account of tax in its net tax calculation, and the Alarm Company would not have to account for and remit the tax.

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, CGA
A/Technical Analyst
General Operations Unit
General Operations and Border Issues Division
Excise and GST/HST Rulings Directorate