31 July 2000 GST/HST Interpretation 32195 - GST/HST Information Concerning Compensation Payments

Dear XXXXX:

In response to your recent inquiry concerning the application of the Goods and Services Tax (GST) to compensation payments payable under a court order for damages and out of court settlements, we are providing the following general information.

On April 1, 1997, the provincial sales tax in three participating provinces, Newfoundland, Nova Scotia and New Brunswick, was harmonized with the GST to create the Harmonized Sales Tax (HST). HST applies to the same base of goods and services as the GST, at a rate of 15%. Of this, 7% represents the federal component and 8% represents the provincial component of HST.

Generally, a damage payment is not consideration for a supply, as it is compensatory or punitive in nature, and not given in exchange for a supply of property or services by another party. Accordingly, it would not be subject to GST/HST, even if the payee agrees to release the payer from further liability. This applies regardless of whether the damage payment is made as a result of a court judgement or as a result of a settlement that was concluded in order to avoid a court judgement. Policy statement P-218 provides additional information on the application of the GST to this type of payment. However, where as a result of a breach, modification or termination of an agreement for a 7% or 15% taxable supply, the recipient of the supply is required to pay or forfeit an amount to the registrant supplier, or reduce or extinguish a debt or other obligation of the supplier, the application of section 182 of the Excise Tax Act must be considered.

Section 182 provides that the recipient is deemed to have paid an amount as consideration and tax, in respect of the supply provided for in the agreement. The supplier is therefore required to remit 7/107 or 15/115 of the amount received from the recipient. Consequently, a supplier would be required to remit an amount as tax in respect of a court ordered payment or an out of court settlement which is awarded as a consequence of a breach, modification or termination of an agreement for a supply that is taxable at 7% or 15% where the deeming provisions in section 182 apply.

Section 182 contains a transitional provision which applies where the agreement for the supply was entered into in writing before 1991 (i.e., before the implementation of the GST), the amount is paid or forfeited or the debt or other obligation is reduced or extinguished after 1992 and tax in respect of the amount was not contemplated in the agreement. The effect of the transitional provision is that the recipient is not deemed to have paid tax related to the amount which is deemed to be consideration for the supply and is generally required to pay an additional amount equal to the amount of deemed tax.

Section 182 specifically provides that its deeming provisions do not apply to an additional amount charged to a person because the consideration for the supply is not paid within a reasonable time which is specified in the invoice, an amount paid as or on account of a penalty paid by one railway corporation to another for failure to return rolling stock within a stipulated time, or an amount paid as or on account of demurrage.

It is important to note that there are situations where a payment is made in the context of a claim for damages, but the payment can be linked directly to the provision of some property or service by the payee in return for the payment. The payment is not made to compensate the payee with respect to the original transaction, but rather to obtain the property or service provided by the payee. If the supply of the property or service being obtained is taxable, and if the payee is a registrant, 7% or 15% tax will apply.

Also, if a judgement or settlement requires a person to repair the damage to the property and the person engages a third party to perform the repairs services, the person would be receiving a taxable supply of a service of repairing the damage from the third party. Therefore, if the third party is a GST/HST registrant, tax applies.

The foregoing comments represent our general views with respect to the subject matter of your inquiry. 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 Memorandum Series, do not bind the Canada Customs and Revenue Agency with respect to a particular situation.

If you have any further questions or require clarification on the above matter, please contact

Ms. Dawn Weisberg at (613) 952-9219 or Dawn.Weisberg@ccra-adrc.gc.ca.

Yours truly,

J. Sitka
Director
Financial Institutions and Real Property Division
Excise and GST/HST Rulings
Canada Customs and Revenue Agency