1 August 2003 GST/HST Interpretation 39693 - Application of the GST to Settlement Payments Received by

Dear XXXXX:

Thank you for your letter XXXXX (with attachments) concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to your client's operations.

Statement of Facts

Our understanding of the facts is as follows:

1. XXXXX is a GST/HST registrant, involved exclusively in commercial activities.

2. XXXXX entered into a contract agreement with XXXXX where, during late XXXXX - early XXXXX, XXXXX provided supplies of goods and services to XXXXX XXXXX.

3. At all times, XXXXX and XXXXX were dealing with each other at arm's length. Pursuant to the said agreement, XXXXX invoices XXXXX $XXXXX in total for the work performed which amount includes GST of $XXXXX calculated on the consideration in accordance with subsection 165(1) of the Excise Tax Act (ETA). Although no amount of consideration and tax was collected by XXXXX from XXXXX, the amounts charged as GST were included in XXXXX GST/HST returns in determining their net tax for the reporting periods in which the consideration was due as provided under subsection 168(1) and 225(1).

4. In the first part of XXXXX XXXXX established that both the consideration and tax payable in respect of the supplies was in whole unrecoverable. The entire amount was written off as a bad debt for accounting purposes in XXXXX books of account. In accordance with subsection 231(1) of the ETA, an amount equal to the GST previously recorded in the company's return for the supplies ($XXXXX) was therefore deducted in the reporting period in which the bad debt was written off.

5. In or around XXXXX, XXXXX presented to XXXXX a claim taking legal action against the latter for an amount of $XXXXX (the claim). This amount consisted largely of the invoiced amounts due by XXXXX ($XXXXX), XXXXX renunciation of previous rebates offered to XXXXX ($XXXXX), interest accrued up to XXXXX ($XXXXX) and related legal costs.

6. In a proposal letter XXXXX from XXXXX legal representative, XXXXX offered to pay XXXXX the amount of XXXXX dollars as payment for the unpaid invoices. Furthermore, XXXXX agreed to submit for mediation the outstanding balance of the Claim. XXXXX consented to the said proposal, as well as acknowledged receipt of the amount which was deposited in the company's account on or around XXXXX.

7. Prior to any mediation taking place, a Reciprocal Release, signed and dated XXXXX; was negotiated where XXXXX agreed to pay XXXXX an additional XXXXX dollars which XXXXX also acknowledged receiving. In return for the settlement XXXXX gave to XXXXX, its insurers, employees, officers, directors, agents and legal representatives, full and final release for any and all claim, actions, causes of action, damages or injuries of whatever nature, related directly or indirectly to XXXXX, including without limitation any and all matter related to the XXXXX.

8. XXXXX also gave XXXXX, its insurers, employees, officers, directors, agents, sub-trades and legal representatives, full and final release for any and all claims, actions, causes of action, damages or injuries of whatever nature directly or indirectly related to the said XXXXX, including without limitation any and all matters related to the XXXXX XXXXX.

Interpretation Requested

You requested an interpretation as to whether each settlement payment received by XXXXX from XXXXX ($XXXXX and $XXXXX) is:

1. consideration for a taxable supply pursuant to section 165 of the ETA;

2. a recovery of a bad debt subject to subsection 231(3) of the ETA; or

3. neither consideration for a taxable supply, nor a recovery of a bad debt and therefore not subject to GST.

Interpretation Given

The GST/HST status of a settlement payment does not depend on whether the settlement occurs as a result of a court decision or a voluntary agreement, but on whether the settlement relates to an agreement for the taxable supply of property or services.

Based on the information provided, there seems to be no amount paid otherwise than in respect of an agreement for the taxable supply of property or services. Under the existing legislation, where a person has claimed deduction from net tax in respect of a bad debt under subsection 231(1), and the debt is subsequently recovered, subsection 231(3) requires that an amount equal to the tax fraction of the amount recovered be added to the person's net tax.

If there is additional information which would categorize these payments as having been made otherwise than as consideration for a supply, for example, as a consequence of a breach, modification or termination of the agreement for the making of a taxable supply of property or a service in Canada by the registrant to a person, then subsection 182(1) of the ETA would apply. The supplier will be treated as having collected tax equal to 7/107 of the amount paid.

Consequently, both the amount referred to in paragraph 5 and the amount referred to in paragraph 6 in the preceding "Statement of Facts" are subject to tax as discussed above.

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 Canada Customs and Revenue Agency with respect to a particular situation.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at 957-8221.

Yours truly,

Denise Villeneuve
Corporate Reorganization Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate