9 April 2003 GST/HST Interpretation 25506 - Section 232.1 - Promotional Allowances

Dear XXXXX

Thank you for your letter XXXXX (with attachments) concerning the application of section 232.1 of the Excise Tax Act (ETA) to promotional allowances. More particularly, the XXXXX requests clarification with respect to the application of section 232.1 to various promotional allowances paid by manufacturers to retailers.

You indicate that, based on discussions with XXXXX, theXXXXX is operating with the understanding that section 232.1 was intended to apply broadly and as such, the legislation would apply to the diverse transactions carried on by all GST/HST registrants that employ promotional allowances in the course of carrying on their business. The XXXXX is concerned that there is ongoing risk of exposure to audit assessments to XXXXX, should your understanding of this intended broad application not coincide with the CCRA's interpretation of section 232.1.

Interpretation Requested

The XXXXX requests the CCRA's views on the application of section 232.1 to the following examples of promotional allowances paid by manufacturers to retailers. In all of the following examples, it is assumed that all parties are registrants.

Allowances Understood by the XXXXX to Qualify for s. 232.1 Treatment:

1. Manufacturer A pays an allowance to a retailer so that the retailer will not stock Manufacturer B's goods. The allowance is paid as an incentive to the retailer to purchase Manufacturer A's products in place of Manufacturer B's products. Similar allowances are paid to retailers to persuade them to remove a competitor's products from their shelves with the intent that the retailer will then replace these goods with the allowance payer's goods.

2. An allowance is paid on the purchase of a manufacturer's goods that will be used to promote other goods of the same manufacturer. For example, an allowance is paid to a retailer upon purchase of a manufacturer's tool kit, but the allowance is intended to promote "how-to" books sold by the same manufacturer; or a manufacturer pays an allowance to a retailer in connection with his purchase of the manufacturer's peas but the retailer uses the allowance to promote the same manufacturer's beans. In some cases the allowance payer does not know which of its specific goods will be chosen by the retailer for promotion, but rather only intends the allowance payment will be used to promote some of the allowance payer's goods.

3. Allowances are paid by some or all of the manufacturers of products being co-promoted. For example, a spring-cleaning co-promotion might include the cleaning compounds of one manufacturer and brooms, mops, pails, etc. of other manufacturers. Some or all of these manufacturers pay allowances to retailers to feature the spring-cleaning group, which will include several manufacturers' products.

Allowances Requiring Clarification as to the Application of s. 232.1:

1. Company A manufactures equipment supplied to retailers and Company T manufactures parts which can be used in Company A's equipment. An example could be automobiles and tires. Companies A and T are not related. Company T (i.e. the tire manufacturer) pays a promotional allowance to the retailer to promote the sale of Company A's automobiles, which will ultimately increase sales of Company T's tires.

2. A packaging manufacturer pays an allowance to a manufacturer of juices. The juice manufacturer's juices are to be sold in boxes (packaging materials) made by the packaging manufacturer. The allowance is calculated as a percentage of juice manufacturer's promotional expenses incurred to promote these "juice boxes". The resultant increased sales would ultimately require the juice manufacturer to buy more packaging. For example, the juice manufacturer might pay allowances to retailers to encourage them to stock the juices ("listing allowances"); the juice manufacturer might engage in various promotional activities with retailers to increase sales of juice boxes to consumers, thereby increasing sales of both the packaging and juice manufacturers. The allowance paid by the packaging manufacturer to the juice manufacturer would defray all or part of the promotional costs related to the juice manufacturer's subsequent promotional activities.

3. An allowance is paid by a laundry detergent manufacturer to a washing machine manufacturer. The washing machine manufacturer will include the laundry detergent manufacturer's detergent inside its washing machines when they are sold. The sale of more appliances will clearly increase the sales of this detergent. Where the appliance manufacturer purchases the laundry detergent could the related allowance transact without GST if the appliance manufacturer advertises that his appliances include the specific brand of detergent? Would the presence of the detergent in the washing machine be sufficient for the allowance to qualify? If the laundry detergent was supplied free of charge to the washing machine manufacturer in return for an undertaking to advertise the particular detergent in a specified manner (i.e. no cash consideration) would the GST also be nil due to the operation of section 232.1?

4. An allowance is paid to a restaurant on the purchase of ingredients used to prepare the food it sells to consumers, such as cheese slices, which will be used to make the restaurant's cheeseburger. Would the allowance qualify if the cheese brand is specifically promoted? Alternatively, would the allowance qualify if the restaurant does not specifically advertise the cheese brand? Are such allowances automatically disqualified from the simplified handling allowed by section 232.1 because the cheese is not resold in the same form, but is used to make something new, a cheeseburger?

5. A restaurant purchases a Brand Name beverage syrup to be reconstituted into soft drinks. Since the syrup is merely diluted, would the allowance qualify if the Brand Name is clearly promoted or the restaurant advertises the beverages containing the syrup? Alternatively, is the allowance taxable since the beverage sold by the retailer is not in the same form as the syrup purchased from the manufacturer?

Allowances that the XXXXX believes do not meet the Requirements of s. 232.1:

1. A registrant arranges for third-party vendors to make supplies directly to unrelated retailers and the registrant earns promotional allowances as a result of this activity.

2. A supplier sells goods directly to retailers who are members of an Association, such as a franchise group. The supplier often pays the promotional allowance directly to the franchisor, while the related goods are purchased by the franchisees.

Interpretation Given

The following is our interpretation of section 232.1 as it relates to the various allowances provided in your submission. For ease of reference, the examples are dealt with in the order presented.

Pursuant to paragraphs 232.1(a) and (b), the following requirements must be met in order for tax relief to apply to any given allowance:

•   A particular registrant (e.g. a retailer) acquires particular tangible personal property (i.e. particular goods) exclusively for supply by way of sale for a price in money in the course of its commercial activities, and

•   Another registrant (e.g. a manufacturer), who has made taxable supplies of the particular property by way of sale to the particular registrant or to another person (e.g. a wholesaler), pays to or credits in favour of the particular registrant, or allows as a discount on or credit against the price of any property or service supplied by the other registrant to the particular registrant, an amount in return for the promotion of the particular property by the particular registrant.

Pursuant to paragraph 232.1(c), where the preceding requirements are met, the promotional allowance is deemed not to be consideration for a supply. Section 232.1 applies to promotional allowances paid, credited or allowed as a discount after March 1997.

The language used in paragraphs 232.1(a) and (b) is clear and serves to provide relief in circumstances where an amount (the "promotional allowance") is given in return for the promotion of particular tangible personal property that was acquired exclusively for supply by way of sale for a price in money. Therefore, where a vendor makes taxable supplies by way of sale of goods and pays, credits or allows a discount to a purchaser, who acquires the goods exclusively for resale in the course of the purchaser's commercial activities either from that vendor or another person, and gives an amount in return for the promotion of those goods by the purchaser, the promotional allowance is not regarded as consideration for a supply by the purchaser to the vendor. Thus, tax relief is available where the purchaser has undertaken promotional activities in respect of those goods and the vendor receives something in return for the promotional allowance.

The primary concern raised, via the examples in your submission, is with respect to the restrictive language of this provision rather than the type of promotional activity required. The XXXXX correctly notes that a promotional allowance paid to a third party who does not purchase any goods for resale in their own commercial activities will not meet the requirements of paragraph 232.1(a).

Paragraph 232.1(a) requires the purchaser to have acquired particular property with the intention and for the purpose of supplying that property by way of sale for a price in money rather than for some other purpose (e.g. for supply by way of lease, licence or similar arrangement; for consumption or use in the purchaser's activities). It is our view that property acquired with the intent and for the purpose of consumption or use in commercial activities or for further processing prior to sale is not property that is acquired for supply by way of sale for a price in money. Specifically, property will be regarded as having been acquired for consumption or use where it is treated as capital property for income tax purposes or where it is to be fundamentally transformed or altered (e.g. there is a change in form, nature, fundamental characteristics); incorporated into something else whereby it loses its identity in the process; used in manufacturing, processing or production of a 'new good'; improved beyond its original condition prior to sale; or consumed in the process of the formation of a finished product.

Generally, businesses maintain inventories of goods either to be sold to others or to be used or consumed by them in the course of carrying on their business. As such, where a particular property is acquired for consumption or use by a registrant, the registrant is not seen to be making a supply of that particular property but rather a supply of a different kind or nature (of a different property or service). Notwithstanding, it is generally understood that a minimal amount of handling of the particular property may be warranted in preparation for its supply (e.g. sorting, cleaning and bulk breaking).

Given the preceding, it is our view that section 232.1 applies to particular tangible personal property that is acquired with the intent/for the purpose of resale 'as is' for consideration. As a result, goods that are acquired for consumption or use by a registrant, or for supply by way of lease, licence or similar arrangement are excluded from the application of section 232.1.

Allowances Understood by the XXXXX to Qualify for s. 232.1 Treatment:

1. An allowance paid by a manufacturer to a retailer as an incentive to that retailer to not stock a competing manufacturer's product or to remove a competitor's product from their shelves (and to replace the competitor's product with the allowance payer's product) will meet the requirements of section 232.1 provided that the retailer is also promoting goods acquired exclusively for resale from that manufacturer under that incentive program.

2. An allowance paid to a retailer on the purchase of a manufacturer's product and that is used to promote other goods of that same manufacturer will meet the requirements of section 232.1 provided the amount paid is for the purpose of promoting the other goods and not for some other purpose and the retailer also acquires those other goods that are the object of the promotion exclusively for resale. In the circumstance where an allowance is paid by the manufacturer, in connection with the purchase of its peas, and that allowance is used by the retailer to promote the beans of the same manufacturer, the requirements of section 232.1 will be met provided the retailer has acquired the product being promoted (i.e. the beans) exclusively for resale. Similarly, in the example where the allowance is paid to a retailer upon the purchase of a manufacturer's tool kits and the allowance is intended to promote that manufacturer's "how-to" books, the allowance will meet the requirements of section 232.1 provided that the "how-to" books are also acquired by the retailer exclusively for supply by way of sale for a price in money.

3. Allowances paid for the co-promotion of goods of a group of manufacturers will qualify provided the requirements of paragraphs 232.1(a) and (b) are met. Where an amount paid by each manufacturer to the retailer is in return for the promotion of its particular property under a co-promotion program, that amount will meet the requirements of section 232.1 provided the retailer has acquired the particular property of that manufacturer exclusively for supply by way of sale for a price in money.

Allowances Requiring Clarification as to the Application of s. 232.1:

1. Where Company T (i.e. the tire manufacturer) pays a promotional allowance to the retailer to promote the sale of Company A's automobiles, the allowance received by the retailer does not meet the requirements of section 232.1. The retailer has not acquired Company T's tires for resale in the course of its commercial activities, rather it has acquired Company A's automobiles for resale.

2. In the example provided, the manufacturer of juices pays an allowance to a retailer to encourage the retailer to stock the juice. The packaging manufacturer pays an amount to the juice manufacturer to offset or defray all or part of the expense related to the juice manufacturer's promotional activities. The amount paid by a manufacturer of packaging material to a juice manufacturer does not meet the requirements of paragraph 232.1(a) as the juice manufacturer has not acquired the particular property sold by the packaging manufacturer (i.e. the packaging material) for supply by way of sale for a price in money. The juice manufacturer is using the packaging material as a component of its final product made up of the juice packaged in a juice box. Section 232.1 requires that the manufacturer has made a taxable supply of the particular tangible personal property by way of sale (i.e. the property which is the object of the promotion) and the purchaser has acquired that particular property for resale and not for consumption or use in the course of its commercial activities.

3. An allowance paid by a laundry detergent manufacturer to a washing machine manufacturer, who will include the detergent inside his machines when they are sold, is not paid in respect of goods that were acquired for the purpose of resale for a price in money as required by paragraph 232.1(a). In neither example cited - where the appliance manufacturer purchases the laundry detergent or where the detergent is supplied by the laundry detergent manufacturer free of charge - has the appliance manufacturer acquired the laundry detergent for supply by way of sale for a price in money.

While the presence of the detergent in the washing machine may serve to promote the brand of detergent, and the allowance paid may in fact be a promotional allowance, the requirements under paragraph 232.1(a) have nonetheless not been met.

4. An allowance paid to promote the specific brand of a product to a restaurant on the purchase of that product for use in preparing the food it sells to customers, such as cheese slices, does not meet the requirements of paragraph 232.1(a). This provision requires that the person receiving the allowance for the promotion of particular tangible property has acquired that property exclusively for supply by way of sale for a price in money (i.e. to be resold 'as is' and not consumed or used in the course of its commercial activities). Where the cheese manufacturer pays an allowance to the restaurant for promoting the sale of products that incorporate the cheese or for displaying the cheese manufacturer's logo in the restaurant, the restaurant has not acquired the cheese for supply by way of sale for a price in money.

5. An allowance paid by a manufacturer of a Brand Name Syrup to a restaurant that acquires the syrup to be reconstituted into soft drinks to be sold at the restaurant does not meet the requirements of paragraph 232.1(a). The restaurant does not acquire the syrup for supply by way of sale for a price in money; rather, it is our view that the restaurant acquires the syrup for consumption or use in the course of its commercial activities (i.e. the syrup's form, nature and fundamental characteristics are changed or altered in providing the soft drinks). The beverage sold by the restaurant is not the particular property that was purchased from the manufacturer (i.e. the syrup).

Allowances that do not meet the Requirements of Section 232.1:

1. Where a registrant arranges for a third-party vendor to make supplies directly to unrelated retailers and the registrant (i.e. the first party) earns promotional allowances as a result of this activity, section 232.1 will not apply, as the registrant has not acquired goods exclusively for supply by way of sale in the course of its commercial activities. Section 232.1 requires that the person who acquires the particular property for resale, who undertakes promotional activities in respect of that property, and who receives the promotional allowance, be the same person.

2. Promotional allowances paid by a supplier directly to a franchisor, related to goods purchased by the franchisees of that franchisor, do not meet the requirements of section 232.1. Although the allowance may serve to promote the supplier's goods, the allowance is paid to a party who does not acquire the goods exclusively for supply by way of sale for a price in money in the course of its commercial activities as required under paragraph 232.1(a).

In conclusion, it will be a question of fact whether an allowance is granted for the promotion of a particular product. It will also be a question of fact whether such a promotional allowance qualifies for the treatment provided for by section 232.1. These are determinations that must be made on the basis of the substance of the transaction, including relevant contracts or agreements.

Regarding your concerns with respect to the restrictive wording of section 232.1, you should note that your views have been brought to the attention of the Department of Finance. As you are aware, the CCRA is responsible for administering the GST legislation as enacted by Parliament. Any legislative amendment that may broaden the application of section 232.1 is a matter of tax policy, which falls within the scope of the Department of Finance.

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.

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) 957-8226.

Yours truly,

Indra Singh
Specialty Tax Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate

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