20 November 2003 Internal T.I. 2003-0036237 - DEDUCTIBILITY OF HST ASSESSMENT

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CCRA.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.

Principal Issues: Deductibility for income tax purposes of HST, interest and penalties assessed under the Excise Tax Act, in a situation where the reassessment is under appeal and the taxpayer has filed a waiver regarding deductibility that is subject to the outcome of the appeal.

Position: Subject to the amount of the reassessment being upheld after the final resolution of the appeal process, the HST, interest and penalties are deductible in the taxation year in which the notice of assessment was received.

Reasons: The amounts were generally incurred for the purpose of gaining or producing income from the business and therefore, in accordance with the CCRA's longstanding position outlined in IC 77-11, and consistent with the principles enunciated in the SCC decision in 65302 British Columbia Limited, the amounts are deductible in the year the notice of reassessment was received.

		November 20, 2003

	XXXXXXXXXX 	HEADQUARTERS
	Verification & Enforcement Division	Randy Hewlett, B.Comm.
	XXXXXXXXXX  Tax Services Office	613-957-8973

		2003-003623

Deductibility of Harmonized Sales Tax ("HST") Reassessment Under Dispute

We are writing in response to your letter of August 14, 2003, wherein you asked for our opinion on the deductibility under the Income Tax Act (the "ITA") of HST, penalties, and interest that XXXXXXXXXX (the "Taxpayer") was assessed under the Excise Tax Act (the "ETA"). We also acknowledge the additional information supplied in your e-mails (XXXXXXXXXX/Hewlett).

Facts

Our understanding of the relevant facts is as follows:

1. In XXXXXXXXXX, the Taxpayer was assessed HST, penalties, and interest for transactions undertaken in its XXXXXXXXXX taxation years as part of an alleged XXXXXXXXXX scheme (the "Reassessment").

2. The Reassessment included the following:

(a) HST was assessed under paragraph 296(1)(b) of the ETA on certain XXXXXXXXXX purchases for which the taxpayer paid HST but knew the vendors were non-filers and would not remit HST. As we understand it, there was no basis to deny the Taxpayer's claim for input tax credits on these purchases and therefore, an assessment under paragraph 296(1)(b) was issued.

(b) HST was assessed under section 221 of the ETA because the Taxpayer did not charge HST on certain XXXXXXXXXX sales to individuals whom the Taxpayer claimed were status Indians and exempt from HST. The Taxpayer could not document that the sales were to status Indians and that the XXXXXXXXXX were delivered to a native reserve.

(c) Penalties and interest were assessed under section 280 of the ETA in respect of the HST assessments referred to above in 2(a) and (b).

(d) Gross negligence penalties assessed under section 285 of the ETA in respect of the HST assessments referred to above in 2(a) and (b).

3. It is our understanding that the transactions referred to above in 2(a) and (b), were reported for income tax purposes by the Taxpayer. In addition, we also understand you have accepted that these transactions are legitimate for income tax purposes.

4. The Taxpayer did not face criminal prosecution for its part in the alleged XXXXXXXXXX scheme due to a lack of evidence.

5. The Taxpayer has appealed the Reassessment and the matter will proceed to the Tax Court of Canada (the "TCC") in the near future.

6. The Taxpayer deducted the HST portion of the Reassessment in its income tax return for the XXXXXXXXXX taxation year. The Notice of Assessment (the "NOA") was dated XXXXXXXXXX. The Taxpayer has indicated that, subject to the outcome of the appeal before the TCC, it will deduct the interest and penalties portion of the Reassessment in the taxation year in which these amounts are paid.

7. The Taxpayer has provided you with a waiver with respect to the deductibility for income tax purposes of the Reassessment, which is subject to the outcome of the appeal before the TCC.

Our Comments

The CCRA's longstanding position on the deductibility of sales tax reassessments in computing income under the ITA is described in Information Circular IC 70-11, Sales Tax Reassessments: Deductibility in Computing Income. In general terms, if the transactions that gave rise to the sales tax reassessment are made or incurred by the taxpayer for the purpose of gaining or producing income from the business, the sales tax and interest imposed on the transactions is also deductible for income tax purposes. Generally the deduction is permitted in the year in which it is payable, however, if the taxation year in which the transactions occurred is statute barred for income tax purposes, the deduction is allowed in the year the reassessment notice is received.

In a situation where a taxpayer disputes a sales tax reassessment, the deduction of the amount under dispute will normally be allowed against income for the year in which it is finally determined. However, if the taxpayer does not agree with this approach and it seems likely that part or all of the disputed amount will have to be allowed eventually, the amount in dispute will be allowed in the year the sales tax reassessment notice is received, provided a waiver is obtained pursuant to subsection 152(4) of the ITA.

In our view, there is sufficient information to conclude that the Taxpayer's participation in the alleged XXXXXXXXXX scheme was for the purpose of gaining or producing income from the business. Your letter of August 14, 2003, outlined in detail how the Taxpayer profited from participation in the alleged XXXXXXXXXX scheme. In addition, you have accepted that the transactions referred to above in 2(a) and (b) are legitimate for income tax purposes and were reported by the Taxpayer. Given that the Taxpayer has provided you with a waiver, subject to the amount of the Reassessment being upheld after the final resolution of the appeal process, it is our view that the Reassessment is deductible by the Taxpayer. However, since the NOA was received on or around XXXXXXXXXX, the amount of the Reassessment is deductible in the Taxpayer's income tax return for the taxation year that includes XXXXXXXXXX.

The deductibility of the HST and interest portions of the Reassessment is consistent with the CCRA's position outlined in IC 70-11. The deductibility of the penalties imposed on the Taxpayer under sections 280 and 285 of the ETA, is consistent with the decision of the Supreme Court of Canada (the "SCC") in 65302 British Columbia Limited ("65302"). In 65302, the SCC ruled that a taxpayer cannot be disallowed a deduction for a fine or penalty under paragraph 18(1)(a) of the ITA on the basis that the fine or penalty was avoidable or its deduction would be contrary to public policy. The SCC did state that it is conceivable that a "breach could be so egregious or repulsive that the fine subsequently imposed could not be justified as being incurred for the purpose of producing income". In our view, however, it is unlikely that the penalties imposed on the Taxpayer would be considered "egregious or repulsive". Finally, we also note that, if the Taxpayer revokes the waiver prior to the final resolution of the appeal process, no portion of the Reassessment is deductible until the taxation year that the amounts are finally determined under the appeal process.

We trust our comments are of assistance.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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