12 November 1997 GST/HST Interpretation HQR0000023 - Application of Subsection 182(1) of the Excise Tax Act to Judicial Costs

Dear XXXXX requesting our comments on the above noted subject.

Background

In December of 1993, your office received a letter from XXXXX , questioning the application of subsection 182(1) of the Excise Tax Act (the Act) to costs awarded by the Courts in civil litigation cases.

 XXXXX memorandum raised a number of questions based on the following assumptions.

1. Party "A" and party "B" are both registrants under the Act.

2. Party "A" entered into a contract with party "B" for the making of a taxable supply of property or a service.

3. A dispute arose between "A" and "B" as a result of a breach in the contract, and the matter goes to court.

4. The court orders "B" to pay to "A" damages as a result of the breach, as well as judicial costs. Both the damages and judicial costs are paid directly to "A", and not to "A's" lawyer.

5. The damages paid by "B" to "A" (as ordered by the court) are as a consequence of the breach of the contract for the making of a taxable supply, and are not consideration for the original supply stipulated in the contract. Subsection 182(1) will apply to the payment of the damages.

Questions

1. Would the judicial costs awarded by the court to "A" be considered to have been paid "as a consequence of the breach ... of an agreement for the making of a taxable supply ... otherwise than as consideration for the supply"? In other words, would subsection 182(1) apply to the judicial costs paid by "B" to "A", or only to the damages paid by "B" to "A"?

2. Are judicial costs always treated separately from the damages for purposes of subsection 182(1)? Can subsection 182(1) ever apply with regards to judicial costs?

3. If subsection 182(1) does not apply to the judicial costs, would the amount of the costs be otherwise subject to the Goods and Services Tax/Harmonized Sales Tax?

Analysis

As defined in the Black's Law Dictionary, costs is "a pecuniary allowance, made to the successful party (and recoverable from the losing party), for his expenses in prosecuting or defending an action or a distinct proceeding within an action ...". The awarding of damages, on the other hand, is intended as a remedy for a breach of contract or for tortious acts.

Amounts awarded for judicial costs are usually based on an established court tariff which do not always cover full legal costs incurred in relation to a case. The amount awarded, if any, is independent of any amounts awarded as damages.

Since the underlying purpose and nature of these two types of payments are different, they should be treated separately in applying any section of the Act.

The application of subsection 182(1) to a particular payment depends upon whether such a payment could satisfy the conditions set out in that provision. One of those conditions is that the amount must be paid or forfeited as a consequence of the breach, modification or termination of an agreement for the making of a taxable supply. It is the Department's position that judicial costs are not a consequence of the breach, modification or termination of the agreement in itself, but rather a consequence of the party having to institute legal proceedings. Therefore, subsection 182(1) would not apply to judicial costs in these circumstances.

Whether a payment of judicial costs would otherwise be subject to tax under Part IX of the Act depends on whether it constitutes "consideration for a taxable supply". In order for party "B" to be the recipient of a taxable supply, party "A" must be conferring something of value to party "B" in exchange for the payment. Since party "B" receives nothing in exchange for the payment of judicial costs, there is no supply and the payment falls outside the scope of the Act.

The tax status of judicial costs must not be confused with that of the legal fees. The legal fees are subject to tax as long as the supplier is required to collect. By virtue of subsection 165(1) of the Act, it is the recipient of the supply who is liable to pay that tax.

"Recipient" of a supply of property or a service is defined in subsection 123(1) to mean, "(a) where consideration for the supply is payable under an agreement for the supply, the person who is liable under the agreement to pay that consideration, ...". The party who has contracted for the legal services is liable for the payment of tax. The awarding of costs by the Courts to the successful party does not change the recipient of the legal services, or transfer the liability to pay tax to the losing party.

I trust these comments will be of assistance in responding to the inquiry from XXXXX Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at 613-952-8806.

Yours truly,

Jane Mah, CA
Policy Officer
General Operations and Border Issues Division
GST/HST Rulings and Interpretations Directorate

Legislative References: ETA: Section 182, 165, Subsection 123(1), Definition of "recipient", "supply"