25 February 2000 GST/HST Interpretation HQR0001569 - Real Property Transaction - Bad Debt Deduction -

Thank you for your e-mail of January 8, 1999, to Patrick McKinnon, and subsequent correspondence concerning the application of the Goods and Services Tax (GST) to XXXXX and his entitlement to a bad debt deduction under subsection 231(1) of the Excise Tax Act (ETA). I apologize for the delay in responding to this matter.

Background Information

XXXXX [(i.]e., the purchasers) entered into a "Contract of Purchase and Sale" on December 13, 1994, with XXXXX (i.e., the registrant vendor), to purchase a new property located at XXXXX XXXXX, subject to financing and the sale of the purchasers' residence.

The sale was to be completed on XXXXX[.] The purchasers agreed to rent the property from XXXXX at the monthly rate of XXXXX[.] The vendor was to pay the taxes and the utility bills to the XXXXX XXXXX. It is our understanding that the rental payments were not to be applied to the purchase price of the property. The purchasers did have the right to alter the property. As well, they were allowed to paint and carpet the basement.

In his letter of August 10, 1998, XXXXX advised that the conditions provided for in the "Contract of Purchase and Sale" between the vendor and the purchasers had not been satisfied. As such, the "Contract of Purchase and Sale" was not completed, and ownership of the property did not transfer to the purchasers. No action in court was taken against the purchasers. The purchasers occupied the premises until the property was subsequently sold to another party.

Interpretation Requested

You requested clarification whether or not the vendor would be entitled to a bad debt deduction under subsection 231(1) of the ETA with respect to the above noted real estate transaction.

Interpretation Given

Based on the information provided, the vendor would not be entitled to a bad debt deduction under subsection 231(1) of the ETA, with respect to the real estate transaction in question since the purchasers' obligations under the agreement appear to have extinguished. As such, there would likely have been no "consideration" to write off.

Analysis

Where paragraph 168(5)(a) of the ETA does not apply, in determining when tax is considered payable, paragraph 168(5)(b) of the ETA provides that notwithstanding subsections 168(1) and (2), tax in respect of a taxable supply of real property by way of sale is payable on the earlier of the day ownership of the property is transferred to the recipient and the day "possession" of the property is transferred to the recipient under the agreement for the supply.

Section 123 of the ETA provides that a sale in respect of property includes a transfer of the possession of the property under an agreement to transfer ownership of the property. Given that "possession" was transferred at the time the purchasers were granted occupancy of the property under an agreement of purchase and sale, tax became payable in respect of the real property at that time.

The question of when a debt becomes a "bad debt" is a factual one, and must be determined on a case by case basis. A determination whether or not an amount is a "bad debt" must be consistent with Generally Accepted Accounting Principles (GAAP). Generally, a debt is considered a bad debt when all reasonable steps have been taken to obtain payment and it has become evident that the debt is uncollectible.

Since the "Contract of Purchase and Sale" was not completed, the sale may not have taken place for purposes other than Part IX of the ETA. Given the uncertainty of the factual circumstances which prevented the transfer of ownership, it remains unclear whether the "consideration" relating to the transaction ever became due.

Even if the vendor had a right of claim to the proceeds of the "sale", the facts are that the vendor chose not to enforce the contract and, more specifically, not to pursue his right to collect the proceeds of the "sale". In addition, the facts are that the purchasers gave up, either voluntarily or involuntarily, possession and occupancy of the property, and the vendor regained possession of the property.

Finally, the vendor supplied the property, by way of sale, to a third party purchaser. As a result of these events, the purchasers' obligation to pay the "consideration" for the sale of the property would have, in all likelihood, been extinguished. Without an amount due as consideration, there cannot be a debt, or for that matter a "bad debt" as described in subsection 231(1) of the ETA.

In the case at hand, since the vendor would not likely have been in a position to write-off any consideration, he would not be entitled to a bad debt deduction under subsection 231(1) of the ETA, since one of the conditions that must be satisfied for the purposes of subsection 231(1) of the ETA is that consideration (and tax) must have become in whole or in part a bad debt.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-9699.

Yours truly,

Douglas Wood
A/Technical Officer
General Operations Unit
General Operations & Border Issues Division
Excise and GST/HST Rulings Directorate