11 March 2004 GST/HST Interpretation 49193 - Does the Elimination of a Reserve Trigger the Bad Debt Provisions Under Section 231 of the ETA?

Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.

This memorandum is in response to your e-mail message XXXXX to Anne Kratz of the General Operations Unit, our subsequent telephone conversations and e-mail messages, and your most recent telephone call XXXXX.

Background Information:

XXXXX a registered distributor XXXXX sold magazines in Canada to a large registered retailer. The retailer purchased magazines for re-supply in the course of its commercial activities.

The magazines were sold on a "sale-and-return" basis. According to the verbal agreement between the parties, the retailer had to pay the distributor for the invoiced amount, including GST, upon delivery. Where the retailer identified a shortage or returned unsold magazines to the distributor, the distributor was supposed to refund an amount to the retailer and issue a credit note. The distributor reported and remitted the tax on the sale while the retailer claimed full input tax credits on the purchase.

After some time, the distributor determined that the obligation to provide the credit to the retailer no longer existed because the time to claim the credit had expired under a common law statute of limitations. The distributor therefore brought the previously deducted reserve into its income for income tax purposes. Neither the distributor nor the retailer adjusted their tax, input tax credit(s) or net tax as a result of the elimination of the distributor's liability.

Questions and Answers:

1. Is the elimination of the reserve by the registered distributor considered to be a bad debt written-off by the registered retailer, pursuant to subsection 231(1) of the ETA?

In the context of the relationship between the parties, it is our understanding that the retailer is the purchaser, rather than the supplier. Since it is not apparent that the retailer has made a taxable supply to the distributor, relief would not be available to the retailer under subsection 231(1) of the ETA in relation to the expired/forgone credit.

2. Is the elimination of the reserve by the distributor considered to be a "debt forgiven" and does GST/HST Policy Statement P-084R FORGIVEN DEBTS CONSIDERED BAD DEBTS apply?

GST/HST Policy Statement P-084R addresses debts forgiven pursuant to an arrangement under the Companies' Creditors Arrangement Act ("CCAA"). However, you have made no mention in your submission that an arrangement has been entered into between the parties pursuant to the CCAA. Consequently, it would seem reasonable to assume that the situation would fall outside the scope of that policy. Furthermore, since we concluded earlier that subsection 231(1) of the ETA does not apply (on the basis that the retailer did not make a supply to the distributor) in regards to the forgone credit, policy statement P-084R cannot apply.

3. Does the distributor have to adjust its GST, ITCs or net tax?

Based upon our understanding of the verbal agreement between the registrants, the distributor was to have provided the retailer with a credit, since the distributor was informed of delivery shortages and/or magazines returned.

For purposes of subsections 232(1) & (2) of the ETA, a supplier has the option of refunding, adjusting, or crediting tax (or amounts on account of tax) to the purchaser. The CRA has always maintained that the decision whether or not to refund, adjust or credit the tax (or amounts on account of tax) to the purchaser rests with the supplier.

Where the customer is a registrant, the supplier may choose not to refund, adjust or credit the tax previously charged or collected. This is often the case where the supplier has already accounted for the tax and the customer has already claimed (or is entitled to claim) a corresponding input tax credit.

Since the distributor did not adjust, refund or credit an amount in favour of, or to the retailer in accordance with subsections 232(1) or (2) of the ETA, paragraphs 232(3)(a) & (b) of the ETA do not apply. That is to say, the distributor is neither required to issue a credit note, nor are they entitled to adjust or reduce an amount from their net tax in relation to the returned magazines and shortages.

4. Does the retailer have to adjust GST, ITC or net tax?

No. In the case at hand, the registered retailer does not have to adjust its tax, input tax credits or net tax. Because the registered distributor has not refunded, adjusted, or credited amounts to the retailer under subsections 232(1) or (2) of the ETA, paragraph 232(3)(c) of the ETA does not apply. Consequently, the retailer is not required to adjust or add an amount back to their net tax in relation to the credit that was not provided to them.

5. Will the Crown suffer a loss in revenue as a result of no adjustment being made?

The revenue effect for the Crown should be nil, provided that:

•   both registrants are fully compliant,

•   the distributor collected the applicable tax from the retailer on the taxable supply of the magazines,

•   the distributor included this amount in their net tax calculation, and remitted any positive net tax, and

•   the retailer claimed full input tax credits.

Since neither the distributor nor the retailer made any adjustments to their respective net tax calculations in relation to the forgone credit, the revenue effect to the Crown would be nil.

Should you have any further questions, do not hesitate to contact me by telephone at (613) 954-9699, or mailto: Douglas.Wood@ccra-adrc.gc.ca. Feel free to check out the GST/HST provisions for which our unit has responsibility at: http://7.28.66.49/pl/organization/gst/division/GOBI/geneop-e.htm