Section 231

The taxpayer (Alcoa) entered into a supply agreement with a purchaser (Sural), which provided that Sural would maintain a standby letter of credit of US$25 million (later reduced to US$16 million) to ensure payment by Sural of the amounts invoiced by Alcoa. After Sural entered into CCAA proceedings, and was in default as to the payment of US$52.7 million (including GST and QST) in invoices, Alcoa made a demand for, and was paid, US$16 million by the Bank of Montreal (BMO) under the L.C. By virtue of BMO’s rights of subrogation, Sural now owed US$16 million to BMO. In its books, Alcoa initially only recorded a doubtful debt provision that was net of the US$16 million, but later reversed this provision and recorded a provision for the invoices’ full (tax included) amounts. The ARQ denied the portion of Alcoa’s bad debt deduction under QSTA s. 444 (and ETA s. 231(1)) that corresponded to the QST (and GST) components of US$16 million.

After referring to the presumption in Re Rizzo & Rizzo Shoes Ltd., [1998] 1 S.C.R. 27, at para. 27 that “the legislature does not intend to produce absurd consequences,” Bourgeois JCQ indicated that the position of Alcoa entailed it both claiming a bad debt deduction for the QST and GST included in the US$16 million and also receiving compensation for those amounts under the L.C.

After also noting that the L.C. was issued pursuant to the agreement for the supply of aluminum to Sural and for invoicing Sural therefor, he concluded that the US$16 million should be considered as a partial payment of the unpaid Sural invoices, so that the ARQ position was confirmed.

In Policy Statement P-058R - Recovery Of Bad Debts (obsolete from September 2011), CRA concluded that a credit insurance claim payment that related to the indemnification of an account receivable that became a bad debt did not constitute the recovery of the bad debt for the purposes of ETA s. 231(3). Bourgeois JCQ distinguished P-058R on the grounds that it dealt with credit assurance rather than a stand-by letter of credit, unlike that Policy, here it was clear that the sum received included amounts for QST and GST and, here, the sum related to a taxable-supply contract rather than a financial service (an insurance policy).

As a condition to receiving a loan to fund the renovation of a property of the two registrants (the Castros), the Castros were required to transfer the property to a corporation of which they were equal shareholders (using the services of a notary appointed by the lender) and to pledge the voting shares of the corporation to the lender. Such transfer was made by the Castros for the sum of $1.00, and the transfer documents certified that the property was an exempt residential property. Later, in settlement of a dispute, the shares of the corporation were transferred to the lender. The Castros were subsequently assessed for failure to charge GST on the fair market value of the property on the basis that the transfer was a taxable supply. The Castros unsuccessfully tried to recover such tax from the corporation, and then claimed a bad debt deduction pursuant to ETA s. 231 equal to such tax assessment of them.

In confirming the denial of such claim, Smith J found that the share pledge did not remove the right of the Castros to elect the board of the corporation, so that the corporation and they were related persons pursuant to ITA s. 251(2)(b)(ii) and, thus, did not deal with each other at arm’s length pursuant to ETA ss. 126(1) and (2). Furthermore, in addition to thus not satisfying the requirement of s. 231(1) that the recipient was dealing at arm’s length with the supplier, the Castros had not satisfied the requirement in s. 231(1.1) that they had declared and remitted the tax on the supply. Smith J stated (at para. 47, TaxInterpretations translation):

It would be altogether too easy to avoid paying the tax if there was simply a failure to include it in the return, followed by a wait of several years for the tax authorities to assess it, only to claim a deduction at that point because the passage of years had rendered the claim uncollectible.

The appellant (“Greenfield”) entered into a services contract with a junior Quebec mining company (“CRI”) to assist it in developing a nickel deposit. CRI started experiencing financial difficulties as a result of poor project management decisions by it and a low price of nickel, and Greenfield sued CRI for unpaid fees of around $15 million. After 30 months of unfruitful legal proceedings (reflecting successful tactics of CRI’s counsel) and incurring over $1 million in legal fees, Greenfield agreed to settle its action by agreeing to receive $7 million in instalments over a two-year period.

Greenfield then wrote down the receivable on its books accordingly, and claimed a credit under the Quebec equivalent of ETA s. 231 based on that part of the receivable having become a bad debt, which the ARQ was prepared to grant until it took the view that Greenfield should have issued a credit note to CRA for the reduction in the fee amount which, once done, would have given the ARQ the right to receive a refund of the applicable portion of the input tax refunds that had been claimed by CRI under the Quebec equivalent of ETA s. 232(3)(c).

After reviewing this evidence, Zaor JCQ found (at para. 68, TaxInterpretations translation) that (as per Rich at para. 15) Greenfield had made “an honest and reasonable” assessment that it would not “recover anything more than the $7 million dollars as agreed” and that a subsequent amendment of the settlement agreement with CRI was merely to achieve a catch-up for arrears by CRI in paying the agreed $7 million in instalments, rather than being an indication that recovery efforts by Greenfield were still ongoing.

She indicated that these findings were sufficient to allow Greenfield’s appeal, and noted (at para. 89) that “the Court cannot order CRI to repay excess amounts claimed as inputs”.

The appellant (North Shore) paid half (or approximately $3.0 million plus HST) of the purchase price for various solar array projects to the supplier (“Menova”). Menova only completed approximately 1/5 of the work, and issued “Credit Memos” (including HST) to North Shore late 2010 and in 2011 to reflect the work for which it had been paid but had not performed. North Shore made additions to its net tax under s. 232(3)(c) to reflect the HST in these credit memos. However, Menova was insolvent and was petitioned by North Shore into bankruptcy on June 29, 2012. North Shore sought to effectively reverse the s. 232(3)(c) additions to its net tax by claiming bad credits under s. 231. CRA's ultimate position was that the s. 232(3)(c) additions and s. 231 credits were valid and invalid, respectively. North Shore ultimately accepted that the s. 231 credits claimed were invalid. In accepting this concession (and before going on to accept the CRA position), Bocock J stated (at para. 26):

North Shore was neither a “supplier” nor did it make a “taxable supply”. Factually, North Shore was a recipient who received a taxable supply.

The appellant, a registrant in the events management business, invoiced a customer (Flora) for a total of $1,769,694 including GST of $103,440 for services rendered (and invoiced, see para. 22) over a 12-month period ending on October 2006, but was unable to collect anything as Flora was determined to be insolvent in November 2006. Flora made a settlement offer to its creditors in February 2007, which the appellant accepted, but no payments were made thereunder.

After Revenue Quebec indicated (at the end of 2008) that it would deny the appellant's claim (made for its quarterly reporting period ending on 31 January 2007) under s. 231 on the basis that the situation instead had called for a claim under s. 232 (apparently based on viewing the February 2007 agreement as an adjustment to the consideration), the appellant (in January 2009) entered into a write-off agreement with Flora, issued a credit note to Flora, and claimed a credit under s. 232(3) for the GST of $103,440 in its return for the reporting period ending on 31 January 2009. Revenue Quebec considered that the credit note had not been issued "within a reasonable time," as required by s. 232(3).

After stating (at para. 19) (TaxInterpretations translation) that the jurisprudence indicated "that the creditor need not have taken proactive measures if it reasonably and sincerely believed that recovery was impossible," Tardif J concluded (at para. 30) that in light of Flora's known insolvency, it was appropriate at the effective time of the bad debt claim to consider the debt to be irrecoverable and that any expense or effort to recover it would have been "a pure waste of energy and money." Respecting the "write-off" branch of s. 231(1), he stated (at para. 39) that "a contemporaneous document recording the decision to write-off the debt appears essential to the application of section 231," and (at para. 40) that here, the preponderance of evidence indicated the satisfaction of the write-off requirement.

The disposition of the "reasonable delay" issue is summarized below under s. 232(3). The appeal was allowed.

The appellant was not entitled to a credit under s. 231(1) in respect of the GST of approximately $170,000 owing to it as there was "little evidence as to the actual measures taken by the appellant to collect any specific debt" (para. 12), there was no evidence of the debt having been written off in the reporting period in question (although, at para. 14, the finding in Burkman v. The Queen, [1997] G.S.T.C. 98, "that a written note, as opposed to a journal entry, could satisfy the requirement that the debt must be written off in the books of account, in circumstances where no ledger existed" was accepted.) Furthermore, 1/3 of the appellant's receivable was owing by the holder "Garden Hill") of 98% of its shares. In this regard, Bowie J rejected the appellant's submission (at para. 20) that the provisions of ITA s. 251(2) (adopted for ETA purposes by ETA s. 126(2)) "simply raise a rebuttable presumption that the appellant and Garden Hill did not deal at arm's length, and that this presumption is rebutted by the evidence that the appellant's policy was to provide service to Garden Hill and its members at the same commercial rates that it charged to all its other customers."

In finding that the appellant, a criminal lawyer, had not satisfied the "writing off" requirements of s. 231(1) in respect of amounts owing to him by the Ontario Legal Aid Plan, Bonner J stated (at para 6):

[A] bad debt cannot be considered to have been written off in a person's books of account unless and until a notation is made in those books that the particular debt has been written off. …A journal entry ought to be made to clear out each worthless receivable. Otherwise, subsection 231(3) would be impossible to enforce.

The appellant (“9267”) sold domain names on September 2012 for $500,000, payable in instalments, plus GST and QST to another corporation (“9210”) that was owned equally by its individual shareholder and an unrelated individual. Only $25,000 in instalment payments under the first contract were made before 9210 started experiencing financial difficulties. In the autumn of 2013, a receiver was appointed, in March 2014 a bankruptcy proposal was made, and subsequently, the domain names were sold by 9210 for $5,000 to a company related to 9267.

The GST return for the reporting period of 9267 that included September 2012 was not filed until March 2016, with 9267 being assessed for the tax shown as collectible by it, and in September 2016, a return for the March 2014 to February 2015 reporting period claimed a credit under s. 231(1) for the uncollected GST (which the ARQ on behalf of CRA rejected).

Before concluding that 9267 was not entitled to the s. 231(1) credit, D’Auray J stated (at para. 42, TaxInterpretations translation):

… 9267 did not remit GST on the taxable supply, i.e., on the sale of its domain names to 9210, when it filed its return. Therefore, subsection 231(1) of the ETA does not apply in this case because the condition in paragraph 231(1.1)(b) is not met. Since this condition is not met, 9267 cannot use this provision.

Furthermore, she found that 9267 had not taken reasonable measures to pursue collection of its debt, including claiming under its security interest, and having its debt included in the debtor claims made against 9210 in connection with the receivership and bankruptcy proceedings.

She also noted that, in the absence of generating a credit under a specific provision such as s. 231(1), no claim could be made for the bad debt under s. 225(1).