In a general procedure hearing that was later moved under the informal procedure[1] rules and rendered on December 17, 2024,[2] the Tax Court of Canada (the “Tax Court”) dismissed 267 O’Connor Limited’s (the “Appellant”) appeal, and thereby denied input tax credits (“ITCs”) that had been claimed by the Appellant in connection with expenses incurred as part of the settlement of a civil action with a third party (“Starwood”).
- The dispute arose when the Minister disallowed ITCs claimed by the Appellant in respect of a lump sum payment made to Starwood to settle an ongoing litigation.
- Basing its conclusion on a review of the minutes of settlement and the full and final release agreement between Starwood and the Appellant, the Tax Court determined that most of the settlement payment made to Starwood was to cover Starwood’s expenses and not as consideration for a supply.
- The Tax Court further stated that, even if it had concluded otherwise, the mandatory documentary requirements in subsection 169(4) of the Excise Tax Act (Canada) (“ETA”) and the Input Tax Credit Information (GST/HST) Regulations (the “ITCRegulations”) were not met at the time the Appellant made its ITC claims.
Background
In August 2013, the Appellant entered into a purchase agreement (the “Agreement”) with Starwood for the sale of a commercial property owned by the Appellant (the “Transaction”). Pursuant to the Agreement, Starwood was to assume carriage of the Appellant’s appeal before the Ontario Municipal Board (the “OMB Appeal”) of a decision rendered by Ottawa City Council regarding the property.
When the Transaction failed to close, carriage of the OMB Appeal reverted to the Appellant and Starwood filed a lawsuit against the Appellant notably claiming performance of the Agreement and an abatement of the purchase price payable in respect of the property (the “Lawsuit”). Starwood later amended its statement of claim to add equitable damages or, alternatively, damages at common law to cover expenses incurred, inter alia, as part of the OMB Appeal.
In August 2018, the Lawsuit was settled, with the Appellant agreeing to pay $800,000 to Starwood, which amount was “comprised of the return of the deposit [$350,000] and reimbursement for legal fees and consulting fees” (as agreed by the parties in the full and final release agreement). (para.14)Pursuant to such settlement, Starwood released the Appellant of all current and future claims pertaining to the Agreement, and assigned to the Appellant its rights and interests in intellectual property and legal services acquired for purposes of pursuing the OMB Appeal.
In its July 1, 2018 to September 31, 2018 reporting period, the Appellant claimed ITCs of $53,758.44 for sales taxes (“GST/HST”) payable on the $450,000 payment ($800,000, less the $350,000 deposit reimbursement) made to Starwood (the “Settlement Payment”) on the basis that such Settlement Payment was made to Starwood in consideration for taxable supplies of intangible and tangible property provided by Starwood to the Appellant in 2014. More specifically, Starwood would have transferred a waiver of conflict for its attorneys and other professionals to represent or act for the Appellant for purposes of the OMB Appeal, as well as its rights to intellectual property and reports prepared as part of the OMB Appeal.
Issue
A set of very specific rules govern a registrant’s entitlement to ITCs under the ETA. In this case, two main questions were raised for the Tax Court’s consideration:
- Was the Settlement Payment made in consideration for a taxable supply that was acquired by the Appellant for consumption or use in the course of a commercial activity?
- Was the Appellant in possession of all the prescribed information under subsection 169(4) of the ETA or the ITC Regulations at the time it claimed the relevant ITCs?
Tax Court Decision
Recipient of a supply of property or service
Following a review of the minutes of settlement and the full and final release agreement, the Tax Court concluded that, though intangible and tangible property had been transferred to the Appellant, the evidence presented at trial did not support the Appellant’s argument that the Settlement Payment had been made to pay for such property, nor did the evidence sufficiently support the calculation of the amount of ITCs that would have been attributable to the portion of the Settlement Payment allegedly paid in respect of the property. Instead, Justice MacPhee found that the Settlement Payment was, for the most part, compensatory and was therefore not taxable for GST/HST purposes. Based on the foregoing, Justice MacPhee concluded that, in making the Settlement Payment, the Appellant was not “the recipient of services for consumption or use in the course of its commercial activities” and was therefore not entitled to ITCs in respect of such payment. (paras. 25-31)
Considering the foregoing, this conclusion was sufficient for the Tax Court to dismiss the Appellant’s appeal.
Documentary requirements for ITCs
In obiter, the Tax Court also considered whether the Appellant had obtained, at the time it claimed the ITCs, all the prescribed documentation required to support its claim. Justice MacPhee reiterated that, unless an exception under subsection 169(5) of the ETA is applicable, such documentary requirements are mandatory. Unconvinced by the Appellant’s efforts to persuade him that it had complied with subsection 169(4) of the ETA and the ITC Regulations – which notably imposed on the Appellant the obligation to obtain Starwood’s GST/HST registration number prior to, or at the time of, filing its GST/HST return and claiming the ITCs – Justice MacPhee found that such omission was “fatal to the success of the appeal” (para. 41). Although in the context of a purchase of commercial real property a purchaser will generally provide its GST/HST registration number to the vendor to “self-assess” any GST/HST that could be payable in connection with the transaction, as the Transaction failed to close, it is possible that Starwood never provided it to the Appellant in the case at hand.
In addition, Justice MacPhee found that the facts of the appeal lacked evidence to determine the “total amount of consideration paid [and] the total amount of tax paid by the Appellant for the assignment of Starwood’s intellectual property” (para. 43).
Section 182 of the ETA
Finally, Justice MacPhee also briefly addressed the application of section 182 of the ETA. This section generally deems GST/HST to be included in payments received by a registrant following the breach, modification or termination of an agreement for the making of a taxable supply. However, this deeming rule only applies in the case where the payment is made by the recipient to the supplier under the agreement for the making of a taxable supply.
In the case at hand, pursuant to the Agreement, the Appellant was the supplier of the real property and not the recipient. Accordingly, the Settlement Payment made by the Appellant (as the original supplier under the Agreement) did not meet the conditions under section 182 of the ETA (even if such payment was arguably related to a breach of the Agreement) and no GST/HST was deemed to be included in the Settlement Payment.
Key Takeaways
- Taxpayers should be mindful that, where certain rights or property are transferred to a party as a part of a settlement, the legal documentation should include a breakdown of the portion, if any, of the settlement payment that is made in respect of the transfer of property or services, as the case may be.
- This decision also serves as a good reminder of the consequences of not obtaining sufficient documentation to support ITC claims, especially in the context of a settlement.
- Where a settlement payment involves any amount necessary to cover expenses previously incurred by indemnified party, one should determine whether the indemnified party is otherwise able to recover GST/HST payable on such expenses through ITC claims of its own. If so, such taxes should then be excluded from the settlement payment.
- In a context where an indemnifying party is paying the settlement payment (or any portion thereof) to obtain the benefit of any property or service previously acquired by the indemnified party, a “resupply” of such property or service could be envisaged. In this case, any amount payable specifically for such “resupply” (and any applicable GST/HST) should be clearly identified as such.
- In all cases, parties to a settlement agreement must always consider the application of section 182 of the ETA to the settlement payment.
[1] Tax Court decisions issued pursuant to the informal procedure cannot, in theory, be treated as precedents for other cases.
[2] 267 O'Connor Limited v. The King, 2024 TCC 161 (Informal Procedure).
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