If you own or manage a business, you occasionally end up in disputes with customers or suppliers over the terms of a contract or payment. Sometimes these disputes have to be referred to lawyers, and sometimes they end up in court.
Regardless of how far the dispute goes until it’s settled, are you aware of the GST of HST consequences of any settlement or damage award? Your lawyer might not be aware of this issue.
A settlement or award for breach of contract will normally be considered tax-included if the following conditions are met:
- The payment is made by the “recipient” to the “supplier” rather than the other way round. That is, it is the purchaser, lessee or customer who is making the payment, and the vendor, lessor or supplier who is receiving it. (In other words, money is flowing in the same direction as it would have flowed under the contract.)
- The payment is for breach, termination or modification of a contract or agreement. (It need not be a written contract; an oral agreement to buy or lease property, or to provide services, is still a contract.)
- GST or HST was payable, or would have been payable, under the contract, if it had been fulfilled as planned.
In these circumstances, any settlement amount is normally deemed by the Excise Tax Act to be a total that already includes GST or HST.
The supplier (vendor, lessor) must carve out a fraction of the total and remit it to the Canada Revenue Agency as GST or HST. The fraction depends on the province. In Ontario (where the HST rate is 13%), the fraction is 13/113ths, or just over 11.5%. In the Atlantic provinces (15% HST rate), the fraction is 15/115ths. In non-HST provinces (5% GST rate), the fraction is 5/105ths. In Quebec, the Quebec Sales Tax (QST) is treated the same way.
The recipient (purchaser, lessee) can claim an input tax credit and recover the same amount from the CRA, if the recipient would have been able to claim the credit had the money been paid under the contract.
The same rule applies to an amount that is kept as a forfeited deposit.
Landlord leases office space in Ontario to Tenant for $5,000 per month plus 13% HST, under a one year lease. Six months into the lease, Tenant wishes to cancel. After some discussions, Landlord agrees to accept a one-time payment of $10,000 to release Tenant from the lease.
Landlord must treat the amount received as HST-included. If Landlord accepts $10,000, it must calculate 13/113ths of this amount or $1,150.44 and remit this amount to the CRA as HST collected. In other words, Landlord has really settled for $8,849.56 plus 13% HST of $1,150.44.
Similarly, Tenant is paying $8,849.56 plus HST of $1,150.44. If Tenant is a normal business that can claim input tax credits for HST that it pays, Tenant can recover the $1,150.44 as a refund when filing its next HST return — which may be something of a windfall if Tenant made the deal without expecting this. This is so even if the settlement agreement does not mention the HST.
If Landlord really wants to settle for $10,000, Landlord should add 13% for HST and settle for $11,300. Then Landlord keeps $10,000 and sends $1,300 (13/113ths of the $11,300) to the government as HST, and Tenant (if a business) can claim the same $1,300 as an input tax credit.
B (a builder) builds a new home for sale in Edmonton. P (the purchaser) offers $300,000 for the home, putting down a $10,000 deposit. P then changes his mind and walks away from the deal, forfeiting the deposit. B decides not to sue and just keeps the $10,000.
B does not really get to keep $10,000. The $10,000 is considered to be GST-included. The GST is calculated as 5/105 of this amount, or $476.19. Thus, B really gets $9,523.81 plus 5% GST of $476.19, and must remit the GST to the government.
This may come as a shock to B. B should not have accepted the $10,000 deposit unless B was aware that it was really only a deposit of $9,523.81 plus GST.
(Note that in this case the deposit includes the full 5% GST even though, if the home sale had been completed, 1.8 percentage points of that 5% would have been refunded to P via the new housing rebate.)
The moral of the story: whenever you settle a commercial dispute, whether by litigation or otherwise, make sure to “gross up” (increase) the settlement amount by the appropriate GST, HST and/or QST, so that the tax is available to be remitted to the government without eating into the amount of the settlement.
Note that these rules do not apply to payments by a supplier — e.g. payment by a landlord to cancel a tenant’s lease early. They also do not apply to payments that are not related to a contract — for example, payments for damage caused by negligence, such as where someone with whom you have no contractual relationship damages your business’s property.
If your dispute is being handled by a lawyer, do not assume that your lawyer is taking care of this issue.