North Shore Power v. R. - TCC: No ITCs on Credit Memos which were held to be “credit notes”

North Shore Power v. R. - TCC:  No ITCs on Credit Memos which were held to be “credit notes”

North Shore Power Group Inc. v. The Queen (January 16, 2017 – 2017 TCC 1, Bocock J.).

Précis:   The taxpayer paid GST in respect of several contracts with a supplier, Menova.  8 of the contracts were completed, the balance were not.  In respect of the uncompleted contracts Menova issued Credit Memos.  Subsequently Menova went bankrupt.  The Minister treated the Credit Memos as “credit notes” for the purposes of section 232 of the Excise Tax Act (“ETA”), with the result that the taxpayer paid $338,412.50 in HST to Menova, but was allowed ITCs of only $78,620.00 relating to the 8 completed contracts and no ITCs for any of the Cancelled Contracts.  The sole issue was whether the disallowed Credit Memos qualified as “credit notes” for the purposes of the ETA.  If so, then the parties were agreed that the taxpayer was not entitled to the ITCs claimed in the appeal.  The Tax Court reviewed the language and policy of the statute and concluded that the Credit Memos were “credit notes” for the purposes of the ETA and dismissed the appeal with costs.

Decision:   The taxpayer had several arguments to the effect that the Credit Memos should not be treated as credit notes for the purposes of the ETA:

[27]         North Shore argues that section 232 does not apply for the following reasons.

a)     the “Credit Memos” are not credit notes per se

[28]        North Shore’s counsel submits that the Credit Memos were not credit notes with the meaning of section 232. Firstly, the description on the document issued is not the same (namely “credit memos”, not “credit note”). Additionally, counsel submits there was no effective guarantee or security issued to ensure payment under the Credit Memos. North Shore’s filing of the First ITC Reversal and the Second ITC Reversal were errors, committed formulaically by an accounting person or bookkeeper, without any focussed deliberation regarding the composite legal requirements within the credit memos needed to give rise to such a reversal of the ITCs claimed.

b)    paragraph 232(1)(a) does not apply to the facts

[29]        Specifically with respect to paragraph 232(1)(a), North Shore’s counsel argues that 232(1)(a) applies solely in the instance where HST is charged, but not collected. In the present appeal, it was both charged and collected. Therefore, there is no basis to any assessment utilizing this paragraph.

c)     paragraph 232(1)(b) may apply, but has not been engaged

[30]        North Shore’s counsel argues that paragraph 232(1)(b), which does apply where the HST was collected, has embedded within it the requirement that there be an actual refund or credit. A mere recording of the credit does not meet the test. Firstly, there was no amount set aside or provision made by Menova, the debtor, under the Credit Memos, to honour the credit. The credit was merely notional and had no value. Further there were no other prospective or subsisting orders against which the credit could be set-off. This further renders the Credit Memos valueless and outside the ambit of the paragraph.

d)    in any event, public policy should override this occurrence to prevent abuse

[31]        North Shore’s counsel contends that if the appeal before the Court is not allowed, that decision will result in easy abuse of the ITC system by unscrupulous suppliers/vendors on the brink of insolvency. The process would be simple. Render invoices for partial payment of product one never intends to supply. Collect the HST as required and pocket it. Issue credit notes on the eve of bankruptcy. The vendor owes nothing to the extent of the credit notes (subsection 231(3)(b)) (in the present case the Credit Memos). There is no loss to the public treasury. The purchaser, who paid the full amount of the HST on product never received is denied the ITCs (231(3)(c)) and cannot claim a bad debt under subsection 231(1). In turn, the purchaser, similar to North Shore, has little recourse against the insolvent supplier who is permitted to issue notional and valueless credit notes to absolve itself of the HST obligation by saddling the purchaser with full HST liability. This abuses the ETA and offends public policy.

The Tax Court did not accept any of these arguments:

a)     decision

[32]        The Court concurs with North Shore’s counsel that subsection 232(1)(a) does not apply. However, the Court dismisses the appeal on the following grounds: the Credit Memos were credit notes within the meaning of subsection 232(1) and related subsections; the actions of North Shore itself were determinative and informative to the Minister’s assessment, and, public policy, while it may be engaged in certain circumstances to invalidate supplier issued credit notes under section 232, is not offended given the facts of the present appeal.

b)    the Credit Memos were credit notes

[33]        North Shore’s suggestion that the use of the name “credit memo” and the non-reference within the documents to subsection 232(3) of the ETA somehow disqualify the Credit Memos as credit notes, is rejected. Firstly, there is no prescribed form or definition for credit notes within the ETA. Secondly, various definitions for credit notes and credit memorandum exist without much variation:

Credit Note: (acknowledging sum credited, e.g. for goods returned);

Credit note: a note given by a store etc. in return for goods returned, stating the value of goods owed to the customer.

Credit memorandum: A document used by a seller to inform a buyer that the buyer’s account receivable is being credited (reduced) because of errors, returns, or allowances.

Credit note: A note issued by a business indicating that a customer is entitled to be credited by the issuer with a certain amount.

[34]        This consistency, but more importantly consistent reference to commercial custom, reflects the incorporation within the ETA of the law merchant and common commercial understanding.

[35]        To add to such common usage of the terms “credit notes” or “credit memoranda”, notions of securitization, collateral, guarantee and specific reference to the ETA within the form of such a document, reads into the ETA a level of complication and intricacy otherwise wisely rejected. In short, the word “credit” is not disjunctive form either “credit note” or “credit memo”, but part of the same instrument widely used and acknowledge between creditors and debtors alike engaged in commerce.

[37]        The Credit Memos were factually sufficient to provide a clear indication of a credit being established in writing to the detriment of Menova and to the benefit of North Shore. To suggest the Credit Memos were ineffective in doing so ignores the referenced authority.

[39]        The foregoing actions undertaken by North Shore, reliant upon the now disavowed Credit Memos, belie the legal and factual position that the Credit Memos were invalid, unenforceable or did not represent a liability of Menova issued under section 232 of the ETA. That reliance informed the very adjustment and reversal to North Shore’s claimed ITCs which it now appeals.

[40]        This reliance by North Shore marches along with the Court’s rejection that public policy is offended in this appeal by the nefarious and sharp behaviour of an impecunious supplier. This rejection is based upon an omnipresent fact. In carrying out steps (i) through (iv) above, North Shore, itself, accepted and acted upon the Credit Memos when issued by Menova and received by North Shore. If it had repudiated, rejected or disavowed the Credit Memos upon receipt, the facts would be different.

[41]        The suggestion that the Credit Memos representing more than $3 million were received and treated by North Shore as business in the normal course seems contrived, forced and inconsistent. Testimony by the President confirmed intense, prolonged and heated discussions were held at the highest levels concerning the Cancelled Contracts, and the moneys paid as Partial Payments to Menova by North Shore. North Shore was alarmed and very unhappy with the Cancelled Contracts and the Credit Memos. However, this reveals it did turn its full attention to the documents. It did not reject, repudiate or contest them. Instead, it added sums to its HST payable by virtue of the First ITC Reversal and, subsequently the Second ITC Reversal. If it had rejected or repudiated the Credit Memos and not filed accordingly, and thereafter, had the Minister assessed and unilaterally reversed the ITCs, the marshalled policy public argument would have some sway.

[42]        As it is, the Minister simply did what North Shore did when it filed. She relied upon on the Credit Memos in assessing North Shore, but she did so only after North Shore had first reviewed, characterized and concluded the Credit Memos were credit notes within the provisions and meaning of subsection 232(1) of the ETA.

[Footnotes omitted]

As a result the appeal was dismissed with costs to the Respondent, subject to the parties have 30 days to make submissions on costs.