Canada: GST/HST Credit Notes Are Not Effective Until Payment Is Made: FCA Rules On Insolvent Supplier's Unfulfilled Commitment To Reimburse Customer

  • On January 12, 2018, the Federal Court of Appeal ("FCA") delivered its judgment in North Shore Power Group Inc. v. Canada, 2018 FCA 9, an appeal from the Tax Court of Canada concerning HST reassessments under section 232 of the Excise Tax Act ("ETA").
  • Section 232 ETA provides that a supplier of goods or services, at its option, can adjust, refund or credit GST/HST to a recipient, if such tax had been overcharged of if the relevant consideration has been reduced. When triggered, section 232 ETA requires that consequential adjustments be made to each of the parties' net tax calculations.
  • In the case at hand, the tax authorities reassessed North Shore by adding the amount of the HST that had been "credited" by a supplier to its net tax even though, due to the supplier's insolvency, it had not subsequently been paid.
  • The central issue of the appeal was the scope of the term "credit" and its meaning for the purpose of section 232 ETA. Allowing North Shore's appeal, the FCA overturned the reassessments (which had been upheld by the Tax Court).


North Shore Power Group ("North Shore") is in the business of renewable energy projects and had been in a contractual relationship with Menova Energy Inc. ("Menova"), a supplier of solar panels and related services. Pursuant to the contracts, North Shore had the obligation to pay half of the purchase price (including HST) immediately, with the balance payable upon final delivery.

Unfortunately, Menova was unable to fulfill its half of the bargain and cancelled certain of its contracts with North Shore, subsequently becoming insolvent. In light of the large sum that North Shore had paid, Menova issued documentation to North Shore, referred to as "credit memos", to confirm its obligation to refund the money it had received for services and goods never provided, including the HST. Despite these good intentions, Menova's insolvency and subsequent bankruptcy meant that, in reality, North Shore was able to recover only a small fraction of the amounts owing under the credit memos, including the HST.

One detail that should be mentioned – and to which we will return below – is North Shore's inconsistent treatment of Menova's credit memos in its HST returns for the relevant period. At first, North Shore added the HST to be refunded pursuant to the credit memos, in accordance with section 232 ETA, but in later reporting periods it stopped doing so.

Upon reassessment, the tax authorities reincluded in North Shore's net tax the amount of HST to be refunded according to the credit memos. North Shore took the issue to the Tax Court, which concluded that the reassessment was appropriate. An appeal to the Federal Court of Appeal followed.


Under the ETA, a supplier may adjust, refund or credit GST/HST in two specific situations:

  • If the tax was overcharged, under subsection 232(1) ETA; or
  • If there is a reduction in consideration, under subsection 232(2) ETA.

Subsection 232(3) ETA then comes into play, with the result that the supplier is required to issue documentation to the recipient, referred to in the ETA as a "credit note" (unless, as an alternative, the supplier receives a "debit note" from the recipient). Generally speaking, this mechanism allows a supplier to deduct the adjustment, refund or credit from its net tax, provided that the supplier had previously included this amount in its net tax. Also, the recipient will be required to add the adjustment, refund or credit to its net tax, provided that such amount had previously been deducted in its net tax as an input tax credit.

By issuing the "credit memos" to North Shore, Menova was effectively giving formal notification of the cancelled contracts and agreeing to refund the associated payments, including HST. The FCA was therefore required to establish the proper meaning and scope of the term "credit" for the purposes of section 232 ETA, and whether an agreement to refund tax (i.e., the credit memos) is a "credit" within this meaning. The FCA decided to apply a textual, contextual and purposive interpretation to the term, one that would be harmonious with the scheme provided for in the ETA – a piece of legislation that imposes an obligation on all suppliers to collect tax on behalf of the government.

The FCA's Ruling

The FCA held that, if the funds in question were never actually going to be transferred, it would make no sense to interpret the ETA as allowing Menova to deduct the amount from its net tax while requiring North Shore to add the same amount to its net tax. The HST is a tax that is generally intended to be borne by consumers, and suppliers like Menova generally act as a "pass-through entity" who will not usually bear the ultimate tax burden. Regardless of a supplier's financial position, there is no reason to interpret section 232 ETA in a way that would allow for this scenario to occur. This analysis ultimately lead the FCA to interpret the term "credit" in section 232 ETA in accordance with its ordinary meaning of "an operation by which a sum is put at the disposal of someone". In the case at hand, the HST that Menova was supposed to refund in accordance with the credit memos had never actually come to be "at the disposal of" North Shore.

Interestingly, North Shore argued at the Tax Court level that Menova likely issued the credit memos with the ulterior motive of reducing its directors' potential personal HST liabilities. However – to return to the "detail" mentioned above – the Tax Court seized on the fact that North Shore had initially added the yet-to-be-refunded HST to its net tax (in accordance with the credit memos) as precluding it from relying on this "public policy argument".

Key Takeaways

  • The FCA decision protects recipients from insolvent suppliers who issue credit notes while knowing that the relevant tax will never actually be at the disposal of such recipients.
  • As the FCA also rightly pointed out when considering the legislative scheme in analogous situations, although there is a "bad debt" relief for suppliers for tax collectible that is never collected, "there is no such relief provided for credit in section 232 which becomes bad debt." (para. 41)
  • Based on this decision, a recipient should always make sure that it actually receives the full economic benefit of the GST/HST that is "credited" by a supplier through the credit note mechanism before it adds back such GST/HST to "net tax" and remits it to the tax authorities.

The author would like to thank Chelsea Pellegrino for her helpful collaboration to this article.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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