As an incentive to improve cash flow, many companies offer early payment discounts to their customers, such as 2/10 net 30 terms (i.e. two percent discount if paid in 10 days, otherwise payment is due in 30 days). Conversely, they may also penalize customers for late payments, such as a 2% penalty if not paid within 30 days. The GST/HST treatment can vary depending on your payment terms.
Early Payment Discount
The CRA states, “where the value of the consideration received for a supply shown on an invoice is reduced if the consideration for the supply is paid within a time period specified on the invoice, the reduction is generally referred to as a ‘discount for early payment’”. Section 161 of the Excise Tax Act provides that the consideration due is deemed to be the amount of the consideration on the invoice which requires payment for the supply, even if there is an offer for discount for early payment. For example, you, the supplier, invoice a customer in Ontario for $100 and on your invoice, it states to take 2 percent off if you pay within 10 days. If your customer takes advantage of the discount, they should pay you $98 plus $13 of GST/HST. The tax, you as the supplier would need to remit is $13, even though your customer took advantage of the discount, as this is the consideration specified on the invoice.
There is an exception to this general rule, where the amount invoiced to the customer is already net of the discount. In this instance, tax is payable on the invoiced amount. For example, you send your customer an invoice with instruction to pay $200 if the payment is made by March 28, or to pay $210 if payment is made after March 28. The GST/HST would be payable on the reduced invoiced amount of $200 even if payment is made after the March 28th due date.
Late Payment Penalties
The CRA states, “a penalty for late payment occurs where a supplier of tangible personal property or services charges the recipient of the supply an additional amount if payment for the supply is not made within a reasonable period of time specified on the invoice.” With regards to late payment penalties, section 161 provides that where consideration is payable on an invoice, and the invoice stipulates an additional amount will be charged (i.e. penalty) if payment is not received within the reasonable period specified, then the consideration due is deemed to be the amount of the consideration for the supply shown on the invoice. Taxes are payable on the value of the consideration on the invoice whether or not the penalty is imposed for late payment. To illustrate, you send your customer an invoice for $1,000, and on the invoice you include the clause, “if payment is not made within 30 days of purchase, 2 per cent of the amount shown on this invoice will be added for each 30 days this invoice is outstanding.” GST/HST will be payable on the $1,000 invoiced, even if the customer paid the supplier 90 days late in an amount totally $1,060.
Again, similar to the early payment discount, there may be situations where an invoice includes an amount to compensate the supplier for payments that are not received on time. GST/HST will be payable on the invoiced amount which includes the penalty, and section 161 of the Act would not apply. Therefore, if you send your customer an original invoice for $300 with notification that this amount includes a $15 penalty, the GST/HST would be payable on $300.
For additional information, you can check out Memorandum GST 300-7-8 Early/Late Payments.
It would be a worthwhile exercise to check your accounting software to ensure it is calculating the GST/HST appropriately if you offer early payment discounts to your customers, or if you charge late payment fees. Talk to your DJB professional if you require assistance setting up either of these payment terms in your software, we can help.
Article written by: Greg Sawatsky, MAcc, CPA, CA