Claiming GST/HST on Bad Debts
Canada Revenue Agency (CRA) is challenging taxpayers regarding recovering the HST component of their bad debts. The technical requirement to claim a bad debt write-off and recover the related HST requires the company to establish both the consideration and the tax are a bad debt. The aspect of this requirement that has been challenged by CRA is with respect to what constitutes the bad debt being ‘established’ and is requiring the company to have a documented attempted proof of collection.
It is important to maintain documentation of the collection attempts made by the company to support that there is an established bad debt (see commentary below). These collections efforts may include a record of calls made, statements sent or collections e-mails and may also include legal action taken. The current interpretation of the bad debt being ‘established’ has resulted in some cases where CRA has challenged whether steps were taken to establish a bad debt where a company has received information that its customer is insolvent or filing for bankruptcy.
In case 2016 GTC 22 L’Univers Gym Fitness Inc. v. Her Majesty the Queen, the taxpayer’s appeal related to recovering HST on bad debts was dismissed. Specifically, the court held that “in order to justify a finding that any amount owing to a supplier has become a “bad debt” under subsection 231(1), the court must find that the supplier has taken reasonable measures to effect its collection (see Ministic Air Ltd. v. R., 2008 GTC 589). The taxpayer in the present proceedings failed to show that it had taken such measures…”
Subsection 231 (1) of the Excise Tax Act regarding bad debt – deduction from net tax indicates “If a supplier has made a taxable supply (other than a zero-rated supply) for consideration to a recipient with whom the supplier was dealing at arm’s length, it is established that all or a part of the total of the consideration and tax payable in respect of the supply has become a bad debt and the supplier at any time writes off the bad debt in the supplier’s books of account, the reporting entity for the supply may, in determining the reporting entity’s net tax for the reporting period that includes that time or for a subsequent reporting period, deduct the amount determined by the formula.” As a result, a vendor that has recorded the bad debt is able to claim a recovery for the ratio of the GST/HST on the bad debt that was written off once the vendor has established the consideration for the sale and the related GST/HST to be a bad debt, either in full or in part.
To avoid instances where CRA has room to challenge the validity of your evidentiary documentation and possibly deny the GST/HST being recovered on bad debts, documentation should be maintained to support the establishment of bad debts.