Ryan Tax Review

Is it a credit note if it has no value?

When taxpayers disagree with an assessment by the Canada Revenue Agency, it often provides an opportunity for the courts to look at a situation that may not be specifically addressed in the legislation. North Shore Power Group v. R.1 is one such case. What might seem, in principle, to be a simple matter, can turn out to be not so simple, including determining whether a “credit memo” constitutes a credit note. What also makes this case interesting is that the original decision was overturned on appeal, suggesting that the courts also struggled, to some extent, in resolving the disagreement.


North Shore Power Group Inc. (North Shore) entered into eighteen contracts with Menova Energy Inc. (Menova) for the purchase and installation of solar panels. Half of the contract fees, plus HST, were paid on signing the contracts. At that time, North Shore considered this to be a partial payment and claimed an input tax credit (ITC) for the HST on each payment. Menova only completed eight of the eighteen contracts and subsequently issued credit memos for the portion of the contracts that it would not be able to complete. Consequently, North Shore recorded the HST shown on the credit memos as adjustments under section 232 of the Excise Tax Act (ETA), in essence reversing a portion of the ITCs claimed. Shortly thereafter, Menova was forced into bankruptcy and never refunded North Shore for the part of the initial payments that was included in the credit memos. As a result, a number of months later, North Shore reversed the tax adjustments related to the amount never refunded and effectively “reclaimed” the ITCs, on the basis that the uncollected credit memo amounts were, in fact, a bad debt. 

The Minister denied North Shore’s ITC adjustments in assessing net tax for the relevant periods, and the Tax Court of Canada (TCC) dismissed North Shore’s appeal of that assessment. North Shore then appealed to the Federal Court of Appeal (FCA).


The outcome of the appeal at the TCC hinged on three specific sections of the ETA. 

The first issue was whether the payment made by North Shore to Menova was a partial payment or a deposit. Section 168 of the ETA reads: 

168(1) General rule — Tax under this Division in respect of a taxable supply is payable by the recipient on the earlier of the day the consideration for the supply is paid and the day the consideration for the supply becomes due.

(2) Partial consideration — Notwithstanding subsection (1), where consideration for a taxable supply is paid or becomes due on more than one day,

(a) tax under this Division in respect of the supply is payable on each day that is the earlier of the day a part of the consideration is paid and the day that part becomes due; and

(b) the tax that is payable on each such day shall be calculated on the value of the part of the consideration that is paid or becomes due, as the case may be, on that day…

(9) Deposits — For the purposes of this section, a deposit (other than a deposit in respect of a covering or container in respect of which section 137 applies), whether refundable or not, given in respect of a supply shall not be considered as consideration paid for the supply unless and until the supplier applies the deposit as consideration for the supply.

The second issue addressed by the TCC was whether North Shore could claim a bad debt adjustment under section 231 of the ETA.  Under this section, an organization can recover the portion of the GST/HST remitted that relates to an uncollectable receivable that has been written off. 

231(1) Bad debt—deduction from net tax — 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

A × B/C


A is the tax in respect of the supply;

B is the total of the consideration, tax and applicable provincial tax remaining unpaid in respect of the supply that was written off at that time as a bad debt; and

C is the total of the consideration, tax and applicable provincial tax in respect of the supply.

The final issue that the TCC addressed involved section 232 of the ETA, which allows a supplier to credit GST/HST back to its customer.  North Shore argued that this section did not apply. 

232(1) Refund or adjustment of [overcharged] tax — Where a particular person has charged to, or collected from, another person an amount as or on account of tax under Division II in excess of the tax under that Division that was collectible by the particular person from the other person, the particular person may, within two years after the day the amount was so charged or collected,

(a) where the excess amount was charged but not collected, adjust the amount of tax charged; and

(b) where the excess amount was collected, refund or credit the excess amount to that other person.


(2) Adjustment [reduction of consideration] — Where a particular person has charged to, or collected from, another person tax under Division II calculated on the consideration or a part thereof for a supply and, for any reason, the consideration or part is subsequently reduced, the particular person may, in or within four years after the end of the reporting period of the particular person in which the consideration was so reduced,

(a) where tax calculated on the consideration or part was charged but not collected, adjust the amount of tax charged by subtracting the portion of the tax that was calculated on the amount by which the consideration or part was so reduced; and

(b) where the tax calculated on the consideration or part was collected, refund or credit to that other person the portion of the tax that was calculated on the amount by which the consideration or part was so reduced.

(3) Credit or debit notes — Where a particular person adjusts, refunds or credits an amount in favour of, or to, another person in accordance with subsection (1) or (2), the following rules apply:

(a) the particular person shall, within a reasonable time, issue to the other person a credit note, containing prescribed information, for the amount of the adjustment, refund or credit, unless the other person issues a debit note, containing prescribed information, for the amount;

(b) the amount may be deducted in determining the net tax of the particular person for the reporting period of the particular person in which the credit note is issued to the other person or the debit note is received by the particular person, to the extent that the amount has been included in determining the net tax for the reporting period or a preceding reporting period of the particular person;

(c) the amount shall be added in determining the net tax of the other person for the reporting period of the other person in which the debit note is issued to the particular person or the credit note is received by the other person, to the extent that the amount has been included in determining an input tax credit claimed by the other person in a return filed for a preceding reporting period of the other person; …


Deposits and Prepayments

It is important to distinguish amounts paid as deposits from prepayments. Prepayments or down-payments are considered part of the consideration for a supply and, as such, are subject to GST/HST at that time. However, where a deposit is given in respect of a supply, the deposit is generally not regarded as consideration for the supply unless and until the supplier applies the deposit against an amount payable for that supply. It is only at that time that tax becomes payable on the amount placed as a deposit, and not when the deposit is initially paid. 

In this case, both parties considered the payments in question to be prepayments rather than deposits, although the contracts used the term “deposit” to describe the amounts. However, one must sometimes look beyond the wording of a contract to determine the true nature of a transaction.

The TCC determined that the “deposit” was, in fact, a partial payment meant to fund the large costs associated with the solar panels. Without this view by the TCC, the legislative analysis would have likely ended here. If the TCC had determined that the payments were deposits, then North Shore would not have been able to claim an ITC on the original payment. However, in that situation, North Shore should not have paid HST in the first place and might have been eligible for a rebate for tax paid in error, subject to the audit to net tax requirements in the ETA.

Bad Debt

Generally, a bad debt is considered to be written off when the debt has been closed and removed from a person’s accounts receivable. The following conditions must be met before bad debt relief under section 231 is available:

  • the supply by the person was taxable and not zero-rated;
  • the supply was made for consideration;
  • the supply was made to a recipient (i.e., the person contractually liable to pay for the supply);
  • the supplier and the recipient were dealing at arm’s length;
  • there is a reporting entity, normally the supplier, who is responsible for reporting and remitting the tax on the supply;
  • all or part of the total consideration and tax payable has become a bad debt;
  • the supplier writes off the bad debt in the supplier’s records for accounting purposes;
  • all the tax was reported and remitted; and
  • the deduction from net tax (i.e., tax relief) is claimed within four years from the due date of the supplier’s return for the period in which the bad debt was written off.

The provision for bad debt relief is based on a taxable supply having been made by a supplier for consideration which was not ultimately collected. The TCC determined that North Shore was not a supplier in this case, nor did it make a taxable supply to Menova. North Shore was the recipient of a taxable supply in this situation; Menova was the supplier. While it appears that, technically, bad debt relief is not available to North Shore, which was the finding of the TCC, it seems unfair that no relief would be available to a recipient in these circumstances. On the other hand, extending section 231 to cover North Shore’s situation might make bad debt relief too broad, covering almost any uncollected amount that includes tax, rather than just traditional bad debt scenarios.

Adjustments for Credit Memos

The TCC felt that North Shore’s last chance for success in this case would be for section 232 to not apply to the credit memos issued by Menova. North Shore’s counsel argued that this section did not apply to its client’s situation for the following reasons:

  • the document received from Menova was entitled “credit memo” and not “credit note”;
  • paragraph 232(1)(a) did not apply, as HST was charged and collected, and this paragraph refers to when HST is charged but not collected;
  • paragraph 232(1)(b) did not apply, as Menova did not actually provide a refund or credit to North Shore that could be applied towards another supply; and
  • if North Shore was denied ITCs in this scenario, suppliers on the verge of bankruptcy could potentially benefit from this decision by issuing credit notes that they have no intention of honoring.

The intent of section 232 is to provide a mechanism under which a supplier can credit GST/HST back to a recipient when warranted. While the TCC agreed that subsection 232(1) did not apply, it determined that the “credit memos” were the equivalent of “credit notes” as per subsection 232(3) of the ETA; while the terminology may have been different, the intent was still the same. In fact, by its own actions, North Shore had accepted the credit notes originally, as evidenced by having recorded them in its books and records and accounting for the requisite tax adjustment. One of the issues with its position was North Shore’s inconsistent treatment of the credit notes, first accepting them and adjusting for the HST, and only afterwards reversing them.

The TCC decision, while following the letter of the law, left North Shore in a position which hardly seems equitable. Through the bankruptcy of Menova, North Shore found itself not only losing the money it prepaid, but also the ability to recover the tax portion of that payment.


On appeal, the FCA determined that the TCC got it wrong when it concluded that the term “credit” in subsection 232(1) obtained its meaning from the commercial terms “credit note” and “credit memorandum”. The FCA noted that these terms are not found in this subsection of the legislation. In fact, the term “credit note” is only used in subsection 232(3), which prescribes the documentation required when a supplier chooses to issue an adjustment or refund the tax under subsection 232(1) or (2).

The FCA focused on the meaning of the word “credit” and, although a broad interpretation is often preferred when reading tax legislation, it determined that, in this case, a narrower interpretation was more appropriate. The FCA felt that:

“… the term “credit” in section 232 should have the meaning from Le Petit Robert,2 above: an operation by which a sum is put at the disposal of someone else. I do not suggest that money must actually be set aside, but it is not sufficient if there is no sum at the disposal of the purchaser.” 

The FCA concluded that, because Menova had not made funds available to North Shore when it issued the credit note, the tax was not credited. It recognized that the credit memos issued by Menova to North Shore had no value.

Interestingly, the FCA also noted that, while subsection 231(1) of the ETA provides relief to a supplier for uncollectable receivables, there is no corresponding relief for customers when a credit issued under section 232 becomes a bad debt. 

From the perspective of North Shore, the FCA decision seems appropriate. However, this decision could pose questions for taxpayers regarding the requirement to adjust for GST/HST on credit notes if there is any doubt that the credit note will be honoured by the supplier.

When laws are written, it is impossible to foresee every situation. The ETA is often like a ship on the ocean, moving with the tides. When situations arise that are not specifically addressed in the legislation, the courts are often required to decide the issue. The FCA’s decision in this case should assist in providing relief to purchasers when credit notes have gone bad. However, it could also lead to adverse results in other situations which have not yet been seen. In the future, we may be reading about a court case involving a purchaser that failed to adjust for the GST/HST on a credit note because it believed the credit had no value at the relevant time, due to the potential bankruptcy of the supplier. Only time will tell.

Irene Belvedere
Manager, Client Support Services

1North Shore Power Group Inc. v. R., 2018 FCA 9.

2 As quoted by the FCA from La Compagnie Minère Québec Cartier v. M.N.R., 84 D.T.C. 8.