- In Automodular Corporation General Motors of Canada Limited, 2018 ONSC 1640, the Ontario Superior Court of Justice dismissed Automodular Corp.’s motion to add HST (13% in Ontario) to an agreed lump-sum settlement amount to take into account the application of section 182 of the Excise Tax Act (“ETA”).
- Section 182 ETA generally deems amounts paid in settlement of a breach of contract to include GST or HST (to the extent that the breached contract was for the making of a taxable supply and the consideration for such supply would have been subject to tax).
- The settlement agreement did not refer to the HST. In particular, it did not stipulate that the agreed lump-sum payment was to be grossed up to take into account the application of section 182 ETA.
- In his March 21, 2018 ruling, Justice Dunphy refused to imply a term into the settlement agreement stipulating that HST would be added to the specified lump-sum settlement amount.
- The lesson is that, because it did not take section 182 ETA into account before committing to the settlement agreement, Automodular ended up with a smaller settlement than it had expected, since the HST that it was deemed to have collected (and which it then had to remit to the Government) was included in the $7 million lump sum.
Automodular had been in a contractual relationship with General Motors of Canada Ltd. and General Motors Co. (the “Defendants”) for several years. The company was a sub-assembler of certain modules installed in automobiles, manufactured by the Defendants. The services it provided constituted a taxable supply on which HST applied in accordance with the ETA.
In April 2010, the Defendants decided to terminate the contractual relationship with Automodular, which then filed a statement of claim asking the Court to award damages on various grounds, including breach of contract. The loss of the contract had long-lasting repercussions for Automodular, which consequently wound down its operations. Its ongoing claim against the Defendants was its principal remaining asset.
As the trial (anticipated to take 14 days) was approaching, the parties finally negotiated an all-inclusive $7 million lump-sum settlement that did not mention HST. Ten days later, the Defendants sent Minutes of Settlement to Automodular, still with no reference to HST. However, at that point, Automodular responded that, as per its tax advisors’ advice, the payment of the settlement should be grossed up to take into account the HST. The Defendants would not agree to this.
The parties agreed that a valid and binding settlement was entered into. However, the issue in regards to the amount that the Defendants would be required to pay – $7 million or the same amount grossed up to include HST – was never resolved, bringing the claim to the Superior Court of Justice.
It might first be noted that, when viewed separately, the settled claims included a number of matters that would not have been subject to HST, given that the issues did not qualify as a taxable supply. However, in the motion as argued, there was no dispute between the parties that HST would be applicable pursuant to section 182 ETA.
Section 182 ETA essentially provides that where at any time, as a consequence of the breach, modification or termination of an agreement for the making of a taxable supply of property or a service in Canada by a registrant to a person, an amount is paid to the registrant otherwise than as consideration for the supply (or a debt or other obligation of the registrant is reduced or extinguished without payment on account of the debt or obligation), the person is deemed to have paid, at that time, an amount of consideration for the supply equal to 100/105 of the amount paid or forfeited (or 100/113 in Ontario where the HST rate is 13%).
In the case at hand, the settlement amount was directly being paid as a consequence of the breach of the original agreement between Automodular and the Defendants. The Court was therefore required to establish whether the parties intended that the $7 million:
- Was in settlement of all claims; or
- Was itself to be subject to the requirement to pay an additional amount as HST.
In the Court’s view, there was no question that Automodular, a sophisticated party represented by sophisticated counsel, simply failed to consider the implication of section 182 ETA “until after the fact”. The Court was therefore required to determine whether to imply a contractual term to the settlement agreement by applying well-established contract law principles (a settlement agreement is a contract like any other). According to Justice Dunphy, contractual terms may be implied only where they are demonstrably necessary to give commercial efficacy to the agreement reached, reflect a mutual understanding so evident as to have been left unexpressed. In this particular case, the language used in the settlement agreement was in no way ambiguous and in line with the language used in other settlements that do not contain a provision specifically relating to HST.
In these circumstances, the settlement agreement was simple and provided for a lump-sum amount without any allocation among the numerous claims advanced in the underlying statement of claim. As evidenced in the language of the relevant provisions, Automodular had agreed to a sum that it was prepared to accept without allocating the amount in any particular way. The Court was of the opinion that it would therefore be inappropriate to imply a term to the settlement agreement because doing so would be the equivalent of imposing an arrangement different from the one the parties had originally reached.
- Other court decisions (Re Ravelston Corp., 2006 CarswellOnt 5697,  O.J. No. 3764, and Re TravelBrands Inc., 2017 ONSC 3161) regarding the application of section 182 ETA were distinguished by the Court. In those cases, a failure to imply a term (of the same type as was under consideration here) would have thwarted the expectations that had been shared by both parties to the contract. In contrast, in the case at hand “[t]here is no provision of the agreement whose operation assumed a certain state of affairs in relation to HST that would be frustrated”. (para. 34)
- Parties should consider all of the aspects and ramifications of a settlement agreement, including the application of sales taxes, before committing to it.
- Tax advisors should review all draft settlement agreements to ensure that sales tax implications are properly taken into account from a contractual standpoint.