I
have been involved in quantifying financial remedies in roughly 50 franchise
rescission cases under the Arthur Wishart
Act and other franchise disclosure acts. One of the most common errors I
have seen in calculations prepared by franchisee counsel relates to the
treatment of GST/HST. This article discusses how these taxes should be treated
in such cases.
(Throughout
the article, for the sake of brevity I will refer to HST only, using the 13%
rate in effect in Ontario; the principles set out here will apply equally to
provinces that have GST).
An Example
Consider
a simple example in which an Ontario franchised business paid a $50,000
franchise fee, purchased $200,000 in equipment and leaseholds from third
parties, did $100,000 in sales, and had expenses of $200,000. Here is how the
rescission remedy would be presented, on both a pre- and post-HST basis:
Which
is the correct figure for the rescission remedy? Is it the $350,000 or the
$389,000? To answer this question, it is necessary to understand how the HST
system works.
Businesses
that are registered to collect HST are required to remit the net HST
they collect. If the HST they paid to other vendors exceeds the amount of HST
they collected, then they are entitled to a refund for the difference.
Returning
to our example, if the franchised business is registered to recover its net HST
paid, then the $39,000 in net HST paid gets refunded back to the business when it
files its HST return, and the true losses are only $350,000, not $389,000.
It
is for this reason that I typically calculate rescission damages on a pre-HST basis.
Some Other Arguments
Is
this issue black-and-white? Or are there some cases in which it might be
appropriate to include the HST paid?
If
the franchised business is HST-exempt, then it cannot recover the HST it has
paid on its expenditures. Examples of HST-exempt businesses that are sometimes
franchised would include child care services, medical services, and (in some
cases) educational services. In those cases, it would certainly be appropriate
to include the HST paid as part of the rescission remedy.
There
may also be semantic arguments to be made. Here is the actual text of
subsections 6(6)(a) to (c) of the AWA:
(b) purchase from the franchisee any inventory that the franchisee had purchased pursuant to the franchise agreement and remaining at the effective date of rescission, at a price equal to the purchase price paid by the franchisee;
(c) purchase from the franchisee any supplies and equipment that the franchisee had purchased pursuant to the franchise agreement, at a price equal to the purchase price paid by the franchisee;
Subsection (a) speaks of the “money received” by the franchisor. When the franchisor is paid a franchise fee or royalty, the amount includes HST. A literal reading of subsection (a) would seem to argue in favour of including the HST paid.
Similarly,
one might argue that the “purchase price paid” for inventory, supplies and
equipment referred to in subsections (b) and (c) might also include HST.
Will
this literal approach result in a windfall to the franchisee? In most cases,
the answer should be “no”. Where a claim is also being made under subsection
(d), then to the extent that the HST paid by the franchisee is being considered
under subsections (a) to (c), it would be appropriate to consider the tax
credit received by the franchisee under the calculation of operating losses.
Thus,
using our example from above, if one includes the $6,500 in HST paid on the
franchise fee as part of the calculation under subsection (a), one would need
to deduct the very same $6,500 from the calculation of operating losses.
Effectively, the final amount calculated would still be a pre- HST amount.
But
what if no claim is being advanced under (d), for whatever reason?[1]
In those cases, a strict reading of the language of the AWA might indeed result in a windfall to the franchisee if they are
granted the post- HST amount under subsections (a) through (c).
