22 February 2005 External T.I. 2004-0109381E5 - Prepaid lease and election under 16.1

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Principal Issues: Is the prepaid portion a blended payment in respect of the year for the purposes of paragraph 16.1(1)(e) of the Act?

Position: No, only the portion of the payment that is in respect of the year.

Reasons: Subsection18 (9) applies, notwithstanding any other provision of the Act.

									2004-010938
XXXXXXXXXX 								C. Tremblay, CMA
(613) 957-2139
February 22, 2005

Dear XXXXXXXXXX:

Re: Leasing Property Rules

This is in reply to your letter of December 23, 2004, requesting our opinion as to whether the entire prepaid amount or only the amount that relates to the year would be deemed to be a blended payment paid or payable for the purposes of and pursuant to paragraph 16.1(1)(e) of the Income Tax Act (the "Act").

You provide the following example:

A Co leases tangible property that is depreciable property, which is not prescribed property as defined in section 8200 of the Income Tax Regulations (the "Regulations") from B Co, a resident of Canada who is not exempt from tax. The lease between A Co and B Co is for 5 years and A Co and B Co elect in prescribed form to have the rules in section 16.1 of the Act apply to the lessee. The annual lease payments are $100 a year. A Co agrees to prepay $200 in year one, which is all amounts owing with respect to the first 2 years associated with the lease.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. However, we are prepared to provide the following general comments, which may be of assistance.

Subsection 18(9) of the Act requires taxpayers to defer and amortize prepaid expenses over the period to which they reasonably relate when computing profit under section 9 of the Act (See Interpretation Bulletin IT-417R2 for further information on prepaid expenses). Generally the Canada Revenue Agency requires that expenses be matched to the taxation year to which they can reasonably be considered to relate. Subsection 18(9) of the Act provides that, notwithstanding any other provision of the Income Tax Act, in calculating a taxpayer's income for a taxation year from a business or property a deduction is denied for certain outlays or expenses.

Paragraph 16.1(1)(e) of the Act states:

"...all amounts paid or payable by or on behalf of the lessee for the use of, or the right to use, the property in the year shall be deemed to be blended payments, paid or payable by the lessee, of principal and interest on the borrowed money outstanding from time to time, calculated in accordance with paragraph (d), applied firstly on account of interest on principal, secondly on account of interest on unpaid interest and thirdly on account of unpaid principal, if any, and the amount, if any, by which any such payment exceeds the total of those amounts shall be deemed to be paid or payable on account of interest, and any amount deemed by reason of this paragraph to be a payment of interest shall be deemed to have been an amount paid or payable, as the case may be, pursuant to a legal obligation to pay interest in respect of the year on the borrowed money;..." (emphasis added)

In our view, the amounts paid for the use of, or the right to use, the property in the year, with respect to your example, refer to the portion that applies to the relevant taxation year. Accordingly, in our view, only the portion that is in respect of year one would be deemed to be a blended payment paid or payable for the purposes of paragraph 16.1(1)(e) of the Act.

We trust the above comments are of assistance.

Yours truly,

Steve Tevlin
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Planning Branch