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: Whether all the payments in a 5 year lease with an initial payment of $XXXXXXXXXX, 59 payments of $XXXXXXXXXX and a BPO of $XXXXXXXXXX are deductible for tax purposes.
Position: Question of fact.
Reasons: Whether an agreement between two parties constitutes a lease or some other form of financing is a question of fact, which can only be determined by reviewing the terms of the agreement between the parties.
XXXXXXXXXX
August 27, 2012
Attention: XXXXXXXXXX John Parker CMA
2012-043874
Dear XXXXXXXXXX:
Re: Deductibility of Lease Payments
We are writing in response to your query of March 2nd 2012 wherein you asked our opinion as to whether lease payments, in a hypothetical situation, would be deductible for Income Tax purposes, because they are identified as “lease payments” XXXXXXXXXX. Our understanding of the facts is as follows:
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A 60 month lease of a $XXXXXXXXXX item of equipment or tangible personal property.
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The lease agreement calls for a first payment of $XXXXXXXXXX (plus applicable taxes) followed by 59 payments of $XXXXXXXXXX (plus taxes) and a purchase option of $XXXXXXXXXX.
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It is your understanding that the first payment of $XXXXXXXXXX would be deductible for tax purposes along with the remaining 59 payments.
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Some accounting firms do not agree, with you, that the initial lease payment of $XXXXXXXXXX would be deductible for Income Tax purposes XXXXXXXXXX.
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 submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Also, where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. Nonetheless, we are prepared to offer the following general comments.
Whether an agreement between two parties constitutes a lease or a form of sale financing is a question of fact, which can only be determined by reviewing the terms of the agreement. A sale agreement between the parties can contemplate only one owner of the property in question. Thus, whether the transaction is a lease or a sale, only one party is entitled to the capital cost allowance and any related investment tax credits. In addition, if the lessee deducts a lease payment as a current expense, then the lessor would be expected to include the corresponding lease payment into the current taxation year’s income. However, specific provisions of the Act could limit the deductibility of lease payments.
For example, subparagraph 18(9)(a)(ii) of the Income Tax Act (the “Act”) entitled “Limitation respecting prepaid expenses” specifically denies a deduction made in respect of an outlay or expense to the extent that it can reasonably be regarded as having been made or incurred as, or on account of or in lieu of the payment of rent which is in respect of a period that is after the end of the year.
Paragraph 2 of Interpretation Bulletin IT-417R2, entitled “Prepaid Expenses and deferred charges” states: “A prepaid expense occurs where an outlay or expense has been made or incurred by a taxpayer in a particular taxation year and it represents, for example, all or part of the cost of services which will be provided to the taxpayer after the fiscal year end.”
Whether or not an amount is prepaid, within the meaning of subparagraph 18(9)(a)(ii) of the Act, is a question of fact that can only be determined following a careful analysis of the lease agreement, the nature of the subject property, the commercial arrangement and any other relevant factors. Accordingly, we cannot give any specific comments on this particular situation.
If a lease agreement includes a bargain purchase option, it would not necessarily change the nature of the transaction. Some concerns with respect to leases with options were alleviated by the introduction of subsection 13(5.2) of the Act. Subsection 13(5.2) of the Act provides rules for establishing the cost and Undepreciated Capital Cost (UCC) of certain capital properties where a taxpayer, who previously leased a property for the purpose of earning income, later acquires the property for a price less than the fair market value. In these circumstances, subject to certain limitations, the rent is “recaptured” if the property is subsequently sold for a profit. This is achieved by treating the lease payments as previously claimed CCA on the property.
We trust our comments will be of assistance.
Doug Watson
for Director
Financial Industries Division
Income Tax Rulings Directorate
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