17 June 2021 Internal T.I. 2020-0872751I7 - CERS - Net Lease to a Non-Arm's Length Party

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 operating expenses paid under a net lease to an arm's length third party would be a “qualifying rent expense” if the rent is paid to a non-arm's length party.

Position: No.

Reasons: Amounts paid as rent between parties not dealing at arm's length are not QREs.

Mr. David Gagné-Therrien
Dedicated Telephone Service
Canada Revenue Agency					Matthew Ross, CPA, CA
(902) 399-8396
								2020-087275

June 17, 2021

Dear Mr. Gagné-Therrien:

Re: Net lease between non-arm’s length parties

We are writing in response to your question concerning whether certain expenses paid by a tenant to an arm’s length third party would meet the definition of “qualifying rent expense” for the purposes of the Canada Emergency Rent Subsidy (“CERS”) where the tenant’s lease is with a non-arm’s length lessor.

Qualifying rent expense, in respect of a qualifying property, for an eligible entity for a qualifying period, is defined in subsection 125.7(1) of the Income Tax Act (“the Act”) to mean the total of certain amounts paid – under a written agreement entered into before October 9, 2020, or pursuant to the renewal (on substantially similar terms) or assignment of a written agreement entered into before October 9, 2020 – in respect of the qualifying period by the eligible entity to a party with which the eligible entity deals at arm’s length.

Whether parties deal at arm’s length is a question of fact and law.

Paragraph (a) of the definition of qualifying rent expense allows, for a tenant, an amount paid (or payable in certain circumstances) where the amount is rent for the use of, or right to use, the qualifying property, including, among other things, and subject to the exclusions listed in subparagraph (a)(ii),

• gross rent,
• rent based on a percentage of sales, profit or a similar criterion,
• amounts required to be paid under a net lease by the eligible entity either to the lessor or a third party, as

o base rent,
o regular instalments of operating expenses, such as insurance, utilities and common area maintenance expenses, customarily charged to the lessee under a net lease,
o property and similar taxes, including school and municipal taxes, and
o regular instalments of other amounts payable to the lessor for services ancillary to the rental of real or immovable properties and customarily supplied or rendered in connection with the rental of real or immovable properties.

In the case of qualifying property owned by an eligible entity that is not used primarily to earn rental income (or, where the qualifying property is used primarily by the eligible entity to earn rental income directly or indirectly from a person or partnership not dealing at arm’s length with the eligible entity, that is not used by that non-arm’s length person or partnership primarily to earn rental income), paragraph (b) of the definition provides that qualifying rent expense is an amount paid for:

• interest on a debt obligation secured by a mortgage or hypothec on the qualifying property (subject to limits),
• insurance on the qualifying property,
• property and similar taxes on the qualifying property, including school and municipal taxes.

According to the definition of qualifying rent expense in subsection 125.7(1) of the Act, where a tenant has a lease other than a net lease, only the gross rent or rent based on a percentage of sales, profit or a similar criterion paid by the tenant may be a qualifying rent expense, provided such rent is paid to a party with which the tenant deals at arm’s length.

Where a tenant has a net lease, the definition provides that additional amounts required to be paid under the net lease by the tenant (either to the lessor or a third party) may be a qualifying rent expense. However, these additional amounts must be considered to be part of the tenant’s rent for the use of, or right to use, the qualifying property.

As these amounts constitute part of the tenant’s rent, in our view, where a tenant’s net lease is with a non-arm’s length lessor, any amount required to be paid under the net lease by the tenant to an arm’s length third party is treated in the same manner as amounts paid directly to the non-arm’s length lessor. Accordingly, such amounts will not be considered qualifying rent expenses.

We trust our comments will be of assistance.

Yours truly,

Amanda Couvrette, CPA, CA
Acting Manager
Business Income and Capital Transactions
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch