Please note that the following document, although correct at the time of issue, may not represent the current position of the Canada Revenue Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence du revenu du Canada.
DATE: July 25, 2014
FROM:
William Parker
Senior Rulings Officer
Special Provisions - FI Unit
Excise and GST/HST Rulings Directorate
Place de Ville, Tower A
320 Queen Street
Ottawa ON
K1A 0L5
TO:
[Addressee]
Case Number: 158278
SUBJECT: GST/HST INTERPRETATION
Election under section 167 - Eligibility when real property is leased
It is our understanding that […] (the Franchisor) has filed a Notice of Objection with respect to a Notice of Assessment amount of $[…] for the supply of [#] franchises, between [mm/dd] and [mm/dd], [yyyy], [#] of which were corporate stores, the other [#] had not been operated as corporate stores prior to the sale. You have asked […], whether the parties are eligible to use the election under section 167 of the Excise Tax Act specifically in one of the […] situations, details of which are described below.
Background and Facts
The registrant Franchisor has entered into a franchise agreement dated [mm/dd/yyyy] (the Franchise Agreement) with a […][corporation], (the Franchisee) also a GST/HST registrant. In the recitals to the Franchise Agreement, […][ABC] grants “…to the Franchisor the right and license to use and license others to use…” certain proprietary marks that it owns, including “[…][the franchise name]”, in the operation of [the] […] franchises.
The Franchise Agreement
Under the Franchise Agreement the Franchisor grants to the Franchisee, the right and licence to operate the Franchise Business only at the specific Franchisor-approved location described in the Site Selection Addendum attached […] to the Franchise Agreement. The term of the Franchise Agreement is for a period of [#] years or the term of the lease, unless otherwise terminated. According to the Franchise Agreement, the Franchisor is to provide to the Franchisee the right and licence to use the proprietary marks, assistance in obtaining an approved location, initial training including the services of one experienced employee. In addition, the Franchisor will provide additional training at cost of the Franchisee, loan of manuals, assistance with hiring employees and setting up an opening inventory, bookkeeping and general operating procedures. The manuals remain the property of the Franchisor and upon expiration or termination of the Franchise Agreement, the Franchisee is to return them to the Franchisor. Goodwill inures to the benefit of the Franchisor and is the property of the Franchisor such that upon termination or expiration of the Franchise Agreement, no monetary amount is attributable to goodwill. As consideration for the rights granted under the Franchise Agreement, the agreement requires an initial franchise fee of $[…] and royalty fees of […]% of gross sales.
Under Article […] of the Franchise Agreement, […], the Franchisor, following the later of the execution of the agreement or the selection of a mutually acceptable location, is to execute a lease for the location upon terms and conditions acceptable to Franchisor. The Franchisee is to execute and deliver an agreement of sublease for the approved location in the form attached as […] to the Franchise Agreement. Upon the request of the Franchisor, or any landlord, of the approved location, the Franchisee is to execute an agreement directly in favour of such landlord, agreeing to be bound by and to observe the terms and conditions of the lease. The Franchisee guarantees in favour of the Franchisor, and/or any landlord, of the approved location, against any losses, damages or expenses under the terms of the lease or other instrument (including the sublease).
Under the same Article, […], the Franchisor shall have the plans and specifications prepared for the Franchised Business and cause the Franchised Business to be constructed, decorated, outfitted with the required fixtures, furnishings, equipment, signs, accessories, supplies and other items as may be necessary in the Franchisor’s opinion to permit the Franchisee to commence the operation of the Franchise Business. This is supplied to the Franchisee from the Franchisor for costs and expenses incurred by the Franchisor. In addition, the Franchisor adds […]% of such costs and expenses representing Franchisor’s administration and supervision costs. Consideration for this property and service is payable as [#] installments of $[…] plus any balance due.
Underlying Lease Agreement between the Landlord and Franchisor’s Subsidiary (the Tenant)
As stated in the Sublease Agreement, the Underlying Lease is effective [mm/dd/yyyy], between […] (referred to as the Tenant), a [GST/HST] registrant subsidiary of the Franchisor and […] (referred to as the Landlord). The agreed-upon premises are located in a mall and, pursuant to the Lease Agreement referred to as the Underlying Lease in the Sublease Agreement, are the same as the sublease premises.
Article […], in part, provides that so long as the tenant is the Tenant, the Tenant generally is not required to obtain consent of the Landlord in the event of a sublease to a duly qualified Franchisee, provided the sublease is made in accordance with certain conditions e.g., the landlord is provided prior written notice, Franchisee is subject to terms in the underlying lease, the Franchisee occupies no less than the whole of the leased premises, the Franchisee carries on the business of the Tenant, the Tenant provides a copy of the Franchise Agreement - - the terms of which will not conflict with the terms of the underlying lease, and the sublease continues for only so long as the Franchisee remains a Franchisee of the Tenant and is not in default of the Franchise Agreement.
In all other cases, the Tenant is not to assign the Lease or sublet it or any part without obtaining the Landlord’s consent. In all situations, the Tenant is not relieved of any liability or responsibility for the duration of the term of the Lease.
[…] to the Franchise Agreement: the Sublease Agreement
[…], the Sublease Agreement, was entered into by the Subsidiary ([…] previously referred to as the Tenant) and the Franchisee and executed on [mm/dd/yyyy]. Sections […] and […] read:
(a) Lease of Premises. The Sublessor (being the Subsidiary) hereby lets to the Sublessee (being the Franchisee), and the Sublessee hires from the Sublessor, the following premises, herein called “demised premises”, situated in […][Participating Province X]:
[…]
and more particularly described in the Underlying Lease;
the demised premises shall be deemed not to include either the land lying thereunder or the exterior walls or roof of the building in which the demised premises are located.
(b) Sublease. This is a sublease, and the Sublessor’s interest in the premises is as a lessee pursuant to a lease made by and between the Sublessor and [the] […] (Lessor), dated effective as of [mm/dd/yyyy], a copy of which, initialed for identification (“Underlying Lease”), is attached hereto. Except as is modified or supplemented by this Sublease Agreement, this sublease is expressly made subject to all the terms and conditions of said original Underlying Lease, and the Sublessee agrees to use the premises in accordance with all of the terms or provisions thereof. If said Underlying Lease is terminated, this sublease shall terminate simultaneously. The Sublessee hereby agrees to assume the obligation for performance of all of the Sublessor’s obligations under the aforesaid Underlying Lease, including, but not limited to, any and all obligations for payment of rent, or other assessments. By its attachment hereto, said Underlying Lease, and all the terms and provisions therein, are hereby made a part of this Sublease Agreement, and are incorporated by reference herein.
Section […] of the Sublease Agreement links the term to the Underlying Lease providing the [#] year plus term of the Underlying Lease and stating that the term of the sublease commences upon the execution hereof, and shall simultaneously terminate with the Underlying Lease, subject to other provisions of the Underlying Lease.
Section […] of the Sublease Agreement stipulates that the rental payments pursuant to the Underlying Lease are due from the Sublessee, including any other rents payable under the Underlying Lease. A security deposit may be payable by the Sublessee to the Sublessor in its absolute discretion.
Section […] of the Sublease Agreement states that the “parties hereby acknowledge that Sublessee has entered into a separate Franchise Agreement by and between […], as Franchisor, and […], as Franchisee, dated [mm/dd/yyyy], pursuant to which the Sublessee has been granted a franchise license to operate a Franchised Business at the premises which are the subject of this Sublease Agreement.” Failure of the Sublessee to abide by or perform any of the obligations assumed by Sublessee pursuant to said Franchise Agreement may result in a termination of the Franchise Agreement. Should the Franchise Agreement be terminated, then, at the option of the Sublessor, this Sublease may also be terminated.”
According to section […] of the Sublease Agreement, the Sublease Agreement does not release the Sublessor from its duties and obligations as Lessee pursuant to the Underlying Lease, and the Sublessor remains liable to the Lessor of the Underlying Lease for payment of rent, percentage rent, taxes and other assessments, expenses, and other obligations of Lessee as the same are set forth in the Underlying Lease. However, it is stated that this provision does not change the terms and conditions of this Sublease Agreement.
The same individual’s name, initials, or signature ([…]) appear on the Franchise Agreement for the Franchisor, on the Underlying Lease for the Tenant, and on the Sublease for the Sublessor.
[…][Interpretation]
To determine whether two persons are eligible to make a joint election under section 167, it is necessary to determine if the following two conditions are met:
1. whether the supplier is supplying a business or part of a business that was established or carried on by the supplier or that was established or carried on by another person and acquired by the supplier; and
2. whether, under the agreement for the supply, the recipient is acquiring all or substantially all of the property such that the recipient is capable of carrying on the business or part as a business.
Supply of a Business or Part of a Business
In accordance with section 167 and as stated in GST/HST Memorandum 14.4, Sale of a Business or Part of a Business, to qualify for the election (Footnote 1) , the supplier must be selling a business (or part of a business) that was established or carried on by the supplier, or that was established or carried on by another person and acquired by the supplier. It is a question of fact whether any particular transaction would qualify as a supply of a business as required under section 167.
In the case of a supply by a franchisor to a franchisee of a new business, the franchisor must make a supply of a business that was established (i.e., a turn-key operation and not just individual assets) in order to qualify for the election. For the supply of a franchised business to constitute a business that was established, the following property and services should be included by a franchisor under the agreement for the supply to the franchisee: right to use a trade name/trademark, land and building, equipment necessary to operate the business, initial inventory, training and operating manuals, etc. What will constitute a supply of a turn-key business may depend on the nature of the business. Real property, whether purchased or leased, is normally required to carry on a food restaurant store/business.
According to the Franchise Agreement, the Franchisor is to provide to the Franchisee the right and licence to use proprietary marks, assistance in obtaining an approved location, initial training including the services of one experienced employee and loan of manuals, as well as having plans/specifications prepared and construction, decoration, outfitting of the required fixtures, furnishings, equipment, signs, accessories, supplies, etc. necessary to permit the Franchisee to commence the operation of the Franchised Business. Since the Franchise Agreement includes terms that transfer all of the above, and terms under which the land and buildings are transferred under a Sublease assigned by the Franchisor’s subsidiary, the first condition to the election is met.
Acquisition of All or Substantially All of the Property
Regarding the second condition, it is necessary to determine whether, under the agreement for the supply, the Franchisee is acquiring all or substantially all of the property such that it is capable of carrying on the Franchised Business.
Any property acquired by the Franchisee subsequently or already in the possession of the Franchisee that can reasonably be regarded as being necessary for it to be capable of carrying on the Franchised Business would need to be 10% or less of the fair market value of all the property required to carry on the business.
Where the value of the property that the Franchisee is acquiring under the Franchise Agreement (which in the case in question excludes inventory) is all or substantially all (i.e., 90% or more) of the property needed by the Franchisee to operate the business, the second condition is met.
Where the two conditions are met, and the Franchisor and Franchisee jointly elect under section 167, no GST/HST would be payable in respect of any property or service (e.g., fixture, furnishings, etc.) made under the Franchise Agreement other than
(i) a taxable supply of a service (e.g. training services, administration and supervision services) that is to be supplied by the Franchisor, and
(ii) a taxable supply of property by way of lease, licence or similar arrangement (e.g. lease or sublease of premises, franchise rights/royalties).
[In accordance with the qualifications and guidelines set out in GST/HST Memorandum 1.4, Excise and GST/HST Rulings and Interpretations Service, the interpretation(s) given in this letter, including any additional information, is not a ruling and does not bind the Canada Revenue Agency (CRA) with respect to a particular situation. Future changes to the ETA, regulations, or the CRA’s interpretative policy could affect the interpretation(s) or the additional information provided herein.]
If you any questions, please contact me directly at 613-952-0328.
Yours truly,
William Parker
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate
FOOTNOTES
1 If the supplier is a GST/HST registrant, the recipient must also be a GST/HST registrant. The recipient, if a registrant must file the election Form GST44, Election Concerning the Acquisition of a Business or Part of a Business, on or before the due date of the return for the reporting period in which tax would have become payable if the supply had been made without the election being made or on a later day as the Minister may determine on application of the recipient.
Email this Content