9 July 2004 GST/HST Ruling 41811 - Tax Status of XXXXX

Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.

This is in reply to your request for our interpretation of how the Harmonized Sale Tax (HST) provisions of the Excise Tax Act would apply to leasehold improvements made by XXXXX (the "Tenant"). We understand that your office is holding their claim for related input tax credits in abeyance while awaiting this interpretation. We apologize for and regret the delay in our reply.

Background

1. The Tenant is a partnership comprised of XXXXX. The Tenant is registered for GST/HST XXXXX.

2. On its annual return for the period ending XXXXX, the Tenant claimed input tax credits (ITCs) of $XXXXX in respect of HST payable to XXXXX ("T"). T carried out construction work on the Tenant's leasehold premises, which is located in XXXXX. The total construction contract was for $XXXXX.

3. To help offset these costs, XXXXX (the "Landlord") agreed to pay the Tenant improvement allowances of $XXXXX in XXXXX and $XXXXX in XXXXX.

4. We understand that the constructed additions in question are sufficiently affixed so that they are considered as "fixtures" (i.e., improvements) to the real property.

5. On its annual return for the period ending XXXXX, the Tenant recorded total revenues of $XXXXX and HST collected of $XXXXX. The supplies from the XXXXX of the Tenant are tax-exempt or zero-rated. The HST collected was on the leasehold allowance of $XXXXX.

Summary Description of the Lease Agreement

6. The Tenant and the Landlord signed a lease agreement for the premises on XXXXX. The lease was for approximately XXXXX square feet in XXXXX for a term of XXXXX years. This was later amended to XXXXX square feet and a term of XXXXX years. Rent was calculated on a per square foot per annum basis (e.g., $XXXXX per square foot for years XXXXX through XXXXX ...).

7. XXXXX means all features, improvements, ... and additions ... made, constructed, ... or installed in or to the Lease Premises (and) shall include, without limitation, storefront and doors, all partitions, however affixed, light fixtures, ... carpeting ... electrical installations.

8. XXXXX Leasehold Allowance:

The landlord agrees to pay to the Tenant, a maximum amount equal to ... $XXXXX per square foot of the floor area ... said amount to be used by the Tenant to pay for the construction of the leasehold improvements to the Premises which when installed in the Premises become the property of the Landlord and the Tenant will not use said Leaseholds to secure financing for the Tenant. Said amount shall be payable by the Landlord to the Tenant. The Landlord has the right to offset the Leasehold Allowance against arrears on the Tenant's account. The following must be completed prior to payment being processed:

i. the Tenant has sent the Landlord receipted invoices for work done to the Premises;

ii. the Mechanic's Lien period has ended;

iii. the Tenant has sent an invoice to the Landlord for the Allowance amount and GST or any other tax ... but not limited to any Harmonized Sales Tax ...;

iv. the Tenant's Tax Registration number ... is on the invoice;

v. ... the Tenant's contractors have been paid;

vi. the Lease is fully executed ...;

vii. the Tenant is not in default under the Lease;

viii. the Tenant is open for business ...;

ix. the Tenant's account is paid up-to-date.

9. XXXXX to the Agreement XXXXX:

XXXXX, annexed hereto, shall be added to the Lease effective on the XXXXX day of XXXXX.

10. XXXXX Leasehold Allowance

The Landlord agrees to pay the Tenant, a maximum amount equal to $XXXXX (in XXXXX) ... toward the building of the Premises ... Said amount to be used by the Tenant to pay for the construction of the leasehold improvements of the Premises, in accordance with XXXXX herein, which when installed in the Premises become the property of the Landlord. ... Said amount shall be due and payable by the Landlord to the Tenant during the original term of the Lease. ... The following must be completed prior to payment being processed:

i. The Tenant has sent the Landlord receipted invoices ...

[(i) to (ix), same as under #8 above]

11. There is no indication in the Agreement that the Tenant is required to make the leasehold improvements. It is our understanding, however, that the improvements are necessary in order to make the facility suitable for its XXXXX, and, pursuant to the terms described above, the Landlord has agreed to assist with the cost of the improvements. There is no indication whether, at the end of the lease, the improvements will be of any benefit to the Landlord (e.g., whether they will enhance the value of the property).

12. We have not been provided a copy of XXXXX. However, information provided XXXXX indicates that the above-noted payment of $XXXXX was to assist the Tenant in constructing a XXXXX, and the payment was made in XXXXX. The information indicates that the XXXXX was part of the $XXXXX contract referred to under #2 above. That is, the Tenant received leasehold allowances of $XXXXX in fiscal year XXXXX and $XXXXX in fiscal year XXXXX for the $XXXXX of leasehold improvements expended in fiscal year XXXXX.

13. For its annual reporting period ending XXXXX, about XXXXX% of the Tenant's XXXXX were zero-rated; the remaining XXXXX% were exempt. We have not been provided similar information concerning other reporting periods.

14. The Tenant has made an election pursuant to subsection 13(7.4) of the Income Tax Act with respect to the leasehold allowance described above. As a result, the leasehold allowances of $XXXXX and $XXXXX were not reported as taxable income, and were not added to the adjusted cost base of the Tenant's capitalized leasehold improvements.

Issue

You have asked for our interpretation of how the HST provisions of the Excise Tax Act would apply to leasehold improvements made by the Tenant. In particular, you have asked whether the Tenant is entitled to claim ITCs with respect to the costs incurred in making the leasehold improvements, and if so, in what manner.

Interpretation

It is our view that, the Tenant is entitled to claim ITCs with respect to the costs incurred in making leasehold improvements for its XXXXX fiscal year in the following manner.

(i) The Tenant should be viewed as having made a taxable supply of improvements to the Landlord and is thereby entitled to claim ITCs with respect to all inputs related to that supply.

(ii) The inputs into the tenant improvements made by the Tenant are also used or consumed by it in the course of its XXXXX ("the endeavour"). For its XXXXX fiscal year, XXXXX% of the supplies made in the endeavour were exempt, and the remaining XXXXX% were taxable (zero-rated) supplies made for consideration. We assume that the percentage of taxable supplies is the same in XXXXX as it is in XXXXX (i.e., XXXXX%). If this is not the case, the percentage should be adjusted accordingly.

(iii) The allocation of improvement-related inputs between the supply to the landlord and the endeavour must be made on a reasonable basis. In the Tenant's case, we regard a reasonable basis for the allocation of improvement-related inputs to be between (1) the portion of improvement costs offset by the leasehold allowance as related to the supply of improvements to Landlord and (2) the remaining portion of improvement costs as related to improvements used in the endeavour (as illustrated in (iv)(a) and (b) below).

(iv) Accordingly, for its XXXXX fiscal year (the year in which the tax was paid), the Tenant's ITCs in respect of the costs of the improvements may be determined as follows.

(a) ITCs related to the supply of improvements to the Landlord

Leasehold Allowance

(b) ITCs related to the improvements used in the endeavour

Total tax paid less (a) above X XXXXX%

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-3772.

2004/08/30 — RITS 42363 — Subsection 240(1) of the Excise Tax Act