26 August 1994 GST/HST Interpretation 11745-5(on)[3] - Supplies of Leased Motor Vehicles

                                                                        Telephone: (613) 954-8585
Fax: (613) 990-3602

                                                                        August 26, 1994

Dear Mr. XXXXX:

I refer to your letters of December 20, 1993, and February 21, 1994 concerning the application of the transitional measures in subsections 340(3) and (6) of the Excise Tax Act (Act), to supplies of leased motor vehicles.

In your earlier letters of February 4, 1993, and March 12, 1993, you advised that audits had been conducted by the XXXXX which revealed a certain practice by motor vehicle leasing companies of transferring a leased motor vehicle to a third party, such as a dealership, in order to comply with the requirements of the XXXXX. The vehicle was then sold by the third party to the original lessee. The issue concerned the GST-status of the supply between the lessor and the third party as well as the status of the sale by the third party to the original lessee.

I replied to your letters on February 19, 1993 and August 19, 1993, explaining that, in the circumstances described, the supply of a vehicle by way of sale by a third party to the original lessee was not made pursuant to an agreement in writing entered into before 1991, and consequently was not grandfathered. Also, the supply between the lessor and the third party was subject to the GST, although the registrant third party would be eligible for an input tax credit for the tax paid.

To address the issues described above, a policy proposal was presented to the Policy Review Committee (PRC) on June 28, 1993. The PRC supported the view that a motor vehicle purchased by the original lessee from a third party is taxable at the standard rate. The supply of the vehicle is not made pursuant to an agreement in writing entered into before 1991 and, consequently, is not grandfathered. The PRC also concluded that the sale of the vehicle by the leasing company to the third party, which preceded the supply to the original lessee, was subject to the GST.

In your letter of December 20, 1993, you advised that the leasing contract contains a clause for determining the residual value of the automobile at the end of the contract (residual value clause). You also advised that at the end of the contract, if the lessee decides to acquire the leased automobile, the original lessor sells the automobile to the third party for a price equal to the residual value of the automobile as provided for by the contract. The leasing contract is not transferred to the third party at the time of the sale of the automobile. After this transaction has been carried out, the third party supplies the automobile by way of sale to the lessee. The price is equal to the residual value provided for by the leasing contract.

The XXXXX met with representatives of the XXXXX on December 17, 1993. The XXXXX representatives contend that the motor vehicle leasing industry in XXXXX does not violate the fiscal policy underlying the transitional measures and, consequently, the sale of the automobiles by the third parties to the original lessees should not be subject to the GST. According to the XXXXX the automobiles are transferred to the third party before final sale to the lessee for administrative reasons:

1. In order to sell vehicles, motor vehicle lessors must hold a road vehicle dealer's license issued by XXXXX and must furnish security. Most motor vehicle lessors do not hold such a permit since they are not road vehicle dealers within the meaning of the applicable provincial legislation.

2. The temporary registration of the vehicle is faster and simplified when carried out by the third party, generally authorized by law to carry out such registration.

The XXXXX further contends that the general purpose of implementation of the GST on January 1, 1991, was not to subject to tax, transactions that were underway before 1991. It is the opinion of the XXXXX that the commercial practices which were in existence at the time of coming into force of the GST system must be taken into consideration in applying the transitional provisions.

The XXXXX has recommended that an administrative practice be adopted which is aimed at grandfathering transactions of this type which have existed in XXXXX for many years. XXXXX is now in agreement with the XXXXX. It is presently the view of XXXXX that the conditions of the application of that subsection are met, namely:

the consideration is paid before 1994 and is attributable to the acquisition of property under an agreement in writing entered into before 1991 for the supply by way of lease of an automobile, the possession of which is transferred to the recipient before 1991.

Consequently, it is your view that the commercial practices which were in existence at the time of coming into force of GST must be taken into consideration in applying the transitional provisions.

In your letter of February 21, 1994, you state that a residual value clause constitutes a clause enabling the exercise of a purchase option in respect of a leased vehicle, according to the comprehension of that clause by the entire XXXXX motor vehicle leasing industry. On this matter, confirmation is sought from this department that such a clause constitutes a purchase option.

A residual value is a residual guarantee payment paid by the lessee during the term of the lease (i.e., a retroactive rent increase due to the lessee's extensive use of the automobile). For example, a residual value of property under a lease may be $10,000 and the lessor only receives $7,000 from a third party sale. In this example the balance of $3,000 would be made up by the lessee. This concept is different from a purchase option which allows the lessee or an assignee to acquire the automobile for a price specified in writing in the leasing agreement. A residual value clause is not, in and of itself, a purchase option.

In your letter of December 20, 1993, you stated that there was no transfer of the lease from the lessor to the third party. In fact, the agreement was no longer in effect since the lease term had expired. Nevertheless, in your letter of February 21, 1994, you state:

subsections 340(3) and 340(6) of the Act may apply if the leasing contract of the motor vehicle contains a purchase option and it is subject to a transfer to the third party who makes the supply of the leased vehicle by way of sale to the lessee.

... the contract must be subject to transfer to the third party for no tax to be payable in respect of the supply of the motor vehicle made to the lessee. According to civil law, such a transfer is valid without the debtor's taking part in the transaction, although he must be officially notified of the agreement reached by the transferor and the transferee.

... in the case where the lessee notifies the lessor that he is exercising the purchase option provided for in the contract and that the sale of the motor vehicle takes place between the lessee and a third party for the residual value of the vehicle of for that fixed to exercise the purchase option, it is our opinion that in order to do so, the lessor necessarily had to transfer his contract to the third party. In addition, the fact that the lessee acquires the motor vehicle from the third party for its residual value or for that of the purchase option constitutes acceptance of the transfer of the contract to the third party.

I do not agree that the fact that the sale of the motor vehicle takes place between the third party and the lessee for the residual value under the lease agreement means that there was a transfer of the agreement to the third party. Even if the residual value clause amounted to a purchase option in the lease agreement, it is a question of fact that there was no transfer of the lease agreement to the third party. In the circumstances, the amount paid for the automobile was not a payment under the agreement.

If the agreement did contain a purchase option and if there had been an assignment of the agreement to the third party, the sale could be grandfathered. However, as I have mentioned above, based on the facts presented, this does not appear to be the case.

Prior to the issuance of the policy proposal on this matter in June 1993, General Tax Policy sought a legal opinion from the Department's legal counsel. In the opinion of legal counsel,

... even if, in interpreting subsections 340(3) and (6) of the Excise Tax Act ("ETA"), we adopt the "liberal interpretation method", the sale of the car by a car dealership to a former lessee in the circumstances described in your policy proposal would still not be grandfathered under either subsection 340(3) or (6).

I do agree with you that the words of an Act are to be read in their entire context and in their grammatical and ordinary sense harmoniously with the scheme of the Act, the object of the Act, and the intention of Parliament. However, where the words of an Act are clear and unambiguous, it is improper to ignore these words and interpret the Act as saying something different from what it really says.

For instance, subsection 340(3) clearly states that in order for a payment to be grandfathered, one of the requirements that must be met is that the payment must be made under an agreement in writing entered into before 1991. This requirement cannot be done away with simply invoking the "liberal interpretation" method. In other words, even if one reads the words of subsection 340(3) "in their entire context, etc.", the fact remains that the payment must be made under an agreement in writing entered into prior before 1991. If the payment is not made under an agreement in writing entered into before 1991, then the payment cannot be grandfathered.

... I do not see how it can be said that the payment made by the former lessee to the car dealership to purchase the car is made under an agreement in writing entered into before 1991.

Based on XXXXX it was determined that the consideration for the supply by the third party to the original lessee was subject to the GST. I am forwarding a copy of our correspondence to the Department of Finance in order that Finance officials will be aware of your concerns.

Should you require any further information, please contact Robert Allwright at (613) 952-8810 or Owen Newell at (613) 954-4280.

Yours sincerely,

H.L. Jones
Director
General Tax Policy
Policy and Legislation
Excise/GST