Dear sir:
This is in response to your facsimile message of October 19, 1995, to Owen Newell, concerning the GST status of a contract between XXXXX (the Company) and XXXXX (the City).
Facts
1. XXXXX permits a municipality to enter an agreement with a gas company to give the company an exclusive right to supply gas to the municipality and its inhabitants.
2. The City entered an agreement with the XXXXX XXXXX, which allowed the company to have a monopoly to supply natural gas to the inhabitants of the municipality. The agreement between the City and the company (which subsequently changed its name to XXXXX) was renewed in XXXXX, and extends until XXXXX.
3. The terms of the agreement specify that the City grants the Company an exclusive franchise to supply natural gas to the City and its inhabitants. The City agrees to permit the company to dig, excavate, et cetera, as necessary to install a distribution system for conveying the natural gas to the City or its inhabitants.
4. If the agreement is not renewed, the City has the right to purchase the distribution system of the company.
5. As compensation for the use of City property by the Company for its distribution system, the Company agrees to pay to the City XXXXX percent of the amount received in each calendar year by the Company for gas consumed within the boundary limits of the City, but not including gas for resale.
Question
Would it be correct to state that the contract involves
(i) supplies of gas by the Company to the City,
(ii) a supply of a right (i.e. the supply of the exclusive franchise) by the City to the Company, and
(iii) a supply of an interest in real property (i.e. the supply of the right to use municipal property for a distribution system) by the City to the Company?
Response
The exclusive franchise granted to the Company by the City to supply gas to the City and its inhabitants should be seen as inseparable from the right granted to the Company by the City to use the real property of the City for the installation and maintenance of the system necessary to supply the gas. The essential component of such a franchise has always been regarded by the courts as the use of real property to supply a utility. (For example, XXXXX XXXXX ruled that the subject matter of such a franchise was not the right to supply the utility, but was instead the right to use the municipal streets and other property for that purpose. Therefore, the supply of the special franchise should be considered to be one with the supply of real property and, even if considered as a supply of a right similar to a licence or permit, would be excluded from the exempting provisions of section 20 of Part VI of Schedule V to the ETA by reason of paragraph 20(l).
Subsection 136(1) deems the supply of the use or right to use real property by way of lease, licence or similar arrangement to be the supply of real property. Based on the facts of this case, the applicable legislation and case law (e.g. the decision is XXXXX it is our view that the rights conferred by the contract are a supply of real property by way of licence.
The supply of rights to use real property by way of licence on a long-term basis is exempted by section 25 of Part VI of Schedule V to the ETA up to and including September 14, 1992. As of September 15, 1992, the supply is excluded from section 25 by reason of section 25(f), since the supply constitutes a supply of real property by way of licence. The supply therefore becomes taxable at that date.
It should be noted that, when the supply of real property becomes a taxable supply, the City would only be entitled to claim input tax credits for GST costs relating directly to property or services that are supplied to the municipality in respect of the acquisition of the special franchise itself (e.g. legal fees for the drafting of the agreement). Where the real property granted for use under the special franchise is otherwise used by the municipality in exempt activities, the municipality is ineligible for input tax credits in respect of such property.
If you require any further information concerning this matter, please contact Mr. Don Dawson at (613) 952-9211.
J.A. Venne
Director
Special Sectors
GST Rulings and Interpretations
11870-5, 11950-5
c.n. 1508(JB)
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