8 October 1997 GST/HST Interpretation HQR0000029 - GST Treatment of Capital Leases -

                                                                        GST/HST Rulings and
 Interpretations Directorate
Place Vanier, Tower C, 10th Floor
25 McArthur Road
Vanier, Ontario
 XXXXX                                                                                K1A 0L5

Dear XXXXX

Thank you for your letter of November 6, 1995 (with attachments) concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to capital leases. I understand that XXXXX a tax recovery company, wrote to your office requesting a ruling regarding this matter.

Our understanding of the facts is as follows:

Statement of Facts

1. The XXXXX entered into an agreement with XXXXX to lease certain tangible personal property XXXXX for a period of XXXXX

2. The lease commenced on XXXXX , 19 xx with subsequent lease payments commencing on XXXXX 19 XXXXX

3. The agreement includes a purchase option at the expiry of the lease for an amount of XXXXX .

4. The XXXXX is a charity for purposes of the GST and had elected to use the "Special Quick Method For Public Service Bodies" to account for the GST.

Interpretation Requested

You requested our comments as to whether the lease of the exercise equipment qualifies as capital property for GST purposes and, if so, whether the XXXXX is eligible to claim an ITC in respect of the total value of consideration for the property (versus claiming an ITC on each individual lease payment).

Interpretation Given

Based on the facts set out above, our interpretation is that XXXXX having elected to use the "Special Quick Method For Public Service Bodies" to account for the GST, is not eligible to claim input tax credits with respect to the lease of the exercise equipment.

At the time of the inception of the lease XXXXX had elected, pursuant to subsection 227(1) of the Excise Tax Act (the "Act"), to use the "Special Quick Method For Public Service Bodies" to account for the GST. This method is set out in Part V of the Streamlined Accounting (GST) Regulations and indicates that one of the conditions necessary in order to claim an input tax credit is that the supply is made by way of sale. Although the exercise equipment may meet the definition of capital property pursuant to subsection 123(1) of the Act, it still must be determined whether or not the exercise equipment was supplied to the XXXXX by way of sale.

As noted in your letter, Interpretation Bulletin IT-233R - Lease-Option Agreements; Sale-Leaseback Agreements sets out the Department's position with respect to leases under the Income Tax Act. The position set out in IT-233R does not apply to the Excise Tax Act. For purposes of the GST, it is necessary to determine whether the agreement is a sale or a lease at law.

The agreement entered into between the XXXXX and XXXXX has been structured as a lease agreement. Included in the document are 'leasing particulars' indicating XXXXX

The lease agreement specifies a number of terms and conditions. These include, but are not limited to:

Rentals: Lessee shall pay to Lessor during the term of this lease the total number of rental payments set out in the Leasing Particulars.

Title and Identification: The equipment is and shall at all times be and remain the sole personal or moveable property of the Lessor and the Lessee shall have no right, title or interest therein or thereto except as expressly set forth herein.

Surrender: At expiry of the Term, Lessee, at Lessee's expense, shall return the equipment to the Lessor in good repair, condition and working order at the place of Re-delivery specified in the Leasing Particulars...

Purchase Option: The exercise of any purchase option herein is subject to there being no default under the Lease at the option date and to 60 days prior written notice to the Lessor.

Applicable Law: This lease shall be construed according to the laws of the Province of the place of delivery of the Equipment x set forth above.

The Department has set out the following descriptions of a lease and a conditional sale in past correspondence:

Generally, a lease is an agreement whereby one party relinquishes a right to possession of property for a specified period of time, while retaining title to the property both during and after the lease period. It is possible, under the terms of a lease, for the lessee to take title to the property after the lessee has satisfied additional conditions (e.g., exercising a buyout option). However, unlike a conditional sales contract, title does not pass automatically to the lessee upon completion of the installment payments.

Generally, a conditional sale is an agreement in writing in which the vendor agrees to sell tangible personal property to the purchaser and, pursuant to the agreement, the purchaser agrees to make payments over a specified period of time. Although the purchaser takes possession of the goods, the vendor retains title to the goods until the purchaser makes all payments required under the agreement, at which point legal title passes to the purchaser.

Subsection 123(1) of the Act defines "sale" as in respect of property, includes any transfer of the ownership of the property and a transfer of the possession of the property under an agreement to transfer ownership of the property.

It is the Department's position that an agreement to transfer ownership generally does not include an agreement that merely contains an option to purchase, regardless of the terms. It is the Department's position that a lease, whether a capital lease or an operating lease, will not be considered as an acquisition of an asset and an assumption of an obligation (i.e. a sale) for GST purposes solely on the basis that it is considered to be a sale or acquisition under generally accepted accounting principles or the Income Tax Act. Unless a capital lease is in fact a sale at law, it will receive the same tax treatment under the GST as any other type of lease.

Subsection 136(1) of the Act states that a supply, by way of lease, licence or similar arrangement, of the use or right to use real property or tangible personal property shall be deemed to be a supply of real property or tangible personal property, as the case may be.

Subsection 152(2) of the Act states that where property is supplied by way of lease, licence or similar arrangement under an agreement in writing, the consideration, or any part thereof, for the supply shall be deemed to become due on the day the recipient is required to pay the consideration or part to the supplier pursuant to the agreement.

Subsection 168(2) of the Act states that where consideration for a taxable supply is paid or becomes due on more than one day, the tax in respect of the supply is payable on each day that is the earlier of the day a part of the consideration is paid and the day that part becomes due and the tax that is payable on each such day shall be calculated on the value of the part of the consideration that is paid or becomes due, as the case may be, on that day. Consequently, tax becomes payable on the lease payments as they fall due under the agreement.

The agreement entered into between XXXXX and XXXXX is structured as a lease and is considered to be a lease at law. Therefore, the GST is applicable to each lease payment as they fall due. XXXXX is not entitled to claim input tax credits with respect to the lease of XXXXX since it was using the Special Quick Method for Public Service Bodies to account for the GST (Part V of the Streamlined Accounting (GST) Regulations). The regulations stipulate that in order to claim an input tax credit, the property must have been supplied by way of sale.

Note: Subsection 227(1) of the Act (as amended by Bill C-70) precludes charities from making an election to use a streamlined accounting method set out in the Streamlined Accounting (GST) Regulations since a new simplified method of determining net tax for charities is provided in new section 225.1. This amendment does not have an impact on this particular case as the election provided by subsection 227(1) of the Act was applicable to charities at the time the lease commenced.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 957-8222.

Yours truly,

Tim A. Krawchuk
Rulings Officer
Financial Institutions Unit
Financial Institutions & Real Property Division
GST/HST Rulings and Interpretations Directorate

Legislative References: ss. 136(1), ss. 152(2), ss. 168(2), ss. 227(1), Part V of the Streamlined Accounting (GST) Regulations