24 December 1998 GST/HST Interpretation HQR 0001373 - GST/HST Implications for Leased Vehicles

GST/HST Rulings and Interpretations  Directorate Place Vanier, Tower C, 10th Floor 25 McArthur Road Vanier, Ontario K1A 0L5XXXXXXXXXXAttention: XXXXX

Case: HQR 0001373December 24, 1998

Subject:

GST/HST INTERPRETATION GST/HST implications for leased vehicles

Dear Sir:

Thank you for your various faxes concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to the application of tax on leased vehicles and vehicle trade-ins.

Interpretation Requested

Your fax of July 22, 1998, deals with the hypothetical case of a customer obtaining a leased vehicle from an automotive dealership and the tax consequences where the dealership takes the customer's old vehicle as a trade-in that reduces the amount to be financed by the new automobile lease.

In all cases, except in the Province of British Columbia, the lease is between XXXXX (lessor) and the user of the vehicle (lessee). In British Columbia the lease originates with the dealer and is assigned to XXXXX. A standard form is used, and the calculations made by the dealer must conform with a published residual guide for the vehicle and a published interest guide.

In all cases the contract is also subject to a credit approval of the lessee. All leases are non-recourse and XXXXX assumes all risks. Prior to delivery of the vehicle the lessee must provide insurance on the vehicle that indemnifies XXXXX XXXXX[.] When the contract is sold by the dealer to XXXXX, the vehicle is registered in XXXXX XXXXX's name. In the event that the residual is too high, the interest rate is too low, or some other clause in the lease does not meet XXXXX approval there are three possible outcomes:

1. The payment made by XXXXX to the dealer would be discounted[;]

2. The dealer could take the lease back and try to re-negotiate it with the lessee; or

3. The dealer is free to sell the lease to another party other than XXXXX[.]

With regard to vehicle trade-ins, XXXXX is not involved in ascertaining the condition or value of the vehicle. It is the responsibility of the dealership to obtain clear title to the traded vehicle. XXXXX will review the agreement with the lessee and, as a normal business practice, XXXXX requires the dealership to prove that the lien has been discharged.

Interpretation Given

Supplemental to this letter, I have attached Departmental publication B-084 TREATMENT OF USED GOODS, that also deals with leases.

There have been two important amendments to the Excise Tax Act (ETA), that may affect tax accounting on leases.

•   On April 1, 1997, the harmonized sales tax (HST) replaced the goods and services tax (GST) and the provincial sales tax (PST) in the three participating provinces of Nova Scotia, New Brunswick and Newfoundland with a harmonized tax rate of 15%. To the extent that supplies are taxable supplies (which are not zero-rated), tax must be collected at the harmonized rate.

•   In 1996, a revised treatment for input tax credits in respect of used goods and the new trade-in approach came into effect. Where a person who is not registered for GST/HST trades a vehicle to a dealer, GST/HST will be charged on the net amount of the sale after taking the reduction for the trade, and a notional ITC is not available to the vehicle dealer.

NOTE: The 1% surcharge imposed in Nova Scotia is a provincial levy that does not form part of the HST calculation.

This letter will only address the application of the ETA, as it currently reads and without reference to the previous letter to XXXXX of August 21st, 1996 by H.L. Jones, Director, General Applications Division, GST Rulings and Interpretations Directorate. It is understood that the facts of that situation were different.

From the above facts, the provisions contained in subsection 153(4) and (5) of the ETA are not applicable to the transaction between XXXXX who is a registrant under the ETA, and the dealer who is also a registrant. Thus, GST/HST applies on the value of the consideration for the supply (sale of vehicle) made by the dealer to XXXXX[.]

Subsections 153(4) and (5) of the ETA provide for the use of the "trade-in approach" in certain circumstances. Subsection 153(4) provides the rules in respect of calculating the value of the consideration for a supply of tangible personal property made by a supplier.

In an arm's length transaction, the value of consideration for a supply is net of the trade-in amount applied against the consideration for that supply. This approach only applies when the property (the trade-in) accepted in full or partial consideration for a supply of tangible personal property (such as a vehicle):

1. is used tangible personal property or a leasehold interest therein,

2. is acquired for consumption, use or supply in the course of a commercial activity of the supplier, and

3. the supply of the trade-in is not a supply on which the customer is required to collect tax, for example where the customer is not a registrant.

The trade-in rules do not apply to registrants who are selling or trading in used tangible personal property (or a leasehold interest therein) that was last used exclusively in commercial activities and who are required to charge tax.

General

When XXXXX purchases the vehicle, a supply is made from the dealer to XXXXX and tax must be collected by the dealership, as a registrant under the ETA, while the tax paid or payable by XXXXX becomes eligible as an input tax credit when determining the net tax due by XXXXX.

In the case of trade-ins, XXXXX XXXXX is not a party to the trade-in transaction. The trade-in transaction is a supply made between the consumer and the car dealership. Trade-ins will have tax consequences for the dealership but will not alter the manner in which the tax is calculated on the transaction between XXXXX and the dealership for the acquisition of the new vehicle by XXXXX[.] Similarly, whether a lien is discharged by the dealership, or the person trading in the vehicle is a registrant, will not affect the manner in which tax is calculated. This is predicated on the fact that all parties are not related and that an agency relationship does not exist between the dealership and XXXXX[.]

Application to Facts

Example No. 1

Dealership's agreed selling price to the consumer	$40,000
LESS Trade-in value allowed	5,000
Difference to be financed by lease	$35,000

Tax Consequence for XXXXX - Where the $35,000 value to be financed is charged by the vehicle dealership to XXXXX, this becomes the value on which GST/HST is payable by XXXXX to the dealership. In other words, if the selling price of the vehicle between the parties is $35,000, this becomes the value on which the dealer will charge tax to XXXXX[.]

The trade-in approach applies when the recipient of tangible personal property is supplying used tangible personal property (or a leasehold interest therein) as full or partial consideration to the supplier. In the event that an amount is credited from the vehicle dealership to XXXXX this is not considered to be a trade-in.

Dealership Tax Calculation - From the dealership's perspective the vehicle will be on a 36 month lease. The tax calculation for a 36 month lease would be similar to the following illustration:

Selling price of new vehicle	$40,000.00
Less: Residual value (buy out option)	20,600.00
note 1 Net difference	$19,400.00
Less: Trade-in allowance	5,000.00
note 2 Amount depreciated over 36 term lease (LDV)	$14,400.00
note 3 Add: Loan repayment	0.00
Gross amount owed to lessor by lessee	$14,400.00
Monthly lease payment Monthly depreciation ($14,400/36)	$400.00
Add: Interest charge	146.27
note 4	$546.27
Add: GST ($546.27 x 0.07)	38.24
Total amount per month lessee remits to lessor (excluding application of PST in all examples)	$584.31

note 1              The residual value for the vehicle was $20,600 established by reference to a published residual guide

note 2              From the dealer's perspective, the agreement to lease the vehicle may include various charges. In addition to the monthly lease payment, there is often a required down payment, a lease acquisition fee, and other charges that are due upon possession. As these amounts are all part of the consideration for the supply by way of lease, the lessor and the lessee may agree to apply the trade-in value to all or a portion of these amounts.

note 3              The difference between the selling price and the sum of the residual value and the trade-in allowance is referred to as the "Leasing Depreciation Value" (LDV).

note 4              The interest portion of the lease payment is calculated by multiplying the published pre-established interest "Rated Factor" by the sum of the residual value and the difference between the selling price of the new vehicle and the trade-in allowance. This value represents the amount of the return on the initial investment of the funds to acquire the vehicle plus the risk cost of financing the residual value of the vehicle over the lease term.

Example No. 2

Building on the above example, the trade-in vehicle is subject to a $3,000 lien.

Tax Consequence for XXXXX - On the transaction between the dealership and XXXXX, the transaction for tax purposes would be similar to the following:

Dealership's agreed selling price to the consumer	$40,000
LESS Trade-in value allowed	5,000
ADD Lien pay-out by dealership	3,000
Difference to be financed by lease	$38,000

The $38,000 value to be financed is charged by the vehicle dealership to XXXXX[.]

Dealership Tax Calculation - From the dealership's perspective, the tax calculation would look similar to the following:

Selling price of new vehicle	$40,000.00
Less: Residual value (buy out option)	20,600.00
Net difference	$19,400.00
Less: Trade-in allowance	5,000.00
Amount depreciated over 36 term lease (LDV)	$14,400.00
Add: Loan repayment	3,000.00
Gross amount owed to lessor by lessee	$17,400.00

Monthly lease payment
Monthly depreciation ($14,400/36)	400.00
Add: Interest charge	146.27
	$546.27

Add: GST ($546.27 x 0.07)	38.24
Amount per month lessee remits excluding loan repayment	$584.51

Add: monthly principal loan repayment (3,000 / 36)	83.33
Add interest factor for loan amount	7.89
Total amount lessee remits to lessor	$675.73

In the above calculation, the amount of GST on each lease payment ($38.24) would remain unchanged from the previous calculation, since, for the purpose of calculating the amount of GST on the monthly lease payments only, the amount of the lien repayment on the trade-in is ignored.

Example 3

In the situation where the dealership refunds to the lessee the difference in cash to bring the LDV to zero, the tax calculation may look similar to the following (in this case the charge made by the dealership to XXXXX would be the net value of the vehicle plus the cash payment made to the customer. This amount is the sale price of the new vehicle by the dealership and would be the value on which tax is computed on the transaction with XXXXX[.]

Tax Consequence for XXXXX - Where $20,600 is the selling price of the vehicle charged by the dealership to XXXXX this is the value on which GST/HST is payable by XXXXX to the dealership.

From the perspective of XXXXX and the transaction with the dealership:

Selling price of new vehicle	$40,000.00
Less: Trade-in allowed	25,000.00
Add: Cash to customer paid by dealer	5,600.00
Selling price of vehicle to leasing company	$20,600.00

Dealership Tax Calculation - From the perspective of the lease between the dealership and the customer, the tax calculation could appear similar to the following:

Selling price of new vehicle	$40,000.00
Less: Residual value (buy out option)	20,600.00
Net difference	$19,400.00

Less: Trade-in allowance	25,000.00
Amount depreciated over 36 term lease (LDV)	(5,600.00)
Amount paid to owner in cash	5,600.00
Gross amount owed to lessor by lessee	0.00
Monthly lease payment
Monthly depreciation (0)	0.00
Add: Interest charge ($20,600 x money factor)	108.38
	$108.38
Add: GST ($108.38 x 0.07)	7.59
Amount per month lessee remits to lessor	$115.97

see note

Note - Subsection 153(4) of the ETA provides in paragraph (c) that the value of the consideration for the supply (i.e. the leased vehicle) is deemed to be equal to the value of that supply less "... the amount credited to the recipient in respect of the trade-in ...". This phrase in paragraph 153(4)(c) refers to the amount deducted against the value of the supply. Where the lessee receives a cash advance from the dealer against the value of the trade-in, the advance is considered a financial arrangement. A financial arrangement of this nature does not reduce the value of the trade-in provided that it is clearly segregated on the lease agreement and any subsequent billings or other statements that are provided to the lessee. Conversely, the amount given in cash to the lessee will not be considered to be an amount credited against the leased vehicle where the documentation segregating the cash advance is not clear, for example, where the dealer only indicates on the lease agreement the net value of the trade after providing the cash advance to the lessee.

One Time Payment Lease

The lease could provide the option for the customer to make a "one time lease payment" whereby the customer can pre-pay all the lease payments and the interest rate charged is reduced since the money has been paid in advance. Similar to all the above examples the amount charged by the dealership to XXXXX for the new vehicle is subject to GST/HST.

From the perspective of the lease between the dealership and the customer, the tax calculation would appear as tax calculated on the lump sum charge that is made for the advance payment. If the customer traded in a vehicle and it is worth in excess of the lump sum payment, and the trade-in value is applied to the lump sum payment, you are correct in stating that GST/HST would not apply to the direct offset of the trade-in against the lump sum payment.

Lessee is a Registrant Required to Charge Tax on Trade-in

In the situation where the customer is a registrant under the ETA, the tax consequence on the transaction between the dealer and XXXXX is unchanged since the price charged by the dealership to XXXXX remains the same. What does change, however, is the tax calculation between the dealership and the customer who is a registrant, since subsection 153(4) cannot be applied if the person is required to charge tax on the supply of the vehicle. In this situation, there are two supplies being made. The dealer is required to collect GST/HST on the full cost of the lease of the vehicle, and the customer must charge and collect GST/HST on the vehicle being traded in.

Undisclosed Registrant

In the situation where the lessee is an undisclosed registrant, there will be no tax consequence for XXXXX, if an agency relationship does not exist or if the customer cannot be said to be dealing directly with XXXXX. Based on this understanding, in the event that there are any further tax consequences, the Department would look to the two original parties to the contract (dealer and lessee).

Co-lessee

In a co-lessee situation where one lessee is a registrant and the other is not, and the non-registrant is trading in the vehicle, the trade-in can be applied against the supply of the lease. Where the trade-in is by the registrant, if the registrant is required to charge tax the trade-in rules would not apply.

You have also asked whether the registered owner of the vehicle traded in must be the same as the lessee. The response in the previous letter of August 21, 1996, indicating that it must be the same person has been reviewed and is confirmed.

Tax Treatment by Lessee

Where a registrant leases a passenger vehicle, the GST/HST paid or payable is creditable in the normal manner. However, to the extent that the lease costs incurred exceed the maximum amount deductible under the Income Tax Act (ITA) (currently $650 per month), the input tax credit is subject to recapture.

To the extent that the lease costs incurred exceed the allowable amount, section 235 of the ETA requires a portion of the amount eligible for an input tax credit to be added in determining the net tax for the appropriate reporting period. Usually the amount is added to the net tax for the first reporting period beginning after the end of the taxation year. However, if the person is an annual filer, or ceases to be registered, the adjustment is added to the person's net tax for the last reporting period in the taxation year.

The amount of the recapture for a taxation year is calculated as:

A x B x C

where

A is the portion of the lease payments for the year that is not deductible for income tax purposes divided by the total of the lease payments for the year;

B is the total tax paid or payable on the lease payments for the year (other than tax that, because of section 170 of the ETA, cannot be claimed as an input tax credit, for example, the amount was unreasonable) and

C is the proportion of total use of the vehicle in commercial activities of the registrant.

Place of Supply and GST/HST Consequences

As discussed in our telephone conversation, under the ETA there are important tax implications that XXXXX should be aware of in the event that an automobile changes its ordinary situs from the place where it was originally leased.

Subsection 136.1(1) of the ETA provides that where property is supplied by way of lease, and the lease includes payments that are attributable to a lease interval, such as a calendar month, the lessor is deemed to have made a separate supply of the property for each lease interval. For each lease interval, the supplier is deemed to have made, and the lessee is deemed to have received, a separate supply of the property on the earliest of the first day of the lease interval, the day on which the payment for that interval becomes due, and the day on which the payment attributable to the lease interval is paid. This subsection is relevant for determining the place of supply, and therefore, the amount of tax applicable to each lease payment. When a lessee relocates to a province other than the one in which the vehicle was originally leased, the amount of tax applicable to the lease payments may change. This subsection applies to lease intervals that begin on or after April 1, 1997.

Section 2 of Part II of Schedule IX of the ETA, outlines the rules governing the supply of automobiles by a means other than sale (e.g., lease). The first rule applies to periods of three months or less, the other rule for longer periods.

Under the second rule, where the property is a specified motor vehicle, it is considered to be leased in the province in which it must be registered under provincial motor vehicle legislation. Specified motor vehicles are most motor vehicles other than certain racing cars.

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed amendments to the Excise Tax Act, if enacted, could have an effect on the interpretation provided herein. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST/HST Memoranda Series, do not bind the Department with respect to a particular situation.

For your convenience, find enclosed a copy of section 1.4 of Chapter 1 of the GST/HST Memoranda Series.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact Gisèle Prévost, CGA, at 957-8253.

Yours truly,

Gisèle Prévost, CGA
Officer
General Operations & Border Issues Division
GST/HST Rulings and Interpretations Directorate

Encl.:

Legislative References:	153(4) ETA
NCS Subject Code(s):	I-65009