29 January 1999 GST/HST Interpretation HQR0001426 - Characterization of Sub-sublease Agreement

Dear XXXXX:

Thank you for your letter of November 19, 1998 (with attachments) concerning the application of the Goods and Services Tax (GST) to a long term supply of a residential complex. All references herein are to the Excise Tax Act (the Act) unless otherwise indicated.

Facts

The facts as we understand them are as follows:

1. The Crown leased land on an Indian reserve XXXXX to XXXXX for a term XXXXX 99 years.

2. XXXXX in turn subleased a portion of the lots to XXXXX.

3. XXXXX entered into an Offer to Purchase/Interim Agreement with the XXXXX[.] That agreement described the subject matter of the purchase as being "the leasehold interest of the lands for a period of 99 years.XXXXX and a semi detached dwelling" ...

The purchase price in the Offer was set at $XXXXX plus GST. XXXXX of that amount is allocated for the land and $XXXXX is allocated for the building. GST was calculated on the full purchase price at $XXXXX and the GST/HST new housing rebate to be credited to the vendor was calculated at $XXXXX[.] The agreement stipulated that the purchaser was to enter into a sub-sublease agreement with XXXXX[.]

4. According to the sub-sublease agreement, XXXXX was to construct a semi-detached house on the lot. The land and building are to be subleased to the XXXXX for 99 years less three days for $XXXXX consideration plus GST. The words of demise read as follows:

XXXXX in consideration of the money paid by the Sub-Sublessee and other terms and conditions contained in this sub-sublease, does hereby demise and lease the following lands and premises to the Sub-Sublessee (hereinafter called the "Leased Premises"):

XXXXX with improvements thereon (hereinafter referred to as the "lot") from XXXXX hereinafter called the "demised term") at which time the lot and all improvements thereon will revert to XXXXX

The agreement also stipulates that:

(a) the XXXXX are to maintain damage and liability insurance, satisfactory to XXXXX with respect to the improvements;

(b) at the termination of the lease, the XXXXX are to surrender the leased premises to XXXXX; which improvements are to be in good and substantial repair and condition and, "all improvements thereafter shall be the wholly owned property of XXXXX";

(c) in the event of default, XXXXX can declare the lease to be at an end and title to the buildings, fixtures improvements shall vest in XXXXX with the XXXXX not being entitled to any refund of the purchase moneys paid for the leased premises.

(d) the XXXXX are entitled to mortgage and assign or sublease their leasehold interest.

5. XXXXX consent to the sub-sublease describes the arrangement as an assignment of sub-lease, however, the XXXXX consent describes the arrangement as a sub-sublease.

Interpretation Requested

You have asked us whether this transaction can best be characterized as:

(i) an assignment (i.e. a sale for GST/HST purposes) of a leasehold interest in a land and house;

(ii) a lease of land and house; or

(iii) a lease of land and sale of the house.

Interpretation Given

Based on the information provided, we are of the opinion that this transaction constitutes a sublease of a residential complex comprising both the residential unit and the subjacent and adjacent land. There is no sale to the purchasers of the XXXXX interest in the property.

Analysis

Sale v. Lease

Essential Elements of a Sale

The definition of "sale" as set out in subsection 123(1) of the Act includes a transfer of ownership or a transfer of ownership pursuant to an agreement to transfer ownership. Likewise Policy P-111R, "The Meaning of Sale With Respect to Real Property", describes a transfer of ownership as generally meaning a transfer of legal ownership.

It should be noted that the definition of "sale" in the Act is not exhaustive. In general, a sale refers to any transaction in which a vendor transfers all of his rights and obligations with respect to a given property to another person. These rights include the rights of possession, the right to alter or destroy the property and the right to dispose of the property. Black's Law Dictionary (Sixth Edition) in comparing a sale with a bailment, notes that a sale, "never involves the return of the article itself, but only consideration in money".

Note that, according to the GST/HST Memoranda Series, Chapter 19.1 entitled, "Real Property and the GST/HST", the concept of a sale applies not only to transfers of legal title but also to transfers of equitable interests. Thus, a transfer of a leasehold interest by way of assignment could be considered to be a sale where all the rights and obligations under that lease are conveyed to another person.

Essential Elements of a Lease

The term "lease" is not defined in the Act, however, Black's Law Dictionary (Sixth Edition) states that a lease is a contract for exclusive possession for a term that is less than that of the lessor. It goes on to note that at the end of the term the owner has an absolute right to retake, control and use of the property.

Analysis of the Substantial Terms of the Lease Agreement

An analysis of the substantial terms of the sub-sublease support the conclusion that the agreement is a lease because XXXXX does not fully divest itself of all its rights and in retains certain responsibilities in respect of the property.

The key element that stamps this agreement as a lease is that the agreement is for a fixed length of time. It expires after 99 years or after the expiration of the two renewals which are set out in the agreement. A time limitation of some sort is an essential element to a lease and is incompatible with a sale of an interest.

Another distinguishing feature of the agreement is XXXXX reversionary interest in the property. When the agreement comes to an end, the XXXXX are to surrender possession of the premises to XXXXX. Moreover, the surrendered property must be in good repair. Similarly, in the event of a breach by the XXXXX of any of the conditions of the agreement, XXXXX is entitled to terminate the agreement, and have the property vest in it without paying any compensation to the XXXXX[.] These rights are fundamental elements of a lease arrangement and are inconsistent with an outright sale.

In addition to the basic rights outlined above, XXXXX retains a certain measure of control over the property by virtue of provisions that require the XXXXX to maintain insurance on the improvements, to maintain and repair the improvements.

The ongoing commitment by XXXXX towards the property is demonstrated by their requirement to arrange for the provision of utility services to the XXXXX and to arrange with the head lessee for the provision of garbage pick up and road clearing.

A party may of course supply certain elements of a residential complex by way of a sublease and other elements of the complex by way of a sale or assignment of lease. However, nothing in this agreements accords different treatment to any of the elements of the residential complex. The words of demise, in the lease agreement convey both the land and building and all of the other terms and conditions of the agreements apply equally to all elements of the residential complex, with the exception of such items such as the tenants' obligation to insure the buildings and improvements. It therefore appears that all the elements of the residential complex are supplied entirely by way of sublease and not by way of sale or by some combination of sale and lease.

Form of the Document

The form of the agreement further supports the conclusion that a lease is being created. The agreement is called a "sub-sublease" agreement, the XXXXX are described as sub-sublessees, the agreement contains a covenant for quiet enjoyment, and all of the references in the agreement characterize the rights given to the XXXXX as being in the nature of a leasehold interest.

Note, however, that XXXXX consent describes the document as an assignment of sublease.

Conclusion

Based upon an analysis of the form and substance of the agreement, XXXXX has made a supply of its sublease interest by way of a sub-sublease and not by way of assignment.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-4393.

Yours truly,

Michael Ezri
Real Property Unit
Financial Institutions & Real Property Division
GST/HST Rulings and Interpretations Directorate