10 October 2000 GST/HST Interpretation 32279 - Section 167 Election and Leased Property

Dear XXXXX

Thank you for your letters of July 14 and August 8, 2000, concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to a number of situations outlined therein.

Interpretation Requested

You have requested confirmation as to how the section 167 election is being administered with respect to leased property. In particular, you wish clarification of how a leased asset is accounted for in calculating whether a purchaser has acquired use to "all or substantially all" of the assets needed to operate a business (i.e., for the calculation, what value is attributed to the leased asset in both the numerator and denominator).

You have submitted the following examples. In these examples you have assumed that a business is being acquired and that "all or substantially all" means 90%.

Example 1

A business is made up of the following assets, with the following values (no other assets are required or used in operating the business):

If the purchaser buys the Equipment and Inventory from the Vendor for $85,000 can the purchaser use section 167 if it leases the property in the following situations:

Situation 1

Purchaser enters into a one-year lease with the Vendor with the monthly rent being $5,000. As the rent is excessive given the value of the property, the fair market value of the lease is negligible (probably a liability).

How would you calculate whether the purchaser is acquiring use to 90% or more of the Assets?

Situation 2

Purchaser enters into a twenty-year lease with monthly rent of $1,000. As this is the going rate for the facilities, the lease is still not a valuable asset (minimal value if anything).

Is the purchaser acquiring use to all or substantially all of the assets?

Example 2

Assume the same facts and values as Example 1; however, the Vendor does not own the Real Property, but rents the property from a third party (20-year lease with monthly rent of $1,000).

Once again, the value of the property is $100,000 but the value of the lease is negligible given that rent is equal to or higher than the going rate.

If the purchaser assumes the entire lease, and acquires all assets other than the intellectual property, is the purchaser acquiring use to 90% of the assets?

For the "all or substantially all" calculation, what value would be included for assets which the purchaser acquired "use to" and what value for assets "required to operate the business".

If the value of the lease is used, the purchaser will only have acquired use to 85% of the requisite assets. If either the value of the building or the present value of the lease stream is used, the 90% test would be satisfied.

Example 3

Same fact situation as Example 2, however, instead of the rental payment being $1,000 (fair market value), the rental payments are only $500. In this situation, the lease has been valued at $50,000. Accordingly, the purchaser pays $135,000 for the business.

Is the "all or substantially all" test satisfied, and what calculation would you use?

Example 4 (in letter dated August 8, 2000)

If the vendor does not own the real property used in the business but holds it as a tenant on a month to month lease, how would the "substantially all" calculation be made:

(a) where the purchaser assumes the lease?

(b) where the purchaser does not assume the lease, but acquires use of the necessary real property elsewhere?

Interpretation Given

Based on the information provided, we have the following comments:

In order that the parties may be eligible to use the section 167 election, the recipient, under the agreement with the supplier, must acquire ownership, possession or use of all or substantially (generally 90% or more) of the property required to carry on the supplier's business.

It should be noted that even where the recipient meets the "substantially all" test, another test must first be met; the supplier must be supplying a business or part of a business.

In these examples, there is some question as to whether a business is actually being purchased. Generally, if the intellectual property required to carry on the business is not being supplied under the agreement, it would appear that various assets, rather than a business is being supplied. As well, the agreement for the supply of an existing business generally would include an element of goodwill and would likely include other items such as customer lists, supplier and customer contracts, provision for transfer of employees, etc.

However, for discussion purposes, it will be assumed that, in these examples, a business is being supplied by the supplier under the agreement with the recipient.

Example 1:

In this example the recipient, under the agreement, is acquiring possession and use of the real property by way of lease from the supplier of the business (who owns the real property), but certain other necessary assets are not being acquired from the supplier. (It should be noted that the section 167 election itself does not apply to property supplied under the agreement by way of lease, but this property is included for the purpose of determining whether the "substantially all" test is met.). Generally, our view is that both the term and the value of the lease (i.e., the present value of the stream of lease payments) that is used to evaluate the "all or substantially all of the property" requirement, must be within the norms of the relevant industry. It would be the responsibility of the persons making the election to provide this value, based on the normal commercial practices of the industry and any specific provisions in the lease agreement.

Examples 2 and 3:

In these examples, the supplier is assigning his interest under the lease to the recipient.

An assignment of a commercial real property lease is considered to be a sale of real property since a lessee that transfers its leasehold interest to a third party is transferring the ownership of the real property (that is, the ownership of the leasehold interest) and therefore is making a sale of real property. Accordingly, the value assigned to the assignment of the lease in the sales agreement would generally be the value used in making the calculation for the purposes of the section 167 election, as is the case with any other asset that is sold. With respect to the valuation of the business assets sold, normally the allocation of the purchase price in the agreement for sale of these assets would be used in determining whether the "substantially all" test has been met, if this allocation is reasonable in the circumstances.

Example 4

It is always a question of fact whether the "substantially all " test is met. In some cases, the requirements may depend on the norms of the relevant industry or may be unique to the specific business. As this particular example (i.e. the month to month lease of the premises of an ongoing business which is then sold) appears likely to be extremely rare, it is not possible to provide any opinion, as the actual agreements and the particular surrounding circumstances would have to be considered.

In addition to our comments with respect to the specific examples above, we have the following general comments.

It is the CCRA's view with respect to the administration of the section 167 election, that the unique context and specific facts of a transaction would need to be taken into account, in the determination of whether "substantially all" of the necessary property is being acquired by the recipient under the agreement.

We have noted the issues that you have raised in your correspondence and will take these into consideration during our ongoing review of the CCRA's administration of the section 167 election.

Should you wish to submit a ruling request for a particular transaction that raises some of these issues, we would be pleased to examine the situation in detail at that time.

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 Canada Customs and Revenue Agency with respect to a particular situation.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at 952-1512.

Yours truly,

Mark Seigel
Corporate Reorganizations Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate