12 April 2000 GST/HST Interpretation 8394/HQR0002000 - Sale-leaseback Arrangements - Entitlements to ITCs

Dear XXXXX

Thank you for your letter of October 20, 1999 concerning the application of the Goods and Services Tax (GST) and entitlement to Input tax credits (ITC) to your client's sale-leaseback transaction.

Statement of Facts

Our understanding of the facts and the transactions is as follows:

The Registrant constructs a Facility that is real property for the express purpose of selling the Facility to another party, the Purchaser/lessor, who will then lease back the said Facility to the Registrant for consideration. The Registrant's intention is to use the leased-back Facility in activities for which it would be entitled to only partial, or no ITCs.

For a number of non-GST reasons, the Registrant needs to be involved directly with the construction of the Facility, as owner, and thereby incur the GST costs related to the construction prior to selling the Facility to the Purchaser/lessor. The Registrant also incur the GST costs on the purchase of the land.

The Purchaser/lessor is a wholly-owned subsidiary of the Registrant, whose business is the holding of properties to be leased, for consideration, to the Registrant. The Registrant and the Purchaser/lessor enter into a written sale-leaseback agreement before the construction of the Facility is completed. When the Facility is complete, but prior to its being commissioned to use by the Registrant, the Registrant transfers the Facility by way of sale to the Purchaser/lessor. The purchase price for the sale is the cost to the Registrant of the land and construction of the Facility. The Purchaser/lessor leases the entire Facility to the Registrant and charges GST on the rental fee.

The Facility is not a "residential complex" and there was no election under ETA section 150 made between the Registrant and the Purchaser/lessor.

Your arguments are that:

•   The Registrant's sale of the Facility to the Purchaser/Lessor is a GST-taxable supply that is made in the course of commercial activities.

•   The Registrant is entitled to claim full ITCs with respect to its acquisition of the land and the construction of the Facility, in the current periods prior to the sale of the Facility to the Purchaser/Lessor.

•   GST will apply to the Purchaser/Lessor's leaseback of the Facility to the Registrant.

•   The Purchaser/Lessor will be entitled to claim full ITCs with respect to the purchase price for the Facility, and its other costs in relation to the leasing the Facility to the Registrant.

Interpretation Requested

1. Are the construction and sale of the Facility by the Registrant commercial activities as defined under ETA paragraph 123(1)(c) "commercial activity", and therefore GST taxable supplies?

2. Since the Registrant's ultimate intended use of the Facility would be in activities that would not entitle it to claim full ITCs, are we allowed to look at the Registrant's first-order supply for purposes of determining ITC entitlement?

3. Is the Purchaser/Lessor's lease of the Facility to the Registrant a GST-taxable supply?

4. If the Purchaser/Lessor's lease of the Facility to the Registrant is a GST-taxable supply, is it entitled to full ITCs with respect to its purchase of the Facility and with respect to its ongoing operations?

Interpretation Given

Based on the information provided, our interpretation is given in the same order as the questions posed:

1) Yes, both the construction and sale of the Facility are commercial activities as defined under paragraph 123(1)(c) of the definition of "commercial activity", and therefore GST taxable supplies.

In order to conclude that the sale of the Facility is a GST-taxable supply, the sale must be a supply that is made in the course of commercial activities of the Registrant. According to the information you provided on behalf of your client, the Registrant makes both taxable and exempt supplies.

The definition of "commercial activity" in ETA paragraph 123(1)(c) include:

"the making of a supply (other than an exempt supply) by the person of real property, including anything done by the person in the course of or in connection with the making of the supply."

Hence, the sale of the Facility to the Purchaser/lessor will be "the making of a supply of real property". Is it an exempt supply? The Facility being sold does not fall within the exemption listed in Schedule V to the ETA, so it is not excluded from the definition of "commercial activity".

With regards to the construction of the Facility subsequently sold to the Purchaser/lessor, to conclude that it is a commercial activity of the Registrant, it must have been undertaken "in the course of or in connection with the making of the supply". I agree with your position that there is a direct connection between the construction of the Facility and its sale, and consequently, the construction of the Facility was undertaken in the course of or in connection with the supply of the Facility to the Purchaser/lessor.

2) Yes, it is the Canada Customs & Revenue Agency's position on sale-leaseback transactions that one must look to the first-order supply, not the ultimate intended use, for purposes of determining ITC entitlement.

The "first order supply" is generally discussed in relation with subsections 141.01(2) and (3) of the ETA. These subsections require that a person determine whether it acquired or imported property or services, for the purpose of an endeavour that involves the making of supplies for consideration. For this case, we must determine if the construction of the Facility was made for the purpose of making a taxable supply to the Purchaser/lessor according to ETA subsections 141.01(2) and (3).

I agree with your position that the Registrant's intended first-order supply is a taxable sale of the Facility and thus the Registrant should be entitled to claim full ITCs on a current basis with respect to the GST paid on its inputs to construct the Facility.

3) Yes, the Purchaser/Lessor's lease of the Facility to the Registrant is a GST-taxable supply.

In order to conclude that the lease of the Facility is a GST-taxable supply, the lease must be a supply that is made in the course of commercial activities of the Purchaser/lessor. The information you provided on behalf of your client is that the Purchaser/lessor's business consists of the holding of properties to be leased, for consideration, to the Registrant and that the Purchaser/lessor is charging GST on the rental fee.

In accordance with the definition of "commercial activity" in paragraph 123(1)(c) of the ETA and of "supply" in paragraph 123(1) of the ETA, the Purchaser/lessor is making a supply of real property be way of lease to the Registrant for consideration, although they are related. Is it an exempt supply? The Facility being leased does not fall within the exemption listed in Schedule V to the ETA, so is not excluded from the definition of "commercial activity". Also, there was no election under ETA section 150 made between the Registrant and the Purchaser/lessor and, accordingly, the Registrant is making taxable supplies.

However, the Registrant should be made aware of subsection 155(1) since the Registrant and the Purchaser/lessor are not dealing at arm's length (Purchaser/lessor is a wholly-owned subsidiary of the Registrant) and the Registrant is not acquiring the property for consumption, use or supply exclusively in the course of its commercial activities. Your view is that when the Registrant is claiming ITCs to recover the GST cost during the construction of the Facility, it does not result in any avoidance of GST but only creates a GST deferral to the Registrant because the Registrant will pay GST on the rental fee for the Facility over the term of the lease. Pursuant to subsection 155(1), your view will be accurate as long as the lease payments are at fair market value.

4) Yes, the Purchaser/lessor will be entitled to full ITCs with respect to its ongoing operations. As for the purchase of the Facility from the Registrant, the Purchaser/lessor will be entitled to claim full ITCs for that purchase if GST was charged by the Registrant.

Subsection 169(1) of the ETA provides that, where property or a service is acquired or imported for consumption, use or supply by a Registrant, the Registrant is entitled to claim an ITC for the tax which is paid or payable based on the acquisition or importation to the extent to which the property or service is for consumption, use or supply in a commercial activity of the Registrant.

In this case, the Purchaser/lessor is entitled to full ITCs because, from the information you provided, the Purchaser/lessor will be acquiring the Facility exclusively for use in its commercial activities.

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 & 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 (613) 941-2046.

Yours truly,

Nathalie Joly
Financial Institution Unit
Financial Institutions & Real Property Division
Excise and GST/HST Rulings Directorate