5 December 2003 GST/HST Interpretation 44874 - Concurrent Lease

Please note that the following documents, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ces documents, bien qu'exacts au moment émis, peuvent ne pas représenter la position actuelle de l'Agence.

Dear XXXXX:

Thank you for your e-mail XXXXX, with attachments, concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to payments made under the XXXXX. We apologise for the delay in responding.

Interpretation Requested

Whether the XXXXXAgreement between XXXXX XXXXX and XXXXX qualifies as a lease for the purposes of the Excise Tax Act (ETA).

Interpretation Given

Based on the information provided,

The XXXXX agreement between XXXXX XXXXX XXXXX and XXXXX qualifies as a lease for the purposes of the ETA.

Explanation

Our interpretation is based on the following facts:

1. XXXXX (Lessor) entered into a XXXXX (Concurrent Lease) with XXXXX as Performance Guarantor and the XXXXX XXXXX, a trust established under the law XXXXX (Concurrent Lessee) on XXXXX.

2. The Lessor owns various leases including equipment leases referred to as Standard Form Leases in XXXXX the Concurrent Lease. According to XXXXX

... XXXXX

3. A Standard Form Lease agreement drafted by XXXXX (Asset Lease) and accepted by the Lessor describes a typical Standard Form Lease used by the Lessor. This Asset Lease is between a supplier of the equipment (lessor) and the user of the equipment or lessee of the equipment (Asset Lessee). According to XXXXX the Asset Lease the supplier or lessor has the right to sell or assign its rights under the Asset Lease without the written consent of the Asset Lessee. XXXXX the Lessor under the Concurrent Lease, accepts the Asset Lease and the Lessor becomes the owner of the assets under the Asset Lease, subject to the rights of the Asset Lessee under the Asset Lease. XXXXX the Asset Lease indicates that the Lessor retains ownership to the equipment and the agreement is not intended to be a security agreement.

4. The Lessor also gives the Asset Lessee an option to purchase the equipment on an option date set by the Lessor at a prescribed option amount. In order to exercise the purchase option the Asset Lessee is required to give the Lessor XXXXX days written notice prior to the option date.

5. XXXXX the Concurrent Lease describes the rights received by the Concurrent Lessee as follows:

XXXXX The Lessor acknowledges that the Concurrent Lessee has the rights of possession to the leased assets subject to the rights of each Lessee under the Asset Lease (XXXXX and XXXXX the Concurrent Lease).

6. The term of the Concurrent Lease relates to the term of each Asset Lease. Each Concurrent Lease will commence on the lease date set out on the Asset Lease and ends "... XXXXX (XXXXX the Concurrent Lease). The Lessor has indicated that the XXXXX-month extension was necessary to enable the Concurrent Lessee to collect on all the payments associated with the pledged assets.

7. As consideration for the grant of the Concurrent Lease the Concurrent Lessee;

... XXXXX

8. The Lessee is also given the option to pre-pay rent in accordance with XXXXX the Concurrent Lease. The pre-payment option includes the payment of deferred rent as described in each monthly XXXXX report. In general, as described in a lease request XXXXX, the pre-paid rent amounts to approximately XXXXX% of the net present value of the Asset Leases.

9. A monthly XXXXX Report XXXXX provides a detailed description of the Leased Assets and deferred rent payments. This report includes information on the net present value of the Leased Assets, the balance in the Deferred Rental Account and information on overdue lease payments. These Asset Leases are accounted for as direct financing leases for accounting purposes.

10. The Concurrent Lessee is registered for GST and satisfies its obligations relating to GST on Prepaid Rent and Deferred Rent by providing the Lessor with a promissory note (XXXXX the Concurrent Lease).

11. On the termination of each Concurrent Lease the Concurrent Lessee is required to re-assign or re-convey all its rights in the Asset Leases and leased assets to the Lessor (XXXXX the Concurrent Lease).

12. According to a Declaration of Trust XXXXX, the Concurrent Lessee was set up as a Trust for the purpose of producing income for its beneficiaries that are XXXXX. The Declaration of Trust indicates that the activities of the trust include the XXXXX (XXXXX Declaration of the Trust). The Trust Indenture between the Concurrent Lessee as Issuer and XXXXX as Indenture Trustee XXXXX describes the various categories of notes issued to investors under the securitization process. The securitized assets include lease rights including the right to the payment of money under the lease XXXXX the Trust Indenture).

13. The Concurrent Lessee appoints the Lessor as the Servicer responsible for the administration of the leases (XXXXX Concurrent Lease). The Lessor has all the powers necessary for the administration and enforcement of the Asset Leases (XXXXX the Concurrent Lease).

14. The Lessor does not receive an additional fee for its duties as a Servicer. However, if a replacement is hired the Concurrent Lessee has the option of paying this person a service fee (XXXXX the Concurrent Lease).

If the Concurrent Lease qualifies as an arrangement that is similar to a lease as referred to in subsection 136(1) and the definition of "debt security" in subsection 123(1) of the ETA the Concurrent Lease will qualify as a lease for the purposes of the GST. The Blacks Law Dictionary (sixth edition) defines a lease of tangible personal property as:

A contract by which one owning such property grants to another the right to possess, use and enjoy it for [a] specified period of time in exchange for periodic payment[s] of a stipulated price, referred to as rent. Undercofler v. Whiteway Neon Ad Inc., 114 ga. App. 644, 152 S.E. 2nd 616, 618

A Concurrent Lease is defined as:

One granted for a term which is to commence before the expiration or other determination of a previous lease of the same premises made to another person; or, in other words, an assignment of a part of the reversion, entitling the lessee to all the rents accruing on the previous lease after the date of his lease and to appropriate remedies against the holding tenant.

As described in the definition referred to above, a concurrent lease arises when the Lessor grants a second lease for the same property. In effect a head lease is interposed between the Lessor and the Asset Lessee and the Concurrent Lessee receives the benefit of the existing or original lease under the sublease.

The first element of a lease is the right to possess and enjoy the property; the second element is a specified period of time and the third is the periodic payment in return for possession.

The first element is satisfied as the Concurrent Lessee is given the rights of possession enjoyed by the Lessor under the Asset Lease (XXXXX the Concurrent Lease).

The second requirement is met as the Concurrent Lease commences on the lease date on the Asset Lease and ends XXXXX months later. The third requirement is also met as the periodic payment for possession is also clearly stipulated as the Concurrent Lessee is given the option of either paying XXXXX% of the rents received under the Asset Leases or paying XXXXX% of the net present value of the Asset Leases and deferred rent. Therefore, the legal form of the agreement indicates that a lease exists between the Lessor and the Concurrent Lessee.

The next issue is whether the Concurrent Lease qualifies as a concurrent lease. As the Concurrent Lessee has the right to possession under the lease instead of the Lessor XXXXX, and the Lessor's right to the reversion is subject to the rights of the Concurrent Lessee for the duration of the lease XXXXX, the Concurrent Lessee receives the rights to part of the reversion as referred to in the definition of Concurrent Lease referred to above. The Concurrent Lease commences before the expiration of the Asset Lease (XXXXX the Concurrent Lease) as required by the definition of Concurrent Lease. We recognize that the Concurrent Lease ends XXXXX months after the Asset Lease however, the Lessor has confirmed that this date was set for administrative purposes to ensure the collection of all amounts owing under the Asset Lease. The structure of the Concurrent Lease agreement recognizes that the proper administration of the leases is an essential part of the Concurrent Lease agreement and the Lessor is appointed as the Servicer to administer the various Asset Leases. The Concurrent Lease between the Lessor and the Concurrent Lessee qualifies as a concurrent lease as it has the elements referred to in the definition of a concurrent lease.

The CCRA has indicated that a concurrent lease where the agreement is considered to be a lease will be considered to be an operating lease for GST purposes. We have also suggested that in situations where the Lessor collects the rent as Servicer on behalf of the trust (otherwise than as Agent) the Lessor as Servicer will be liable to remit the GST and the CCRA's policy on third party remittances (GST/HST Policy Statement P-131: Remittance of Tax by a Third Party) could be applied to avoid double taxation.

The words "similar arrangement" in subsection 136(1) and in the definition of "debt security" as defined in subsection 123(1) of the ETA indicates that arrangements that are similar to leases are included for the purposes of these sections. Therefore, it is likely that a Concurrent Lease will qualify as a "similar arrangement" for the purposes of subsections 136(1) and the definition of "debt security" in subsection 123(1) of the ETA.

We also recognize that Asset Leases owned by the Lessor are classified as Financing Leases for accounting purposes. However, we have indicated that the concept of a lease for the purposes of the definition of "debt security" in subsection 123(1) of the Excise Tax Act does not differentiate between financing leases and operating leases.

The existence of an option to purchase that characterizes a lease, as a conditional sale for Income Tax purposes does not automatically result in the lease becoming a conditional sale contract under the ETA. If the lease qualifies as a lease at law it will generally qualify as a lease for GST purposes. Therefore, the option to purchase granted by the Lessor does not necessarily result in a change in the characterization of the Concurrent Lease. As the Asset Lessee is required to provide written notice to invoke the option, the option to purchase does not qualify as an automatic transfer of the Asset to the Asset Lessee. Therefore, granting an option does not always change the characterization of the Lease for GST purposes.

In general, the CCRA has indicated that financing leases where the underlying property is transferred to the financial institution qualifies as a taxable sale of a lease rather than a financing arrangement. By accepting the Asset Lease the Lessor has purchased the underlying property subject to the rights of the Asset Lessee under the Asset Lease.

The Supreme Court of Canada in Shell Canada vs. The Queen 99 DTC 5682 (SCC) criticized the substance over form doctrine. In Shell Canada the Supreme Court suggested that the economic realities of the situation should not re-characterize a bone fides legal relationship. Therefore, in the present situation the form of the Concurrent Lease should be respected.

In general, we have indicated that the form of the lease agreement should be respected where the Lessor has title to the underlying property. In the present situation the Concurrent Lease indicates that the Lessor has title to the Asset Leases and grants the rights of possession under the Asset Leases to the Concurrent Lessee in consideration for payments of rent. The rights of possession acquired under the Concurrent Lease include the administration of these leases, which is delegated to the Lessor as the Servicer of the Asset Leases. Therefore, this Concurrent Lease will qualify as an arrangement that is similar to a lease as referred to in subsection 136(1) of the ETA and in the definition of "debt security" in subsection 123(1) of the ETA.

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,

Manjula Vethanayagam
Financial Institutions Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate