25 September 2003 GST/HST Interpretation 42635 - Registrant Trade-ins Involving Outstanding Liens

Dear XXXXX:

This is in response to the letter XXXXX from XXXXX of your office to the XXXXX GST/HST Rulings office, concerning the application of the Goods and Services Tax (GST)/Harmonized Sales Tax (HST) to a trade-in by a registrant leasing a vehicle where the trade-in is subject to an outstanding lien.

A company in Canada ("the Lessor") leases vehicles to various persons ("the Lessees") in Canada. In many cases, the Lessee will trade in a used vehicle they own as a partial payment for the leased vehicle. In some cases the trade-in will have an existing lien on it. In this situation the Lessor will pay off the existing lien on behalf of the Lessee so that the Lessor has clear title to the trade-in and it can be resold. In paying off the lien, the Lessor has effectively made a loan to the Lessee and that lien loan is factored into the monthly lease payment made by the Lessee.

Technical Information Bulletin B-084, Treatment of Used Goods, addresses the situation where a vehicle with a lien is accepted as a trade-in from a Lessee that is not required to charge GST, and the lien is paid off by the Lessor. TIB B-084 indicates that in this situation GST is not payable on the portion of the monthly lease payment that is the principal and interest being paid by the Lessee in respect of the funds advanced by the Lessor to pay off the lien on the trade-in. However, TIB B-084 does not address the issue of a trade-in with a lien where the Lessee is a GST registrant required to charge GST.

Interpretation Requested

Would GST apply to the portion of the monthly lease payment that represents principal and interest on a lien loan where the person who traded in the vehicle with the lien is a GST registrant required to charge GST on the trade-in?

Interpretation Given

Under subsection 165(1) of the Excise Tax Act (ETA), every recipient of a taxable supply made in Canada shall pay to Her Majesty in right of Canada tax in respect of the supply calculated at the rate of 7% on the value of the consideration for the supply.

Under subsection 153(4) of the ETA, where, at the time a supplier makes a supply of tangible personal property to a recipient, the supplier accepts, in full or partial consideration for the supply, other property (referred to as the "trade-in") that

(a) is used tangible personal property or a leasehold interest therein, and

(b) is acquired for consumption, use or supply in the course of a commercial activity of the supplier, and the recipient is not required to collect tax in respect of the supply of the trade-in, the value of the consideration for the supply made by the supplier is deemed to be equal to the amount, if any, by which the value of the consideration for that supply exceeds

(c) except where paragraph (d) applies, the amount credited to the recipient in respect of the trade-in, and

(d) where the supplier and the recipient are not dealing with each other at arm's length at the time the supply is made and the amount credited to the recipient in respect of the trade-in exceeds the fair market value of the trade-in at the time ownership thereof is transferred to the supplier, that fair market value.

The Lessor is making a supply of the leased vehicle to the Lessee, and accepting the trade-in as partial consideration for that supply. However, subsection 153(4) does not apply to a trade-in by a Lessee that is a registrant if the Lessee is required to charge tax on the supply of the trade-in. There are two taxable supplies being made, and GST will apply to the full consideration on both of them. The Lessor would charge GST on the full consideration for the leased vehicle including the trade-in value, and the Lessee would charge GST on the value of the trade-in. Both the Lessor and the Lessee will be entitled to input tax credits to the extent allowable.

TIB B-084 states that where a person trades in used property for the lease of other property, and the trade-in allowance is used to reduce the capital cost of the property, the GST is calculated on the monthly payments reduced by the amount credited as a trade-in allowance. TIB B-084 also states that where there is an outstanding lien on a trade-in by a person not required to charge GST, the amount of the lien increases the monthly lease payment, but is ignored for purposes of calculating the GST.

The Lessor has extinguished the lien by making a loan to the Lessee. The loan is a debt security, which, as defined in subsection 123(1) of the ETA, means a right to be paid money and includes a deposit of money, but does not include a lease, licence or similar arrangement for the use of, or the right to use, property other than a financial instrument. A debt security is a financial instrument, and the issue or granting of a financial instrument is a financial service under subsection 123(1). As the supply of a financial service is exempt under section 1 of Part VII of Schedule V to the ETA, GST is not calculated on the portion of the monthly lease payment that is in respect of the repayment of the loan.

The analysis in TIB B-084 focuses on trade-ins that meet the conditions of subsection 153(4) of the ETA, and outlines the application of this provision. However, the characterization of the loan by the Lessor in respect of the lien as a debt security is not due to subsection 153(4). When the lien loan is granted to a registrant that trades in a vehicle with an outstanding lien, the loan is a debt security, and the supply will be exempt. GST will not apply to the amount in respect of the lien.

The value of the trade-in by the Lessee will be used to reduce the capital cost, and therefore the monthly payments, of the leased vehicle, while the amount of any outstanding lien will increase the capital cost and the monthly lease payments. However, the GST charged on the monthly payments will not change because subsection 153(4) does not apply to reduce the consideration by the value of the trade-in, and the lien loan is an exempt supply. In most cases where a registrant uses a trade-in to reduce the monthly lease payments, the GST charged each month will be greater than 7% of the actual monthly lease payment.

To illustrate with a numerical example:

A Lessor leases a vehicle costing $35,000.00 to a Lessee that is a GST/HST registrant, and accepts a trade-in worth $10,000.00. The trade-in has an outstanding lien of $6,000.00, and the Lessee is required to charge GST on the supply of the trade-in. The Lessor applies the trade-in value, and the GST on the trade-in, to reduce the capitalized lease cost of the new vehicle. The lease is for a term of 36 months, the residual value of the vehicle is $17,000, and the annual percentage rate ("APR") is 6.0%, such that the money factor is 0.0025.

Calculation of Monthly Lease Payment:

The Lessee in this example would make monthly lease payments of $487.69 plus $44.10 GST. As a GST registrant, the Lessee would also be required to report and account for the $700.00 GST on the supply of the trade-in.

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 (613) 957-8253.

Yours truly,

Jacqueline Russell
Goods Unit
General Operations and Border Issues Division
Excise and GST/HST Rulings Directorate