Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Are certain amounts amounts set out on the taxpayer's balance sheet as "secured receivables" eligible for an investment allowance under subsection 181.2(4)? In particular, are the amounts "loans and advances" within the meaning of paragraph 181.2(4)(b)? Landlords party to standard form lease agreements opted to pay tenant inducements over a period of 20 years. The taxpayer, in some years, accounted for the amounts payable as "secured receivables" on its balance sheet and in others, as deferred income. The taxpayer reduced the cash payments it made for its rents by the amounts owing from the landlords, but did not reduce its rent expenses by the amount set off.

Position: The amounts are not loans or advances for the purposes of 181.2(4)(b). Rather, the amounts constitute indebtedness of another corporation. The indebtedness is not in respect of any loan or advance to the other corporation, nor does it satisfy the formal requirements of the obligations of a note for the purposes of paragraph 181.2(4)(c). Therefore, no investment allowance may be claimed in respect of the amounts.

Reasons: There appears to be no lender and borrower relationship between the taxpayer and its landlords. The taxpayer has not delivered any money to its landlords that is subject to repayment. Therefore, the amounts are not loans. No amounts have been paid by the taxpayer to its landlords before due. Rather, the taxpayer is offsetting its rent liabilities as they arise against concurrent obligations from the landlords to make payments in respect of the amounts. Therefore, the amounts are not advances. The "allowance" provision in the standard lease does not appear to satisfy the formal requirements of a note. Therefore, there is no basis upon which the taxpayer could claim an investment allowance in respect of the amounts. It is not relevant whether the amount is "indebtedness in respect of a lease" for investment allowance purposes.

March 21, 2001

TORONTO CENTRE TSO					HEADQUARTERS
R. Maley
Attention:  Katrin Cowan					(613) (957-9226)

2000-005629
XXXXXXXXXX

This is in reply to your memorandum of November 9, 2000, regarding the application of Part I.3 to certain amounts amounts set out as "secured receivables" ("the amounts") on the above-noted taxpayer's balance sheet. In particular, you have asked for our comments as to whether the amounts are loans and advances within the meaning of paragraph 181.2(3)(c) or "indebtedness in respect of a lease" within the meaning of paragraph 181.2(3)(f). As we understand it, the taxpayer has submitted that the amounts receivable constitute loans and advances to several of its landlords pursuant to their respective tenancy agreements and as such, qualify for an investment allowance pursuant to paragraph 181.2(4)(b).

In our view, the amounts are not loans or advances for the purposes of 181.2(4)(b). Rather, the amounts constitute indebtedness of another corporation. The indebtedness is not in respect of any loan or advance to the other corporation, nor does it satisfy the formal requirements of the obligations of a note for the purposes of paragraph 181.2(4)(c). Therefore, no investment allowance may be claimed in respect of the amounts. Our detailed comments follow.

Background

Your memorandum was based on amounts set out in "standard form" lease agreements, an example of which was attached to your memorandum dated November 9, 2000.

Each leasing agreement contained the following provision:

XXXXXXXXXX.

We understand that most of the landlords party to the standard form agreements opted to pay the allowance over the period of XXXXXXXXXX years, as permitted by the leases. The taxpayer has accounted for the amounts payable in respect of the allowances as "secured receivables" and as "deferred rent receivables" on its balance sheet (referred to in this opinion, in both cases, as "the amounts"). For accounting purposes, the taxpayer has set off the amounts against its rent by reducing the cash payments made to the landlords for rent. The taxpayer's view is that the amounts are loans and advances for investment allowance purposes.

Opinion

The title ascribed to an amount on a taxpayer's balance sheet does not determine its capital tax treatment. Rather, it is the legal nature of the amount that is relevant. For example, see Autobus Thomas Inc.¹ Therefore, the fact that the amounts have been referred to on the taxpayer's balance sheets both as "secured receivables" and "deferred rent receivables" would not affect the eligibility or ineligibility, as the case may be, of the amounts for an investment allowance.

If the taxpayer is to claim an investment allowance in respect of the amounts, it must establish that the amounts constitute a loan or advance to another corporation (other than a financial institution) in accordance with paragraph 181.2(4)(b) or that the amounts are indebtedness of another corporation represented by a note or similar obligation in accordance with paragraph 181.2(4)(c).

In order for there to be a loan at law, it is necessary that there be a delivery of the subject of the loan by the lender to the borrower and that there be an obligation on behalf of the borrower to return the subject matter of the loan. For example, see the definition "loan" adopted in McVey and McVey² and Simmonds & Sons.³

In this case, there does not appear to have been any advance of funds from the taxpayer to the landlords or to third persons at the direction of the landlords. Based on the information provided, there appears to be no lender and borrower relationship between the taxpayer and its landlords. The taxpayer has not delivered any money to its landlords that is subject to repayment. Rather, the amounts owing arise from the obligations set out in the leases. Therefore, the taxpayer has not "loaned" any amounts to its landlords for the purposes of paragraph 181.4(3)(b).

The concept of an "advance" for Part I.3 purposes was defined in Oerlikon Aerospatiale⁴ as having two distinct meanings. First, it includes loans. Second, it includes amounts paid before they are due. As noted above, the amounts at issue do not appear to have the character of loans to the landlord. The question whether they may be viewed as advances to the landlord depends upon whether amounts have been paid to the landlord before they are due.

It does not appear, however, that any amounts have been paid by the taxpayer to its landlords before due. Rather, the facts suggest that the taxpayer is offsetting its rent liabilities, as they arise, against concurrent obligations from the landlords to make payments in respect of the amounts. In absence of evidence establishing that the allowance obligations of the landlords have been legally settled by prepayment of rent, our view is that the secured receivables do not constitute advances for the purposes of paragraph 181.2(4)(b).

The taxpayer's view that the amounts constitute "loans or advances" for investment allowance purposes seems to be founded upon its balance sheet presentation of the amounts as "deferred rent receivables". Deferred income, for accounting purposes, is an amount received or recorded as receivable but not yet earned and meanwhile carried forward to be taken into income over a period of years: E9303470. Generally, deferred income will constitute a reserve for the purposes of paragraph 181.2(3)(b), to the extent that the amount has not been deducted for the purposes of Part I of the Act. The deferred income may also constitute an advance to the person within the meaning of paragraph 181.2(3)(c) or other indebtedness within the meaning of paragraph 181.2(3)(f) depending on the factual circumstances: E9303470.

Where deferred revenue has been legally earned but not received in cash, Rulings position is that the amount is included in capital as a reserve or other surplus: see E9614387, E9828577. Whether or not an amount has been earned is a question of law, not accounting presentation: see E9828577; E2000-0054507.⁵ In the present case, the taxpayer does not have to perform any additional services or provide any further goods to its landlords in order to be entitled to the deferred rent receivables; therefore, the amounts have been earned. Thus, even if the amounts may appropriately be viewed as deferred rent receivables (a characterization or description with which we do not agree), there is no basis upon which the taxpayer could claim an investment allowance as no investment allowance is available in respect of reserves and other surpluses of a corporation.

Rulings position is that deferred revenue received in cash generally constitutes an advance: E9614387, as in those circumstances, the amounts are paid before they are due in accordance with the definition "advance" confirmed by the Federal Court of Appeal in Oerlikon Aerospatiale, supra. It is to be noted that, however, under this reasoning, the deferred income constitutes an advance received by the person who has recorded the deferred revenue and not an advance made by that person. Thus, that person would include the amount of the deferred revenue in its capital. No amount could be claimed as an investment allowance in respect of the deferred revenue as paragraph 181.2(4)(b) only allows an investment allowance in respect of advances to other corporations.

Indebtedness represented by bonds, debentures, notes, mortgages or similar obligations is included in the issuer's capital under paragraph 181.2(3)(d) and deducted from the holder's capital under 181.2(4)(c). In legal and commercial language, the word "note" is used interchangeably with "promissory note".⁶ It is always a question of fact whether or not particular agreements in writing constitute notes at law.

Subsection 176(1) of the Bills of Exchange Act⁷defines a promissory note as follows:

A promissory note is an unconditional promise in writing made by one person to another person, signed by the maker, engaging to pay, on demand or at a fixed and determinable future time, a sum certain in money to, or to the order of, a specified person or to bearer.

In our view, the "allowance" provision in the sample lease is not sufficient, in and of itself, to render the lease a "note" in respect of the allowance obligation for capital tax purposes. For example, it does not identify a sum certain to be repaid. (While the total amount of the allowance is specified by way of a formula based on square footage, it does not specify how much of that amount will be the subject of the note) Unless there exists collateral written instruments satisfying the necessary formality in respect of the amounts, our view is that no investment allowance is available under paragraph 181.2(4)(c).

Having concluded that the amounts do not constitute loans, advances or notes for the purposes of subsection 181.2(4), our conclusion is that there is no basis upon which the taxpayer could claim an investment allowance in respect of the amounts.

However, as a final comment, we would like to briefly address comments in your memorandum respecting "indebtedness in respect of a lease" within the meaning of paragraph 181.2(3)(f). Your referral notes that Rulings opinion E912735 has confirmed that no capital inclusion and no investment allowance is available in respect of such amounts. In particular, you have referred to opinion E912735 which provides as follows:

Accordingly, it is the view of the Department that any indebtedness in respect of a lease is not synonymous with any of the terms used in paragraphs 181.2(3)(d) and 181.2(4)(c) for the purposes of the calculation of the capital and the investment allowance of a corporation respectively.

In determining whether an amount is included in capital or qualifies for an investment allowance a determination must be made whether the amount is described in 181.2(3)(d) or 181.2(4)(c) irrespective of whether it is indebtedness in respect of a lease. If it is not described in 181.2(3)(d) and it is indebtedness in respect of a lease, then it is other indebtedness that would not be included in capital pursuant to 181.2(3)(f). Such amount would not qualify for an investment allowance as there is no provision in 181.2(4) which includes other indebtedness in respect of a lease.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the Canada Customs and Revenue Agency's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version, or they may request a copy severed using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (613) 994-2898. A copy will be sent to you for delivery to the client.

F. Lee Workman
Manager
Financial Institutions
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch

ENDNOTES

¹ 99 DTC 259 (TCC) affd on appeal 2000 DTC 6299 (FCA).

² 96 DTC 1225 (TCC)

³ 89 DTC 707 (TCC)

⁴ 99 DTC 5318 (FCA)

⁵ XXXXXXXXXX.

⁶ For example, see Federated Co-operatives Limited 2000 DTC 1946 (TCC).

⁷ Statutes of Canada, c. B-4.