11 February 2002 External T.I. 2001-0111435 - LEASE OPTION AGREEMENTS

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 CCRA.

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

Principal Issues:

Whether a particular agreement would be considered a lease such that the payments made under the terms of the said agreement would be deductible in computing income for purposes of the Act.

Position TAKEN:

General comments.

Reasons FOR POSITION TAKEN:

See ITTN - 21 - Question of fact to be determined based on the legal relationship created by the terms of the agreement.

XXXXXXXXXX 								2001-011143
P. Diguer
February 11, 2002 

Dear XXXXXXXXXX:

Re: Lease-option agreements

This is in reply to your letter dated November 15, 2001, in which you request our views on the characterization of an arrangement whereby miscellaneous equipment is acquired for a business under the terms of an agreement.

In particular you describe a situation where the equipment is acquired by a business under the terms of a 3-year agreement with an option at the expiration of the agreement to purchase the equipment at a nominal price.

You ask:

Will the agreement be considered a lease such that the payments made under the terms of the agreement would be deductible under subsection 9(1) and that deduction will not be prohibited by paragraph 18(1)(a) of the Act in computing income for purposes of the Income Tax Act (Canada) the (the "Act") in the year paid.

Our comments

The situation that is described in your letter appears to involve a series of actual completed transactions involving specific taxpayers. Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular IC-70-6R4 dated January 29, 2001. Where the particular transaction is completed, the inquiry should be addressed to the Kitchener/ Waterloo Tax Services Office. Although we are unable to provide any opinion in respect of the specific transactions described in your letter, we have set out some general comments which we hope are of assistance to you.

The Supreme Court held in Shell Canada Ltd. v. The Queen, 99 DTC 5682 and other decisions, that the economic realities of a situation cannot be used to recharacterize a taxpayer's bona fide legal relationships. It held that absent a specific provision of the Income Tax Act to the contrary or a finding that there is a sham, the taxpayer's legal relationships must be respected in tax cases. As a result, the Canada Customs and Revenue Agency ("CCRA") announced in Income Tax Technical News No. 21 (ITTN No. 21), dated June 13, 2001 that it has cancelled Interpretation Bulletin IT-233R dated February 11, 1983 entitled "Lease-option Agreements and Sale-leaseback Agreements," which described circumstances where the substance of a transaction was allowed to dictate its treatment for tax purposes rather than its legal form.

As stated in ITTN No. 21, it is now CCRA's view that the determination of whether a contract is a lease or a sale is based on the legal relationships created by the terms of the particular agreement, rather than on any attempt to ascertain the underlying economic reality. Therefore, in the absence of a sham, it is our view that a lease is a lease and a sale is a sale.

We trust our comments will be of assistance to you. .

Yours truly,

Paul Lynch
for Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch