31 March 2004 External T.I. 2004-0060021E5 - Automobile Lease Cancellation Payments

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.

Principal Issues: Whether an automobile lease cancellation penalty or fee is deductible under paragraph 8(1)(h.1) of the Act.

Position: Question of fact.

Reasons: Such a determination can only be made after a review of the lease agreement and an examination of the underlying purpose for the payment. The underlying purpose of the payment will determine its deductibility. For example, where the cancellation penalty or fee is merely a way of determining what the leasing costs would have been under a shortened lease, the payment otherwise qualifies for deductibility. Where a lease cancellation penalty or fee otherwise qualifies for deductibility under paragraph 8(1)(h.1) of the Act, it will be subject to the application of subsection 67.3 of the Act. The amount of the payment must be included with the other lease costs incurred by the employee in the year to determine the total lease costs that are eligible for deduction under section 67.3 of the Act. The proportion of the employee's personal use of the vehicle would further reduce the total eligible lease costs that are deductible under paragraph 8(1)(h.1) of the Act.

Randy Hewlett, B.Comm.

XXXXXXXXXX 613-957-8973
2004-006002
March 31, 2004

Dear XXXXXXXXXX:

Re: Automobile Lease Cancellation Payment

We are writing in response to your e-mail of February 2, 2004, wherein you requested our opinion on the deductibility of an automobile lease cancellation payment under paragraph 8(1)(h.1) of the Income Tax Act (the "Act").

You referred to a published technical interpretation document (our file 9704905), wherein we indicated that in a situation where an employee is not replacing an automobile, the lease cancellation payment incurred to terminate a lease is not deductible under paragraph 8(1)(h.1) of the Act. You inquired whether this document still reflects the view of the Canada Revenue Agency.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following comments.

Paragraph 8(1)(h.1) of the Act provides for the deduction by an employee of motor vehicle expenses incurred for travelling in the course of the office or employment where the employee was ordinarily required to carry on the duties of the office or employment away from the employer's place of business or in different places, and required under the contract of employment to pay motor vehicle expenses incurred in the performance of the duties of the office or employment. An employee is not entitled to a deduction for motor vehicle expenses under paragraph 8(1)(h.1) of the Act where the employee received an allowance for such expenses that was not included in computing the employee's income because of paragraph 6(1)(b), or the employee is a commissioned salesperson who claims a deduction under paragraph 8(1)(f).

As discussed in Interpretation Bulletin IT-522R, Vehicle, Travel and Sales Expenses of Employees, motor vehicle travel expenses for purposes of paragraph 8(1)(h.1) of the Act include the amount paid in the year by the employee for leasing a motor vehicle that is used in the performance of the duties of the office or employment. The amount that may be deductible under paragraph 8(1)(h.1) of the Act in respect of the costs incurred to lease a "passenger vehicle" could also be restricted by the application of section 67.3.

The deductibility under paragraph 8(1)(h.1) of the Act of a cancellation penalty or fee paid by an employee to terminate a lease for an automobile that was used in performing employment-related duties, will depend on the terms of the lease agreement and the underlying purpose of the payment. In our view, there may be circumstances where such a payment is otherwise deductible, provided all the requirements of section 8 of the Act are met. For example, where it is clear under the terms of the lease that the cancellation penalty or fee is merely a way of determining what the leasing costs would have been under a shortened lease, we are of the view that the payment qualifies for deductibility under paragraph 8(1)(h.1) of the Act (subject to any restrictions under the Act discussed in the next paragraph).

Where a lease cancellation penalty or fee qualifies for deductibility under paragraph 8(1)(h.1) of the Act, it will be subject to the application of subsection 67.3 of the Act. The amount of the payment must be included with the other lease costs incurred by the employee in the year to determine the total lease costs that are eligible for deduction under section 67.3 of the Act. It should also be noted that the proportion of the employee's personal use of the vehicle would further reduce the total eligible lease costs that are deductible under paragraph 8(1)(h.1) of the Act.

The determination of whether an automobile lease cancellation penalty or fee is deductible under paragraph 8(1)(h.1) of the Act, and subject to the application section 67.3, will always be a question fact. Such a determination can only be made after a review of the lease agreement and an examination of the underlying purpose for the payment.

We trust our comments will be of assistance to you.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch