15 December 2004 External T.I. 2004-0093841E5 - Irregular Rent Payment

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: A material additional rent payment is required at the beginning of the 4th year of a 20-year lease. 1. Whether 1/20th of the additional rent payment can be deducted annually on a straight-line basis. 2. Alternatively, following the FCA decision in Buck Consultants Limited (2000 DTC 6015) and subparagraph 18(9)(a)(ii), none of the additional rent payment is deductible in the first 3 years, 4/20th is deductible in the fourth year of the lease and 1/20th thereafter (on an annual basis).

Position: 1. No. 2. Yes.

Reasons: Any amount in excess of the actual rent payable in respect of a taxation year is not deductible by virtue of either paragraph 18(1)(a) or subparagraph 18(9)(a)(ii).

XXXXXXXXXX 2004-009384
Kathryn McCarthy, CA
December 15, 2004

Dear XXXXXXXXXX:

Re: Irregular Rent Payment

We are writing in response to your letters of September 1 and October 6, 2004 and your facsimile of November 24, 2004, on the above noted issue.

You described a situation where an arm's length landlord and a tenant have entered into a 20-year lease for an office complex. At the end of the lease, the landlord remains the beneficial owner of the property. The rent is $100,000 for the first 5 years, $200,000 for years 6 to 10, and $300,000 for years 11 to 20. An additional rent payment of $2 million (lump sum amount) is required at the beginning of the 4th year. In accordance with generally accepted accounting principles (GAAP), the additional rent payment is being amortized on a straight-line basis over the term of the lease. For income tax purposes, you enquire whether 1/20th of the additional rent payment may be deducted annually over the term of the lease. Alternatively, applying the decision of the Federal Court of Appeal in Buck Consultants Limited (2000 DTC 6015) and subparagraph 18(9)(a)(ii) of the Income Tax Act (the Act), none of the additional rent payment is deductible in the first 3 years, 4/20th is deductible in the fourth year of the lease and 1/20th thereafter (on an annual basis).

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 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. We are, however, prepared to provide the following comments.

In our view, the annual rental costs are normal business deductions in each year they are incurred. In order for an expense to have been "incurred" for purposes of paragraph 18(1)(a) of the Act, that expense must be a genuine liability of the taxpayer. In so far as the lump sum amount is concerned, the lease requires the tenant to make a payment to the landlord on or before the beginning of the fourth year of the lease in the amount of $2 million dollars. Hence the lump sum amount would likely not be "incurred" until the fourth year of the lease for purposes of paragraph 18(1)(a) since the lessor does not have an enforceable claim to such amounts before the beginning of that taxation year. While the lump sum amount may be considered to have been "incurred" for purposes of paragraph 18(1)(a) in year four, subparagraph 18(9)(a)(ii) would deny the deduction of any excess amount that can reasonably be regarded as having been incurred as (or on account of) rent in respect of a period after the end of the year. On that basis, it is our view that it would be reasonable to deduct 4/20th of the lump sum amount in the fourth year of the lease and 1/20th thereafter (on an annual basis).

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