4 July 2005 Internal T.I. 2005-0132701I7 - eligible capital property or leasehold interest

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 a particular asset should be treated as an eligible capital property or as a leasehold interest

Position: Question of fact. Based on the information provided, it appears that the contracts should be treated as leasehold interests not eligible capital property.

				July 4, 2005

	XXXXXXXXXX  TSO		HEADQUARTERS
	Verification and Enforcement Division			Income Tax Rulings
	Attention:  XXXXXXXXXX 			  Directorate
G. Moore
(613) 957-8982

				2005-013270

Leasehold Interests or Eligible Capital Expenditures

This is in response to your memorandum of May 24, 2005, regarding whether the purchase price of contracts should be treated as eligible capital expenditures or leasehold improvements. We also acknowledge additional information discussed during the conversation (Moore/XXXXXXXXXX) of June 16, 2005.

Facts

The taxpayer corporation is in the business of managing laundry rooms in residential apartments. The taxpayer leases the rooms from the building owners and has a contract with them to pay a nominal amount for rent every month plus a percentage of the total revenue collected from the laundry machines every month. The taxpayer provides the machines in the laundry rooms, maintains the machines and collects the money.

In XXXXXXXXXX, the taxpayer and a related corporation bought the assets of a laundry business and use of the business name from ABC Ltd. The taxpayer purchased the contracts entered into by ABC Ltd. while a related corporation of the taxpayer purchased the remaining assets such as washing machines and dryers. Each contract is a lease of the laundry room from the building owner as well as the rights to run the laundry room. The payment terms normally consist of a flat monthly rent plus a percentage of the monthly revenue. In some contracts, ABC Ltd. is referred to as the "lessee" and in other cases, it is the "licensee". The contracts/leases have terms anywhere from XXXXXXXXXX or more. The leases were purchased for about $XXXXXXXXXX. The purchase price was established by determining the revenue under each contract/lease for the remaining term and then discounting it at XXXXXXXXXX% to arrive at the present value amount. The present value of all the revenues under the purchased contracts became the purchase price so that essentially, the taxpayer purchased the present value of the revenues under each contract.

For tax purposes, the taxpayer treated the purchase of these contracts /leases as a leasehold interest in class 13.

You have asked for our opinion as to whether the purchase price of the contracts should be treated as a purchase of eligible capital property or a leasehold interest.

Our Comments

Eligible Capital Expenditure

Interpretation Bulletin IT-143R3, Meaning of Eligible Capital Expenditure, discusses the meaning of the term "eligible capital expenditure". An eligible capital expenditure in respect of a business is generally a capital expenditure (i.e., an expenditure that results in an enduring benefit) that does not come within any of the capital cost allowance classes but rather goes into an eligible capital property pool. A percentage of the balance of the pool at the end of the year may be claimed as a deduction for the year. The term "eligible capital expenditure" is defined in subsection 14(5) of the Income Tax Act (the "Act").

An "eligible capital expenditure", as defined in subsection 14(5) of the Act, may be broadly described as an outlay or expense made or incurred by a taxpayer:

(a) in respect of a business;

(b) as a result of a transaction occurring after 1971;

(c) on account of capital; and

(d) for the purpose of gaining or producing income from the business (whether or not income from the business was actually produced by such outlay or expense).

IT-123R6, Transactions Involving Eligible Capital Property, describes eligible capital property as "intangible capital property, such as goodwill and other 'nothings', the cost of which neither qualifies for capital cost allowance nor is deductible in the year of its acquisition as a current expense". IT-143R3, includes in its list of eligible capital expenditures "Goodwill purchased as one of the assets of a business" and provides:

"6. Goodwill cannot be divorced from the business itself. It follows the business and may be sold with the business, but it cannot be sold separately. Generally, goodwill arises as a recognizable asset only when a business is acquired at a price in excess of the value, as a going concern, of its net assets.

7. Where goodwill, as a recognizable asset, is acquired by the purchaser of a business in the circumstances described in paragraph 6, the consideration given for the goodwill, as well as any legal and accounting fees that can be directly associated with the purchase of the goodwill, will qualify as an eligible capital expenditure..."

Leasehold Interests

A leasehold interest is the interest of a tenant in any leased tangible property. A tenant who leases property acquires a leasehold interest in that property regardless of whether or not any capital cost is incurred in respect of that interest. However, a depreciable property is not considered to have been acquired until a capital cost has been incurred in respect of that property. It is necessary to determine with regard to certain apparent leasing agreements, whether these agreements are in substance leasing agreements or agreements either for the purchase of the property or for loans.

A tenant who has acquired an assignment of a leased property or a part of a leased property, or a sublease on a leased property, is considered to have acquired a leasehold interest. IT-464R, Capital Cost Allowance - Leasehold Interests, contains information on the calculation of capital cost allowance. The decision in the case of Saskatoon Drug & Stationery Company Limited v MNR, 87 DTC 6396, supports the statement in paragraph 5 of IT-464R: "...Capital cost of a leasehold interest of class 13 property includes ... an amount that a tenant expends to obtain ... a lease or a sublease."

You have advised us that none of the purchase price for the assets of ABC Ltd. was allocated to goodwill. It also appears that you are satisfied that the leases were acquired at fair market value. Therefore, it is our view, based on the information available, that the purchase price paid by the taxpayer could be considered to be in respect of leasehold interests, and not eligible capital property.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. 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 electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.

We trust that these comments will be of assistance.

Steve Tevlin
for Director
Financial Sector and Exempt Entities Division
Income Tax Rulings Directorate
Policy and Planning Branch