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 the license agreement for a childcare facility should be classified as a license or lease for CCA purposes.
Position: It is a license.
Reasons: The agreement would result is a license as this is the stated intent of the parties
XXXXXXXXXX Charles Rafuse
January 25, 2007
Re: Technical Interpretation Request - License Agreement
This is in reply to your letter dated May 30, 3006, concerning the application of the Income Tax Act (the "Act") in respect of a childcare facility.
Our understanding of the facts is as follows:
Your client, an operator of childcare programs, entered into a "license agreement" dated XXXXXXXXXX with a public school board (the "Board") to establish childcare facilities at a public school. The Board licensed to your client a designated space (the "licensed space" or "facility") that was attached to the school. The licensed space was constructed by the Board at a cost of $XXXXXXXXXX. Under the license agreement, your client was required to reimburse the Board the cost of $XXXXXXXXXX, to pay the day-to-day cost of operating the childcare facility, and as well to pay a monthly fee to the Board to cover the costs of maintaining the facility. Under the license agreement, your client received the exclusive lease of the licensed space for XXXXXXXXXX years.
You considered if the $XXXXXXXXXX cost of construction could be deducted as a current expense in computing income but concluded that the amount should be amortized over the XXXXXXXXXX-year period of the licence agreement. Considering that your client may retire in XXXXXXXXXX years or upon reaching the age of XXXXXXXXXX, you asked if the balance of the unamortized licence cost could be written off quicker or when the childcare business ceases.
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 general comments.
Paragraph 4 of Interpretation Bulletin IT-128R, Capital Cost Allowance - Depreciable Property, ("IT-128R") sets out some of the criteria that the Canada Revenue Agency (the "CRA") will consider in determining whether an expenditure is on account of capital or a current expense. These criteria are those developed by the courts in the various cases considered by them. The four criteria identified in paragraph 4 of IT-128R are: enduring benefit, maintenance or betterment, integral part or separate asset and relative value.
The courts have generally considered an outlay to be on account of capital in those situations where the expenditure is made "with a view to bringing into existence an asset or advantage for the enduring benefit of a trade". "Enduring benefit" is determined with reference to the useful life of the asset. In the case you described, your client acquired the exclusive use of a childcare facility for XXXXXXXXXX years. Accordingly, it is our opinion that your client made an expenditure that brought into existence an asset for the enduring benefit and the amount of $XXXXXXXXXX should be treated as a capital asset. The expenditure of $XXXXXXXXXX is not a current expense.
You indicated that your client received exclusive use of the licensed space for XXXXXXXXXX years. At issue is whether the $XXXXXXXXXX expenditure should be included in Class 13 or in Class 14 of Schedule II of the Regulations. Subject to certain exclusions, Class 14 includes "property that is a patent, franchise, concession or license for a limited period in respect of property". Class 13 includes leasehold interests. Since your client has an agreement with the Board called a license agreement, it is necessary to determine if it is a lease or license. Generally, a lease involves the following elements:
- Exclusive possession is conveyed to the lessee,
- A definite period, having a certain beginning and a certain end, and
- Provision for the payment of rent.
A fourth element is the intention of the parties. In Bowater Power Co. Ltd. (71 DTC 5469), one of the issues to be resolved was whether the agreement entered into by the appellant with the government of Newfoundland constituted a lease entitling the appellant to claim capital cost allowance in respect of its power rights as a leasehold interest. The Court reviewed some of the requisite elements denoting the creation of a contract of lease and, at page 5474, mentioned the intent of the parties to create a lease as one of such elements:
"The matter is also due to the fact that certain decisions have emphasized, as a determining factor, the intention of the parties. In Errington v. Errington and Woods, (1952) 1 K.B.290, however, Lord Denning stated at p. 298:
... although a person who is let into exclusive possession is prima facie to be considered to be a tenant, nevertheless, he will not be held to be so if the circumstances negative any intention to create a tenancy...
According to this decision, the test can be said to be in the case of a licence, whether the parties actual intention was to create a mere permissive privilege of exclusive possession whereas in the case of a lease, the intention was to create an interest in land."
In contrast to a lease, which creates an interest in the property for the lessee, a licence does not create an interest in the property for the licensee but simply gives such person the right to use a property, the use of which without the said right would result in trespassing. A licence does not normally give the right to exclusive possession of the property. The determination of whether an agreement is a lease or a licence will often revolve on the intention of the parties to the agreement.
In the case you described, clause XXXXXXXXXX of the license agreement states: "XXXXXXXXXX". Taking this and the other factors previously mentioned, it would appear that the agreement between your client and the Board describes a license and accordingly, the $XXXXXXXXXX expenditure should be included in Class 14 of Schedule II of the Regulations. Generally, capital cost allowance ("CCA") in respect of Class 14 property is computed by apportioning the capital cost of Class 14 property equally over the remaining life of the property. CCA in respect of licences is discussed in Interpretation Bulletin IT-477, Capital Cost Allowance - Patents, Franchises, Concessions and Licences (Consolidated).
You indicated that your client might dispose of the childcare business prior to the expiration of the license agreement. You also indicated that your client might not be able to find a buyer to take over the childcare business and therefore your client may simply abandon and discontinue the business. With respect to the treatment of the undepreciated capital cost ("UCC") in such case, please refer to Interpretation Bulletin IT-478R2, Capital Cost Allowance - Recapture and Terminal Loss. As explained in IT-478R2, where the total of all the increases exceeds the total of all the decreases to the UCC of the class as of the end of a taxation year and there are no properties remaining in the class, the excess is a terminal loss that is deductible in computing a taxpayer's income. If a business is discontinued, a terminal loss for a particular class of depreciable property used in the business is not available unless and until all the property in that class is disposed of. In a situation where a particular depreciable property, such as a licence, is the only property in a class, simply ceasing to use the particular depreciable property upon the discontinuance of the business does not result, in and of itself, in a disposition of the particular depreciable property that may permit a deduction of a terminal loss. In the case you described, if the licence agreement with the Board is cancelled in connection with the discontinuance of the childcare business, this would result in a disposition of the licence for purposes of determining whether a terminal loss may be claimed.
We trust this information is helpful.
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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