16 June 2009 Internal T.I. 2009-0312851I7 - Deductibility of Average Rent for Long Term Lease

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 comments provided in Technical Interpretation 2008-0272771I7, with respect to the deductibility of average long term lease payments, would have varied if additional information pertaining to the taxpayer had been considered, including the effect of a subsection 97(2) transfer of certain assets.

Position:

No.

Reasons: The legislation.

		June 16, 2009

	Toronto Centre Tax Services Office	HEADQUARTERS
	Large File Auditor	Income Tax Rulings
		  Directorate
	Attention: Mr. Anthony Cutrara, CA	Renee Sigouin
(613) 957-2128
				2009-031285

Deductibility of Average Rent on Long Term Lease

We are writing in response to your correspondence dated November 19, 2008 wherein you requested our comments on whether the views expressed in our letter of May 26, 2008 (Document 2008-0272771I7) would have been altered had consideration been given to various other factors regarding the taxpayer.

In our letter, we considered whether escalating lease payments, which are deductible under generally accepted accounting principles on an average basis, would be deductible on an average basis for income tax purposes. We expressed the view that any amount deducted by the taxpayer on an average basis that was in excess of the rent actually paid or payable in a taxation year (i.e., the "Non-Cash Rent") would be non-deductible by virtue of either paragraph 18(1)(a) or subparagraph 18(9)(a)(ii) of the Act.

We understand that you are currently auditing the taxpayer's XXXXXXXXXX income tax returns which include deductions for Non-Cash Rent. The taxpayer's representative believes that consideration of events occurring in subsequent taxation years could alter our view on the deductibility of the Non-Cash Rent expensed for tax purposes in the years currently under audit.

We understand that the relevant additional facts and events, as provided by the taxpayer's representative, are as follows:

• Amounts deducted by the taxpayer for tax purposes on account of Non-Cash Rent were credited to a liability account in the taxpayer's balance sheet, called "Accrued Rent Equalization Obligation" ("AREO");
• On XXXXXXXXXX , in anticipation of the pending sale of a division of the taxpayer's business, various assets of the taxpayer were rolled into a newly formed limited partnership under a subsection 97(2) election (the "Election"). The taxpayer took back shares in the limited partnership in respect of the transfer;
• The Election included an amount of non-share consideration with respect to the limited partnership's assumption of various liabilities of the taxpayer including the AREO account; and On XXXXXXXXXX , the partnership units were acquired by an unrelated third party purchaser, resulting in a disposition of the taxpayer's limited partnership units.

The taxpayer's representative has indicated that the disallowance of any Non-Cash Rent expense for tax purposes (which on an accumulated basis represents the balance of the AREO account at the date of the Election) would change the tax basis of the AREO account as agreed in the Election to nil, giving rise to an unintentional loss on the transfer of the AREO account to the limited partnership. The representative has indicated that this loss would be offset by the taxable income arising on the reassessment of prior taxation years with respect to the disallowance of Non-Cash Rent expenses for tax purposes, such that ultimately, there would be no net adjustment upon completion of any proposed and/or future reassessments

Our Comments

As outlined in our communication with you on July 14, 2008, it is our view that the transfer of assets to the limited partnership and the subsequent sale of the limited partnership units to the third party purchaser will have no effect on the tax treatment of the lease payments to either party. That is, the taxpayer and the third party purchaser will each be entitled to deduct rent for tax purposes on a current basis. Any amount deducted by either party on an average basis in excess of the rent actually paid or payable in a taxation year would be non-deductible by virtue of either paragraph 18(1)(a) or subparagraph 18(9)(a)(ii) of the Act.

Where there is no Non-Cash Rent expense for tax purposes, it follows that there would also be no corresponding liability (i.e., AREO account) for tax purposes. Therefore, notwithstanding that the Election included an amount of non-share consideration with respect to the limited partnership's assumption of that liability, the actual amount of liabilities assumed did not. The amount of non-share consideration received by the taxpayer is a matter of fact and not an elected amount. The matters agreed to under a roll-over election are the proceeds and cost of eligible properties transferred and not the amount of non-share consideration received or paid in exchange.

We note that the taxpayer is not required to file an amended election to revise the stated amount of non-share consideration received as this adjustment is automatic. The reduction, if any, in non-share consideration received would result in a corresponding increase in the adjusted cost base of the partnership units taken back by the taxpayer and would not therefore give rise to a deductible loss.

We understand that the current audit has been limited to the XXXXXXXXXX taxation years and that the XXXXXXXXXX taxation year has been scheduled for audit in the near future (including a detailed review of the Election). When that occurs, we would suggest that consideration be given to the calculation of the adjusted cost base of the partnership interest for purposes of calculating the capital gain arising in the XXXXXXXXXX taxation year. With respect to the years currently under audit, we understand that the proposed reassessments will disallow the Non-Cash Rent previously deducted by the taxpayer for tax purposes and will therefore give rise to taxable adjustments in the taxation years concerned. In contrast, any adjustment required in the XXXXXXXXXX taxation year to the amount of non-share consideration received by the taxpayer on the transfer of assets to the limited partnership would increase the taxpayer's adjusted cost base in the limited partnership units and therefore give rise to capital gains tax implications (i.e., at a 50% inclusion rate) upon their subsequent disposition on XXXXXXXXXX . Therefore, the net effect of the proposed adjustments will not be purely timing in nature and revenue neutral as indicated by the taxpayer's representative.

We trust that these comments will be of assistance.

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.

Phil Jolie
Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch