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: 1. If a shareholder/landlord reimburses its corporate tenant for the value of leasehold improvements at the end of the lease, will this mitigate or eliminate the shareholder benefit imposed by subsection 15(1)? 2. Assuming the shareholder described in Question 1 subsequently transfers the ownership of the commercial real estate to its Holdco and then the lease between the Holdco and the corporation (tenant) is extended, would this change the timing of the subsection 15(1) benefit to the shareholder/landlord?
Position: 1. Depends on the facts. 2. No.
Reasons: 1. Question of fact. 2. Same reasoning as response to question 1.
September 24, 2014
Re: Shareholder benefit (leasehold improvement)
We are writing in reply to your email dated February 26, 2014, requesting our comments concerning leasehold improvement expenditures incurred by a corporation on real property owned by a shareholder.
Paragraph 10 of IT-432R2 Benefits Conferred on Shareholders indicates that where a corporation is renting a building owned by a shareholder, the corporation is considered to have conferred a benefit on the shareholder pursuant to subsection 15(1) where it incurs the cost of an addition or improvement that vests in the owner of the building.
Your questions are:
Question 1: Making reference to an article (Pela, ''A Review of Selected Real Estate and Leasing Issues,''. 2002 British Columbia Tax Conference (Vancouver: Canadian. Tax Foundation, 2002), 15:1-40), you ask if the shareholder benefit imposed under subsection 15(1) on account of improvements made by the corporation on commercial real estate rented from the shareholder is mitigated or eliminated if the lease provides that the shareholder is required to repay the value of the improvements to the corporation at the end of the lease.
Question 2: Assuming that the shareholder described in Question 1 subsequently transfers the ownership of the commercial real estate and his rights under the lease to another corporation of which he is the only shareholder ("Holdco") and that the period of the lease is extended, when is the shareholder required to include the value of a benefit in his income under subsection 15(1)? Is it at the time of the transfer or would the benefit be calculated at the end of the lease as extended?
This technical interpretation provides general comments about the provisions of the Income Tax Act and related legislation (where referenced). It does not confirm the income tax treatment of a particular situation involving a specific taxpayer but is intended to assist you in making that determination. The income tax treatment of particular transactions proposed by a specific taxpayer will only be confirmed by this Directorate in the context of an advance income tax ruling request submitted in the manner set out in Information Circular IC 70-6R6, Advance Income Tax Rulings.
Response to Question 1:
Paragraph 10 of IT-432R2 Benefits Conferred on Shareholders indicates that:
"A corporation that is renting a building owned by a shareholder may make an addition or improvement to the building. If such an addition or improvement vests in the owner of the building, a benefit is considered to have been conferred on the shareholder by the corporation pursuant to subsection 15(1). The amount of the benefit is considered to be the present value of the amount, if any, by which the addition or improvement increases the value of the building to the shareholder at the time the building reverts to the shareholder. Therefore, in determining the amount of the benefit it is necessary to consider the particular facts of each case. The facts to be considered include the nature of the addition or improvement, the term of the lease, provisions for extension of the lease, provisions of the lease regarding leasehold improvements, and the amount of rent being charged. The benefit considered to be conferred in a particular taxation year is based upon the portion of the addition or improvement completed during that year. If the terms of the lease are later altered in favour of the shareholder, or if the lease is annulled before its term expires, a benefit would be created at that time equal to the increase in the shareholder's reversionary interest created by the alteration or cancellation of the lease."
Paragraph 10 of IT-432R2 continues to reflect the CRA's view.
The benefit is conferred on the shareholder in a particular taxation year based on the portion of the addition or improvement completed during that year. The timing of the inclusion of the benefit in income is supported by jurisprudence, including St. Germain v. MNR, 69 DTC 5086 (SCC), Soyko v. MNR,  Tax A.B.C. 140 (TAB), Kennedy v. MNR, 73 DTC 5359 (FCA) and The Queen v. Neudorf, 75 DTC 5213 (FCTD).
The amount of the benefit is based on the present value of the amount, if any, by which the addition or improvement increases the value of the property to the shareholder when it reverts to the shareholder. The cases that deal primarily with the determination of the value of the benefit are Kennedy v. MNR, 73 DTC 5359 (FCA) and The Queen v. Ginter, 77 DTC 5274 (FCTD).
In rendering a decision in Kennedy v. MNR, 73 DTC 5359 (FCA), the Court stated
"Where a tenant improves the leased premises, the extent to which, if at all, the improvement confers a benefit on the landlord will depend on the extent to which the improvement increases the value of his reversionary interest and that, in turn, will depend on the terms and conditions of the lease and on the nature of the improvement".
If the shareholder reimburses the corporation for the value of the improvements as they are completed each year or at the end of the lease term, the extent to which the reimbursement would reduce the present value of the shareholder benefit under subsection 15(1) will depend on the relevant circumstances, including the conditions and provisions of the lease.
Response to Question 2:
Where the shareholder was subject to an income inclusion in the year in which improvements are made by his corporation on commercial real estate rented from the shareholder, a subsequent transfer of the real estate to a wholly-owned subsidiary for fair market value consideration would not result in an additional inclusion in his income under subsection 15(1). A subsequent extension to the term of the lease would not result in a subsequent application of subsection 15(1) to the shareholder.
We trust these comments will be of assistance.
Corporate Reorganizations Section II
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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