6 July 1983 Income Tax Severed Letter 7-2631 - [Payments received by a Tenant from a Landlord with respect to Leasehold Improvements]

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.

TORONTO DISTRICT OFFICE

W.J. Robertson Audit Reviev 148-1 Business Enquiries Group

Payments received by a Tenant from a Landlord with respect to Leasehold Improvements

July 6, 1983

HEAD OFFICE Corporate rulings Directorate S. Shimerock 593-6937 #7-2631

We refer to your memorandum of June 8, 1983 in which you requested clarification on the Department's view on certain payments made by a landlord to a tenant as set out in paragraphs 9(a) and 14 of IT-359R . Specifically, you address the comments made in the bulletin to a situation where a contribution is made by a landlord toward the cost of leasehold improvements that are presumably carried out by the tenant. The lease between the landlord and tenant provides that the title to the leasehold improvements will vest immediately in the landlord.

Comments

Before an amount paid by a landlord to a tenant can be considered to be an inducement to the tenant to enter into a lease, it is necessary to review the lease agreement and any supporting documentation which should shed light on the true nature of such a payment. Once it has been ascertained that the payment is of the nature of an inducement, it is irrelevant whether the leasehold improvements are to vest in the landlord immediately or at the end of the lease. In this regard, we understand that a special release to IT-3391 that is in preparation proposes to revise paragraph 9(a) to read:

9. (a) a non-taxable capital receipt where the payment is a reimbursement of part or all of the tenant's capital cost of leasehold improvements within the meaning of Regulation 1102(4);

The above tax treatment conforms to the jurisprudence relating to the capital cost of property and more specifically with the decisions rendered in Canadian Pacific Limited v. Her Majesty the Queen (1977- DTC-5383), and in Consumers' Gas Company Ltd. v. Her Majesty the Queen (1982-DTC-6300). This tax treatment is also consistent with the comments made in IT-174R , paragraph 5, except that the test of legal ownership as referred to therein need not be met where a leasehold interest is involved.

The words "capital cost of leasehold improvements" as they appear in the proposed revision to paragraph 9(a) of IT-359R would, in our view, also be effective for the purpose of the calculation set out in Schedule III to the Income Tax Regulations, the second paragraph of which refers to the "capital cost incurred in a particular taxation year of a particular leasehold interest".

It should also be reasonably clear that any inducement payment which takes the form of a reimbursement of part or all of the tenant's capital cost of leasehold improvements is a reimbursement of costs incurred by the tenant as a principal and cost as an agent of the landlord. In this connection, the special release to IT-339R referred to above also proposes a revision of paragraph 14 as follows:

14. The granting of a rebate of rent for a period of the lease will represent a reduction in what would otherwise have been the rental income of the Landlord. An amount paid by a landlord to a tenant to induce the tenant to enter into a lease agreement is usually considered to be a capital expenditure. This is so whether the amount is a contribution towards expenditures by the tenant for or in respect of leasehold improvements or whether the amount may be used at the tenant's discretion. If the rental of the property is incidental to or constitutes a business operation carried on by the landlord, the amount would be an eligible capital expenditure (see IT-143R , Meaning of Eligible Capital Expenditure) for which an allowance is permitted by virtue of paragraph 20(1)(b). However, as amount may be paid to the tenant as a funding or reimbursement of payments made by the tenant while acting as a supervisor or agent of the landlord. Where the landlord is responsible for expenditures for or in respect of the cost of repairs, alterations or improvements to the leased property, the expenditures paid through the tenant may qualify either as an expense of the landlord or as an amount to be added to the capital cost of the property of the landlord. Such expenditures of the landlord may not also be classified as expenses or property of a prescribed class of the tenant.

Obviously, whether a capital cost is incurred by a lessee on his own account rather than as an agent for the landlord will always be a question of fact that can only be determined after a careful review of the lease agreement and supporting documentation, as mentioned above. If a genuine inducement payment has been used by the tenant on his own account, than it would be treated as a non-taxable capital receipt to the tenant that would not, under the existing law, reduce the capital cost of his leasehold improvements for the purposes of Class 13.

In those cases where the tenant demonstrates that he incurred a capital coat of property on his own account, the inducement payment made by the landlord would be considered to be an eligible capital expenditure to him if he meets the business test mentioned in the proposed revision to paragraph 14.

Chief Finance, Insurance & Leasing Section Speciality Corporations Rulings Division Corporate Ruling Directorate Legislation Branch

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