4 October 1993 Internal T.I. 9319827 F - Auto Lease Cancellation Payment

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.

Deductibility of Automobile Lease Cancellation Payments

This is in reply to your memorandum of July 8, 1993 requesting our concurrence with your view that a payment made by a taxpayer in respect of the cancellation of an automobile lease is deductible under section 9 of the Act. You asked whether we share your view that such a payment would fall outside the definition of "actual lease payments" found in section 67.3 of the Act, which characterization would have the effect of capping the amount of such payment to the maximum amount of $650.00 per month. You also asked for our comments whether allowing taxpayers to fully deduct such a payment under section 9 of the Act might create scope for taxpayers to effectively circumvent the cap imposed by section 67.3 on the deductibility of lease payments by structuring leases so as to shift some of what in reality are lease payments to an amount payable on the "cancellation" of the lease.

We understand the facts are as follows:

1.     A corporation was leasing an automobile for $1,000.00 per month.

2.     The automobile was a "passenger vehicle" as defined in section 248(1) of the Act.

3.     The automobile was used 90% for business and 10% for the personal use of the corporation's principal shareholder.

4.     The lease agreement contained a cancellation payment clause to apply in the event the lessee cancelled the lease prior to the end of the term. The clause called for the lessee to make a payment computed with reference to the remaining payments on the lease and the amount the lessor would be able to obtain by way of mitigation in leasing the automobile to a third party.

4.     The lessee broke the lease nine months early and paid a cancellation payment of $6,000.00.

5.     The corporation did not lease another vehicle from the lessor.

Our opinion

In our view, a penalty for the cancellation of an automobile lease is not included in "actual lease charges" for purposes of section 67.3 of the Act.

In order for an amount to be considered an "actual lease charge", it must be payable pursuant to the lease and relate to the use of the vehicle by the lessee. We agree that the factors to be examined in this issue are analogous to those the Department considers relevant in determining whether a fee to prepay a mortgage is interest as outlined in paragraph 3 of IT-114.

Since in the example you describe the penalty was calculated taking into account, among other things, the amount the lessor was able to recoup leasing the vehicle during the unexpired period of the lease, we have assumed that the vehicle would not have been available for use by the lessee after the cancellation date and that therefore it would be difficult to characterize the payment in issue as being in respect of "actual lease charges".

It should be pointed out that the cancellation charges which are the subject of this memorandum are different in nature from the terminal charges and credits discussed at paragraph 12 of IT-63R3. We understand these latter amounts consist of 1) "balloon" payments made at either end of the lease, or 2) payments or credits owing to excessive or minimal wear and tear respectively determined upon inspecting the vehicle at the end of the lease period; amounts which, if not pro-rated over the term of the lease, would distort what has actually been paid to lease the vehicle.

In order to decide whether the penalty is deductible under section 9 of the Act, the usual factors should be taken into account, including whether the payment was made for the purposes of earning income from a business as well as whether the payment was of a capital nature. In addition, section 67 may be applicable to restrict the amount of the deduction.

With respect to your concern that allowing such a deduction might provide scope for abusing section 67.3, our comment is that comparing the amount of the stipulated monthly lease payments against the rates otherwise available in the marketplace for similar leases should be of assistance in identifying abusive cases. Similarly a thorough review of the full lease document should provide insight into whether a cancellation payment made pursuant to a penalty clause is in fact a lease payment.

B.W. Dath DirectorBusiness and General DivisionRulings DirectorateLegislative & Intergovernmental Affairs Branch