7 February 1996 External T.I. 9532605 - 6(2)

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues:

nominal lease costs

Position:

not prudent in most situations where a lessee is paying only nominal lease costs to advise clients to calc automobile benefits "as usual"

Reasons:

only a review of all documentation/agreements could determine if reasonable to consider that a lessee overpaid during an initial term of lease. Must also consider if arm's length relationship exists between parties or, where arm's length, whether barter transaction undertaken.

									953260
XXXXXXXXXX							Sandra Short

Attention: XXXXXXXXXX

February 7, 1996

Dear Sirs:

Re: Lease costs relating to employer-provided automobile situations

This is in reply to your letter of December 1, 1995 which asks for the Department's position in the situation where lease costs are reduced to a nominal monthly amount after the expiry of an initial lease period. You have asked that we consider the following example which relates to a situation where an employer provides an automobile to employees: after a 40 month period, the monthly lease payment by the employer to the lessor is reduced to $10. You have calculated that, if the $10 monthly lease charge is applied for the full year, that the taxable benefit to employees for the standby costs would be $92, assuming that the provincial sales tax is 8% Further, the operating cost benefit would be calculated as $43.20 (based on 50% of standby costs before GST).

You have expressed the understanding that such situations are apparently covered by the comments found in paragraph 13 of Interpretation Bulletin IT-63R5 in that it is assumed that the employee overpaid initially. As such, the taxable benefit calculation described in your example is appropriate. You have asked that if our understanding results in a calculation different from that calculated by you or as you believe to be currently reflected in the comments in paragraph 13 of Interpretation Bulletin IT-63R5, that such revision not take effect until the 1996 or later taxation year. You have noted that the same employee may not have used the vehicle during the life of the lease. As well, in those situations where lease costs decline after each 12 month period during the lease, the employee using the vehicle after the first or second 12 month period has expired receives a lower taxable benefit than the employee who initially used the vehicle.

Our Comments:

Before discussing Interpretation Bulletin IT-63R5, we would like to clarify our understanding of the mathematical calculations above as expressed by you. We assume that the reference to the "taxable benefit for standby costs" is the summation of the standby charge as calculated in subsection 6(2) of the Income Tax Act (the Act) for the purposes of paragraph 6(1)(e) and the GST benefit which is calculated separately pursuant to the provisions of paragraph 6(1)(e.1) of the Act. An operating cost benefit is included in an employee's income only when the conditions of subparagraphs 6(1)(k)(i), (ii) and (iii) of the Act are met. If an automobile is used primarily in the course of the employee's office or employment, the employee can elect that the operating expenses benefit be one-half of the standby charge for the automobile as determined under subparagraph 6(1)(e)(i) of the Act less any reimbursement to the payor in respect of operating expenses. In such circumstances, the employee must inform the employer in writing by the end of a year of the employee's intention to have this election apply for that year.

Paragraph 13 of Interpretation Bulletin IT-63R5 states, among other things, that, where a lease contains terminal charges and credits and the employee(s) and employer agree, the taxable benefit arising from the lease payments will be adjusted over the term of the lease provided that none of the relevant years are statute-barred. Further, where a substantial lease payment is made at the beginning of the lease resulting in lower monthly lease payments, a pro-rata share of the initial payment must be added to each monthly payment over the term of the lease to determine the taxable benefit to an employee, provided that the payment is in fact a lease payment and not a payment for the purchase of the automobile. We do not believe that these comments address or are intended to address a situation where an automobile is made available to a lessee at no charge or at a nominal fee such as $10 a month. The comments discussing a substantial lease payment at the beginning of a lease refer to the situation of one large payment at the commencement of a lease followed by somewhat small monthly payments thereafter rather than the situation of larger payments over a three or four year period followed by nominal monthly lease payments in, say, the final year of a lease or a one year's extension to a lease agreement. We do not share the opinion that an assumption can be made that a $10 a month lease charge is fair or agreed upon or the result of the lessee or employer having overpaid initially.

Paragraph 6(1)(e) of the Act provides that when an employer makes an automobile available to an employee, the employee must include in his or her income for the year an amount that is considered a reasonable standby charge. We would ordinarily consider it unreasonable and unlikely that a lessor would make an automobile available to a lessee for $10 a month. In a situation where a lessor charges a lessee only a nominal monthly charge for the use of its automobiles, we would question whether an arm's length relationship existed between the parties. Where the lessor and lessee deal at arm's length, we would look for the existence of a barter transaction. In a barter transaction between persons who are dealing with each other at arm's length, it is a fundamental principle that each of those persons considers that the value of whatever is received is at least equal to the value of whatever is given up in exchange thereof. We are aware that it is not uncommon for the use of automobiles to be provided in exchange for non-cash consideration such as goods, services or certain rights and privileges. Interpretation Bulletin IT-490 discusses barter transactions. It is our opinion that in any situation where a lessor charges a lessee only a nominal monthly charge for the lease of its automobiles, that only a review of all of the terms and conditions of any agreements between the parties could determine whether it is reasonable to consider that the lessee overpaid during the initial term of the lease.

For example, only a thorough review of the terms and conditions of an agreement can determine whether a particular leasing transaction is in substance a sale. Such a determination depends upon the intent of the parties as evidenced by all provisions of an agreement, read in light of the facts and circumstances existing at the time the agreement is executed. The Department is also aware that many lease contracts are in the nature of "financial leases". We would refer you to Interpretation Bulletin IT-233R in this regard. Where it is determined that a particular leasing transaction between a lessor and lessee (employer) is in effect a sale of an automobile, the calculation of a reasonable standby charge would be made with reference to "C" rather than "E" in the formula laid out in subsection 6(2) of the Act.

Given our comments, we believe that it may not be prudent in most situations where a lessee is paying only nominal lease costs to advise clients to calculate automobile benefits in the manner described by you above.

We trust our comments will be of assistance to you.

Yours truly,

P.D. Fuoco
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch