22 February 1996 Internal T.I. 9604507 - PART I.3 - CAPITAL LEASES & CONDITIONAL SALES AGREEMENTS

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.

RULINGS DIRECTORATE
CORRESPONDENCE SUMMARY

Principal Issues:

(1) Whether the lease obligation reflected as an asset ("Investment in lease receivables") on the balance sheet (in accordance with GAAP (CICA 3065)) of a lessor corporation is eligible for an investment allowance as a loan or advance pursuant to paragraph 181.2(4)(b).

(2) Whether the obligation created by a conditional sales agreement is eligible for an investment allowance.

Position TAKEN:

(1) No. Irrespective of the fact that, in accordance with GAAP, a capital lease is, in substance, treated as a disposition, it is our view that the legal nature governs for purposes of Part I.3. The lease obligation is not a loan or advance neither does it appear to fit squarely within any of the other provisions of subsection 181.2(4).

(2) Generally no unless the purchaser, as a consequence of entering into the conditional sales agreement, issues a note to the vendor.

Reasons FOR POSITION TAKEN:

(1) Previous positions (903168, 5-9548, 901533, 902524) and subsection 181.2(4).

(2) Previous positions (941019, 941063, 912975) and subsection 181.2(4). Obligation created is generally in the nature of a trade payable.

			February 22, 1996

	HAMILTON TAX SERVICES	HEADQUARTERS
	Complex Case	G. Donell
	Section 442-1-2	(613) 957-8953
	Attention:  Vinod Modi
			960450

XXXXXXXXXX
Large Corporation Tax (Part I.3) - Lease option agreements Paragraph 181.2(4)(b) of the Income Tax Act

This is in reply to your memorandum of January 30, 1996 and subsequent telephone communications with Mr.Gary Donell on the 15th and 16th of February, 1996, in which you have requested our views as to whether XXXXXXXXXX for its 1991 taxation year, is entitled to an investment allowance pursuant to paragraph 181.2(4)(b) of the Income Tax Act (the "Act") with respect to (1) certain of its lease receivables characterized as capital leases and (2) receivables resulting from conditional sales agreements (CSAs).

CAPITAL LEASES

Paragraph 181(3)(b) provides that "...the amounts reflected in the balance sheet presented to the shareholders of the corporation...prepared in accordance with generally accepted accounting principles,..." are to be used to determine the various components that comprise the Part I.3 tax base. The accepted authority for GAAP in Canada, the CICA handbook, states at section 3065.09 thereof that leases that transfer substantially all the benefits and rewards of ownership be treated by the lessor as a sales-type or direct financing lease (capital leases). This recommended treatment essentially equates the lease obligation to that of a sale with the effect that the related asset is removed from the balance sheet of the lessor and substituted or replaced with an asset that reflects the obligation between lessor and lessee. This asset, as indicated in CICA 3065.18 "...is similar to a loan." in that lease payments are applied to reduce its balance.

For purposes of Part I of the Act the department's position on the treatment of capital leases is embodied in IT-233R and closely parallels certain of the CICA recommendations, generally requiring capital leases, under certain circumstances to be treated as a disposition of the underlying property by the lessor and an acquisition by the lessee.

In 1993 the department, at the Quebec Income Tax conference, the APFF ("association de planification fiscale et financière"), responded to a question concerning the relevance of IT-233R to the determination of the Part I.3 liability. The department responded that IT-233R is not applicable for purposes of Part I.3. That position remains unchanged.

For purposes of Part I.3, and with respect to leases, it is the department's position that it is the legal nature of the agreement that governs irrespective of the accounting treatment or nomenclature used to describe or characterize the related transaction(s). If a lease is at law, a lease, then it will be treated as such for Part I.3. The question of whether a lease is at law a lease is of course a question of fact that can only be determined on a case by case basis. In the case of XXXXXXXXXX we have examined the few, essentially identical, lease agreements that you have forwarded to us with your request and are of the view that there is nothing in the agreements to lead us to the conclusion that the agreements are, in fact, anything other than true legal leases. Accordingly, in our view the obligation between the lessor and lessee would be considered to retain its character as a lease with the result that no amount with respect to the lease obligation would be included in the capital of the lessee pursuant to subsection 181.2(3) of the Act nor would any amount of that obligation qualify for an investment allowance to the lessor by virtue of subsection 181.2(4).

CONDITIONAL SALES AGREEMENTS (CSA)

Under the terms of a CSA the purchaser will generally have acquired beneficial ownership (i.e. the incidents of title such as possession, use and risk) of a particular property although the vendor may retain legal title in that property as security for the purchase price. A CSA will accordingly be treated, for income tax purposes, as the acquisition/disposition of a property and the establishment of an obligation between the parties to that agreement. This obligation however is, in our view, indebtedness in the form of a payable and therefor would only be included in capital to the extent that the indebtedness had, at year end, been outstanding for more than 365 days. No amount of the indebtedness, however would qualify for an investment allowance under subsection 181.2(4) of the Act in the hands of the vendor.

Our comments should not however be interpreted as precluding CSA transactions from disqualifying for an investment allowance in all cases. In limited circumstances such as where, as a consequence of entering into a CSA a purchaser issues a note to the vendor the amount of the note will be included in computing the purchaser's capital pursuant to paragraph 181.2(3)(d) of the Act and such amount will be included in the investment allowance of the vendor pursuant to paragraph 181.2(4)(c) of the Act. Such treatment is predicated on neither the purchaser nor the vendor being a financial institution as defined in subsection 181(1) of the Act.

We understand that the 1991 capital tax return of XXXXXXXXXX is to become statute barred within two months and have accordingly endeavoured to treat your request on a priority basis. We further understand that representatives of XXXXXXXXXX will be provided a temporary window to respond to our comments and the potential reassessment that may ensue. Should you require our further services in this or any other matter please do not hesitate to contact us.

Director
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy & Legislation Branch

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