18 June 1996 External T.I. 9610825 - AMOUNT RECEIVED FOR TERMINATION OF RENTAL GUARANTEE

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:

Whether amount received to terminate a rental revenue guarantee agreement pursuant to which vendor of property guaranteed minimum rent is taxable.

Position:

Amount likely taxable.

Reasons:

If compensation is received for the failure to receive a sum of money that would have been an income item if it had been received, the compensation will likely be an income receipt.

									3-961082
XXXXXXXXXX							C. Chouinard

Attention: XXXXXXXXXX

June 18, 1996

Dear Sir/Madam:

Re: XXXXXXXXXX
Advance Income Tax Ruling

We are writing in reply to your letter of March 25, 1996, in which you requested an advance income tax ruling on behalf of the above-mentioned taxpayer.

As indicated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990, the Department issues advance income tax rulings with respect to proposed transactions only. A request for a written opinion on a completed transaction is generally considered by the taxpayer's local tax services office. Since the situation to which you refer in your letter concerns a completed transaction, we cannot provide you with a ruling. Nevertheless, we are prepared to make the following general, non-binding comments.

Our Comments

As we indicated in our March 1, 1996 letter, an amount received by a taxpayer in lieu of the performance of the terms of a business contract by the other party to that contract may, depending on the facts, be either an income or capital receipt. If the receipt relates to the loss of an income-producing asset, it will be considered to be a capital receipt; on the other hand, if the compensation was received for the failure to receive a sum of money that would have been an income item if it had been received, the compensation will likely be an income receipt.

According to the terms of the Revenue Guarantee Agreement (the "Agreement"), the vendor of the subject property guaranteed that the rental revenue derived from the subject property would not be less than $336,000 for each 12-month period during the term of the Agreement, which guarantee was secured by the sum of $120,000 (the "Security") to be held in the vendor's solicitor's trust account. As indicated in clause XXXXXXXXXX of the Agreement of Purchase and Sale, the Security was to be applied and used by the vendor's solicitor to fund the vendor's obligations under the Agreement.

You indicate that early in 1994, which was approximately one year following the purchase of the subject property, the purchaser realized that there was a difference between the rent collected and the guaranteed rent of $336,000 amounting to approximately $110,000. In addition, the purchaser was not satisfied with the property management services provided by the vendor pursuant to the Management Agreement and was therefore considering terminating that agreement. However, as termination of the Management Agreement would also bring with it termination of the Agreement, unless termination resulted from a fundamental breach of the Management Agreement, and since the purchaser was concerned that the vendor did not have any assets to meet its obligations under the Agreement, the purchaser was reluctant to terminate the Management Agreement. Accordingly, in order to resolve this matter, the purchaser and vendor agreed to terminate both agreements, on condition that the vendor release the Security for the Agreement to the purchaser.

You argue that the Security (i.e., the $120,000) received by the purchaser was capital in nature because it was received in settlement of the dispute involving the Management Agreement, the breach of which caused the subject property to decrease in value. Alternatively, you argue that, even if the Security was released as a result of the termination of the Agreement, since the Agreement constituted the entire substratum of the purchaser's business, its cancellation has materially affected the whole business structure and organization of the purchaser's profit-making apparatus. You add that non-performance of the Management Agreement and the Agreement could have materially destroyed or crippled the purchaser's business structure, leading to serious dislocation of the normal commercial organization of the purchaser's business.

In our view, given the wording of clause XXXXXXXXXX of the Release and Settlement Agreement of the Revenue Guarantee Agreement, the Security was received by the purchaser in consideration of the termination of the Revenue Guarantee Agreement and not the Management Agreement. In addition, since it appears that the Security was received for failure to receive the deficient payment (i.e., the difference between the rent actually collected and $336,000), which amount would have been an income item if it had been received, it is likely that the Security would be an income receipt. Moreover, given that the purchaser continues to own and rent the subject property, in our view, the rights surrendered by the purchaser on cancellation of the Agreement were not such as to destroy the essence of the purchaser's business or materially cripple its profit-making apparatus. In fact, the profit-making apparatus of the purchaser appears to have survived the termination of the Agreement and has been liberated by that termination, since the subject property can now be managed by someone other than the vendor.

We trust that these comments will be of assistance.

Yours truly,

R. Albert
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch