19 December 1997 Internal T.I. 9724127 - LEASING

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 ISSUE

Whether a leasing contract with an automatic transfer of title upon the last rental payment constitutes a lease for Part I.3 tax purposes.

Position

Yes.

Reasons

Under Quebec law, a leasing contract (crédit-bail) is a lease and not a sale. The owner of the property is the lessor.

			December 19, 1997

	Hamilton Tax Services Office	Headquarters
 	Large Case Audit	Ghislain Martineau
	Section 1214-442-3-1	(613) 957-8962
	Attention:  Vinod Modi
			7-972412

XXXXXXXXXX - Large Corporation Tax

This is in reply to your memorandum dated September 8, 1997 concerning the nature of five lease contracts attached with your request and described by the taxpayer as `lease Contract with automatic transfer of title of property".

Those contracts are entered into the Province of Quebec. We understand that the taxpayer considers these contracts as capital leases and they are recorded on the balance sheet in accordance with generally accepted accounting principles as loans or finance receivable and not as leases; consequently, the amounts recorded on the balance sheet as loans or finance receivable qualify for the investment allowance deduction under subsection 181.2(4) of the Act.

For the purpose of this memorandum, we are assuming that XXXXXXXXXX is not a financial institution within the meaning of subsection 181(1) of the Act.

OUR COMMENTS

Page one of each contract provides that these agreements have the form of leasing contracts which are used as financing device and for an automatic transfer of title after the last scheduled payment. It is also mentioned that the lessee is entitled to all the benefits related to the property such as the investment tax credit and the capital cost allowance.

Whether an agreement between two parties constitutes a lease or some other form of financing is a question of fact which can only be determined by reviewing the terms of the agreement between the parties. It is our view that if a lease is, at law, a lease, then it will be treated as a lease for all purposes of the Act, including Part I.3.

XXXXXXXXXX

The automatic transfer of title upon receipt of the last monthly payment is in fact an option to purchase the property at the expiry of the agreement if the lessee has met all the conditions under the agreement (paragraph XXXXXXXXXX mentions that the lessee may purchase the property if it is not in default).

The clause on page one stating that it is a financing transaction confirms that the agreement is a leasing contract. The doctrine mentions that leasing (crédit-bail) in Quebec is a financing device that requires at least two contracts. There is a sale transaction under which a manufacturer sells the property chosen by the lessee to a financing institution. This sale is followed by a lease between the financing institution and the lessee for a rent equivalent to the purchase price and the financing cost.

Those transactions were made according to article 1603 of the Civil Code of the Lower Canada:

This chapter does not apply to a leasing made by a person who carries on the business of lending or granting credit and who, at the request of the lessee, has acquired from a third person ownership of the property forming the object of the contract provided that

1.the leasing is made for commercial, industrial, professional or handicraft purposes;

2. the leasing relates to a moveable;

3. the lessee has personally chosen the property;

4. the lessor conveys expressly to the lessee the warranty resulting from the sale entered into with the third person; and that

5. the conveyance of warranty is accepted without reserve by the third person.

Since January 1, 1994, these leasing transactions are now covered by articles 1842 to 1850 of the Civil Code of Quebec. Leasing is defined as a contract by which a person, the lessor (crédit-bailleur), having acquired movable property that is subject of the leasing from a third person at the demand and in accordance with the instructions of another person, the lessee (crédit-preneur), puts such property at the disposal of the lessee for a fixed term and in return for payment; a leasing may be entered into for "business purposes only" (article 1842).

In The Queen v. Bérou Construction, 96 DTC 6177, the Federal Court - Trial Division had to determine whether a leasing agreement (crédit-bail) in Quebec with an option to buy was a lease or a sale. Justice Tremblay-Lamer concluded that the lessee did not acquire ownership of the leased property and that the leasing contract was not a sale on a suspensive condition. She stated that, as long as the option to purchase is not exercised, there is no transfer of ownership.

The terms of the agreements submitted refer to a leasing contract because the lessee is not the owner of the property. In fact, the lessee cannot dispose of the property. The right to dispose of property is a requirement of the ownership in Quebec. According to paragraph XXXXXXXXXX, the lessee must use the property in its business only. The property is insured by the lessee for the benefit of the lessor (paragraph XXXXXXXXXX). Paragraph XXXXXXXXXX mentions that the lessor has full ownership of and title to the property and alterations, additions or improvements may be made only with the lessor's written approval. Furthermore, the lessee must keep the property free of all liens. The lessee may not assign its rights and obligations without the lessor's written approval (paragraph XXXXXXXXXX). The clause on the first page mentions that the title is transferred to the lessee at the end of the contract. Paragraph XXXXXXXXXX also states that the leasing contract is a financing transaction under which the lessor allows the lessee to possess and use the property and exercise any option rights.

In conclusion, the five documents that we reviewed should be considered to be leases under Quebec law for the purposes of Part I and I.3 of the Act. This treatment should apply to the lessor and the lessees. It remains that this issue will have to be reviewed should the Federal Court of Appeal reverse the Trial decision in Bérou Construction.

In our view, the amount recorded in the balance sheet as loans or finance receivable for the leasing contracts in Quebec do not qualify for the investment allowance deduction under paragraph 181.2(4)(b) or (c) of the Act. In fact, the amounts recorded are not loans or advances because there is no borrower - lender relationship. They also do not appear to be similar to a note, bond, debenture or mortgage. In fact, the amounts recorded represent the amount receivable pursuant to the leasing contracts.

We trust that our comments will be of assistance. Your file is returned herewith.

Chief
Section du financement et des régimes
Financial Industries Division
Income Tax Rulings and
Interpretations Directorate
Policy & Legislation Branch