28 July 1989 Income Tax Severed Letter AC738342 - 99-Year Leases - Abalone & Roe Herring Licences

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.

July 28, 1989

VANCOUVER DISTRICT OFFICE HEAD OFFICE
Chief of Audit Financial lndustries
Division
Kevin J. Donnelly

Attention Audit Review 148-14 957-3500
W.F. Hannemann
7-3842
SUBJECT: 99 Year leases
Abalone & Roe Herring Licences

Your memorandums dated March 14, 1989 and May 1st 1989 addressed to Head Office, Audit Applications Division, have been referred to this Division with a view to providing you with the opinions requested.

We have examined your submission and in particular

24(1)

These licences were personal to the holders and pursuant to Government Regulations could not be transferred. To get around this restriction, the licence holder apparently entered into lease arrangements for ninety-nine year. Your concerns relate to whether or not the above-noted Agreement constitute leases or dispositions for purposes of the Income Tax Act (the "Act") and in addition you question what tax treatment to be accorded the payments pursuant to these Agreements.

Before addressing the specific Agreements it is relevant for us to clarify in part our current position with respect to the Issue of lease-option agreements, which position will be reflected In IT-133 which Is currently being revised.

Although the Issue in your memorandums is often described as determining whether a purported lease is in realty a sale, this is not an accurate description. The issue concerns whether a purported lease is in reality a lease or a disposition. For income tax purposes, the term "disposition" includes a sale as well as certain events which are not regarded as sales under provincial law. Consequently, the term "disposition" has a broader meaning than the term "sale".

A transaction that constitutes a sale will always constitute a disposition for Income tax purposes. Whether a transaction constitutes a sale will depend on the provincial law governing the transaction. For example, a sale usually includes a conditional sale.

If a transaction does not constitute a sale, it may nevertheless constitute a disposition. A taxpayer has disposed of property if he has given up:

• i) title to the property, or
• ii) the normal incidents of title (such as possession, use and risk).

In determining whether a purported lease constitutes a disposition, one must determine whether the lessor has given Up title or the normal incidents of title to the property. This will involve a consideration of all the legal rights and obligations of the parties. Treatment of the transaction under generally-accepted accounting principles is not in itself considered relevant for this purpose.

The presence of the following factors, no one of which will determine the issue, indicate that a purported lease is, in reality, a disguised disposition and acquisition of property:

• i) the purported lessee Is required to purchase the property during, or on termination of, the lease term
• ii) the purported lessee automatically acquires title to the property after payment of a specified amount in the form of "rental" payments iii) the presence of a nominal option price for property that probably will have a substantial fair market value at the time the option becomes exercisable
• iv) the purported lessee has the Incidents of ownership (i.e. he must obtain permits, licences and registrations pay fees, expenses and charges relating to the property obtain Insurance on the property
• v) the purported lessee is responsible for effecting major repairs to the property rather then merely effecting routine maintenance
• vi) the total cost of all scheduled "rental" payments, after deducting national interest and administrative costs, is equal to the fair market value of the property at the time the "lease" is entered into
• vii) on exercise of an option, the fair market value of the property Is likely to be substantially greater than the option price so that the exercise of the option is a foregone conclusion
• viii) on exercise of an option before expiry of the "lease" term, the "lessee" must pay, In addition to the option price, all "rental" payments that would have been due had the "lease" run its term and
• ix) the rights retained by the "lessor" are In substance no more than the rights retained by a vendor under a conditional sales contract in order to protect its security Interest in the property.

The above criteria are not determinative In and by themselves and must be analyzed in the context of the legal relationship between the parties. For example, an option price that is reduced by previous rental payments not constitute a disposition if the property is a wasting asset (such as a gravel pit) that has been exploited by the lessee during the term of the lease. The reduction of the purchase price in this case may represent an approximation of the decreased value of the asset through exploitation by the lessee.

The criteria set out above are based on various court decisions. Reassessing based on the premise that a purported lease is in reality a disposition may also be justified under the recently- enacted general anti-avoidance rule in section 243 of the Act.

24(1)

The foregoing terms of the Agreement as well as others, clearly demonstrate that the Agreement, for purposes of the Income Tax Act, is not a lease but could be characterized as a disposition of the Licence. The Vendor has disposed of his entire interest in the licence except for his responsibility as the title holder of the licence. For purposes of the definition of eligible capital expenditure in paragraph 14(5)(b) it is not a requirement that the taxpayer actually acquire title in order for paragraph 14(5)(b) to to apply. In our opinion all significant rights associated with the Licence pass to one Purchaser and the Vendor has no intention or expectation of ever getting them back. In our view the transaction between the Vendor and the Purchaser who use the licence to gain or produce Income from business, should be treated as a disposition of eligible property by the Vendor and an acquisition of eligible capital property by the Purchaser.

24(1)

Analysis

While this Agreement is not as comprehensive in its terms as the Abalone Agreement referred to above, in our view there is sufficient content to this Agreement to conclude that it results in the disposition of the licence for tax purposes. Although It may be illegal to transfer the licence the facts support an effective transfer for tax purposes. As in the Abalone Agreement, the "Lessor" has no intention or expectation of ever getting the licence back. It is common knowledge in the fishing community that these 99 year leases are a mere formality to accomplish what is intended, the transfer of all rights under the licence to the "Lessee". In substance the Agreement is a transfer, the lease transaction is a sham. In our view there is a disposition and acquisition of an eligible capital property for tax purposes, on the assumption that both parties use it to generate business income.

Treatment of Payments

Where the Department characterizes the Agreement as one of disposition and acquisition rather than a lease, it will be a question of fact as to the treatment of the payments for tax purposes. Where you have a disposition and acquisition of a fishing licence by parties who use it for the purpose of gaining or producing income from a business, the outlay by the acquiror normally would be an outlay on account of capital which qualifies as an eligible capital expenditure. The proceeds received by the fisherman disposing of the licence would be treated as eligible capital proceeds, a portion of which depending on the taxation year involved, would be credited to the recipient's cumulative eligible capital.

Where the licence is acquired by a taxpayer into is not going to use it for the purpose of gaining or producing Income from a business and the licence is to be used to generate income from property, the payment by the acquiror would be treated as a non-deductible capital expenditure. The licences are property for purposes of the Act and the Income Tax Regulations. On the other hand if the licence is acquired by a person for speculative purposes, the expenditure would be treated as inventory.

We trust the foregoing views will be of assistance to you and will enable you to treat these transactions In a consistent manner.

If you require "clarification" or wish to have us reconsider any aspect of this matter, please do not hesitate to write to us again. We regret the delay In responding to your memorandum.

Chief
Leasing and Financing Section
Ruling Directorate

Document Disclosed Pursuant to the Access to Information Act Document Divulgué en vertu de la loi sur l'accès à l'information