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.
Principal Issues: Merger of the fee simple interest with different leasehold interests, repayment of pre-paid rent and some of the leasehold improvements.
Position: Ruling issued.
Reasons: Satisfied all statutory and administrative requirements.
XXXXXXXXXX 2008-030343
XXXXXXXXXX , 2010
Dear Sirs:
Re: Advance Income Tax Rulings
XXXXXXXXXX
This is in reply to your request dated XXXXXXXXXX for an Advance Income Tax Ruling on behalf of the above named taxpayers. We acknowledge the information provided to us in our various telephone discussions and emails.
We understand that, to the best of your knowledge and that of the taxpayers involved, none of the issues involved in the ruling request:
(i) is in an earlier return of the taxpayers or a related person;
(ii) is being considered by a Tax Services Office or Taxation Center in connection with a previously filed tax return of the taxpayers or a related person;
(iii) is under objection by the taxpayers or a related person;
(iv) is before the courts or, if a judgment has been issued, the time limit for appeal to a higher court has not expired; or
(v) is the subject of a ruling previously issued by the Directorate.
Unless otherwise stated, all statutory references herein are to the Tax Act.
Definitions
(a) "CRA" means Canada Revenue Agency;
(b) "Head Lease" is the lease agreement entered into between XXXXXXXXXX and XXXXXXXXXX with respect to the XXXXXXXXXX Lands described in more detail in Paragraphs 8 to 11;
(c) "XXXXXXXXXX ", a corporation described in Paragraph 7, means XXXXXXXXXX ;
(d) "XXXXXXXXXX ", a corporation described in Paragraph 1, means XXXXXXXXXX ;
(e) "Paragraph" means a numbered paragraph in this letter;
(f) XXXXXXXXXX ;
(g) "XXXXXXXXXX Lands" means the fee simple interest in land owned by XXXXXXXXXX and acquired as described in Paragraph 9 and includes the XXXXXXXXXX Property and the Subleased Property;
(h) "XXXXXXXXXX Property" means the land that is subject to the Head Lease and is the land on which XXXXXXXXXX but excludes the Subleased Property;
(i) "Subleased Property" means the land that is subject to the Head Lease and which is subject to Subleases between XXXXXXXXXX and the Sublessees;
(j) "Subleases" are those long-term sub-leases of land described in Paragraphs 2 to 4 between XXXXXXXXXX and arm's length parties;
(k) "Sublessee(s)" means those persons that have entered into Subleases with XXXXXXXXXX , and includes XXXXXXXXXX ("Sublessee #1") and XXXXXXXXXX ("Sublessee #2"). There are currently approximately XXXXXXXXXX Sublessees; and
(l) "Tax Act" means the Income Tax Act (Canada) R.S.C. c.1 1985 (5th Supplement) as amended to the date of this Advance Income Tax Ruling.
Our understanding of the facts, proposed transactions and the purpose of the proposed transactions is set out below. Any documents and/or arguments submitted with your request do not form part of the proposed transactions and any reference thereto is solely for the convenience of the reader.
Facts
1. XXXXXXXXXX is a corporation incorporated under the laws of XXXXXXXXXX and engaged primarily in the business of XXXXXXXXXX . XXXXXXXXXX is a "Canadian-controlled private corporation" as defined in subsection 125(7).
2. XXXXXXXXXX has a leasehold interest in the XXXXXXXXXX Lands that it leases from XXXXXXXXXX under the Head Lease. XXXXXXXXXX sub-leases pursuant to the Subleases certain of the leased land that is part of the XXXXXXXXXX Lands and is located in and around the XXXXXXXXXX ("Subleased Property"), on a long term basis (the length of term varies from lease to lease but all Subleases terminate on XXXXXXXXXX ) to arm's length parties, on which are XXXXXXXXXX . Each Sublease is in respect of a separate fee simple lot with certain lots subject to XXXXXXXXXX .
Each of Sublessee #1 and Sublessee #2 has a leasehold interest in their respective Subleased Property by virtue of entering into a Sublease and each of them has incurred costs for leasehold improvements on their respective Subleased Property by paying to have improvements constructed, or in acquiring the leasehold interest from a prior Sublessee that had paid for improvements.
3. The Sublease entered into by Sublessee #1 is in respect of the Subleased Property legally described as XXXXXXXXXX , together with an interest in the common property in proportion to the unit entitlement of the XXXXXXXXXX Lot.
Sublessee #1 acquired its interest in the Sublease under which it is the subtenant by way of assignment of the Sublease. The Sublease covers the period from XXXXXXXXXX to XXXXXXXXXX . At the time that the Sublease was entered into in XXXXXXXXXX the amount of rent prepaid by the original Sublessee was $XXXXXXXXXX . The original Sublessee made improvements to the subleased property which involved the construction of a XXXXXXXXXX project and assigned its interest in the Sublease to Sublessee #1 in consideration for $XXXXXXXXXX in XXXXXXXXXX . Sublessee #1 and the original Sublessee dealt at arm's length at the time of assignment of the Sublease.
4. The Sublease entered into by Sublessee #2 is in respect of the Subleased Property legally described as XXXXXXXXXX .
Sublessee #2 acquired its interest in the Sublease under which it is the subtenant by way of an assignment of the Sublease. The Sublease covers the period from XXXXXXXXXX to XXXXXXXXXX . The amount of rent prepaid by the original Sublessee unamortized at the date of acquisition of the Sublease by Sublessee #2 is $XXXXXXXXXX . The original Sublessee made improvements to the subleased property which involved the construction of a XXXXXXXXXX project and assigned its interest in the Sublease to Sublessee #2 in consideration for $XXXXXXXXXX in XXXXXXXXXX . Since Sublessee #2 acquired its interest in the Sublease, he has made $XXXXXXXXXX of additional improvements resulting in the current cost of the interest in the Sublease being $XXXXXXXXXX . Sublessee #2 and the original Sublessee dealt at arm's length at the time of assignment of the Sublease.
5. For tax purposes the prepaid rents paid pursuant to the Subleases are or have been included in XXXXXXXXXX 's income in accordance with paragraph 12(1)(a) and XXXXXXXXXX takes a reasonable reserve pursuant to paragraph 20(1)(m) for the prepaid rents that relate to future taxation years. For tax and financial statement purposes the prepaid rents are recognized as income by XXXXXXXXXX over the terms of the Subleases on a straight-line basis.
6. Certain Sublessees have entered into separate leases with XXXXXXXXXX to lease their portion of the Subleased Property following the expiration of the Head Lease. The term of each of these leases with XXXXXXXXXX is XXXXXXXXXX years and the rent in respect of this period has been prepaid. The amount of such prepaid rent is relatively small because such leases will not commence until XXXXXXXXXX . XXXXXXXXXX has accounted for such amounts as prepaid rent for tax and accounting purposes and has claimed reserves under paragraph 20(1)(m) in respect of such prepaid rent.
Sublessee #1 and Sublessee #2 did not enter into XXXXXXXXXX -year leases with XXXXXXXXXX .
7. XXXXXXXXXX is a corporation incorporated under the laws of XXXXXXXXXX and is XXXXXXXXXX is engaged in the business of leasing real property. XXXXXXXXXX owns the fee simple interest in the XXXXXXXXXX Lands. The XXXXXXXXXX Lands constitute capital property of XXXXXXXXXX .
8.
(a) On XXXXXXXXXX , as lessee, entered into a lease (the "Head Lease") with respect to the XXXXXXXXXX Lands, with a lessor that was not related to and was dealing at arm's length with XXXXXXXXXX .
(b) The lessor in Paragraph 8(a) then sold the XXXXXXXXXX Lands at fair market value to a new lessor, which also assumed the Head Lease.
9. On XXXXXXXXXX , XXXXXXXXXX purchased the XXXXXXXXXX Lands from the new lessor referred to in Paragraph 8(b) at a cost of $XXXXXXXXXX , which was the fair market value on XXXXXXXXXX of the XXXXXXXXXX Lands that were subject to the Head Lease, and assumed the Head Lease. The new lessor referred to in Paragraph 8(b) was not related to and was dealing at arm's length with XXXXXXXXXX .
10. XXXXXXXXXX leases, under the Head Lease, the XXXXXXXXXX Lands, to XXXXXXXXXX on arm's length terms as established under the Head Lease with the lessor described in Paragraph 8. The Head Lease is a long-term lease set to expire on XXXXXXXXXX .
11. Rent payments pursuant to the Head Lease by XXXXXXXXXX to XXXXXXXXXX , are paid annually at a rate of $XXXXXXXXXX plus a percentage of the cost of improvements made by XXXXXXXXXX to the XXXXXXXXXX Lands.
12. Some of the Sublessees use their Subleased Property and leasehold improvements for the purpose of earning income and as a result hold depreciable property of a prescribed class with respect to the cost of their leasehold interests. Approximately XXXXXXXXXX % of the Sublessees hold their Subleased Property for personal purposes.
Sublessee #1 holds depreciable property of a prescribed class as a result of using its Subleased Property together with the leasehold improvements for the purpose of earning income. Sublessee #2 uses his Subleased Property together with leasehold improvements for personal purposes and not for the purposes of earning income.
Proposed Transactions
13. XXXXXXXXXX will transfer the fee simple interest in the Subleased Property to XXXXXXXXXX in consideration for a demand, non-interest bearing note having a principal amount equal to the fair market value of XXXXXXXXXX 's fee simple interest in the Subleased Property. The acquisition cost of the Subleased Property to XXXXXXXXXX will exceed the capital cost of the Subleased Property to XXXXXXXXXX . XXXXXXXXXX will not transfer any other part of the XXXXXXXXXX Lands to XXXXXXXXXX , other than the Subleased Property.
14.
(a) XXXXXXXXXX and XXXXXXXXXX will refund the unamortized portion of the prepaid rents, as determined by XXXXXXXXXX and XXXXXXXXXX , to a Sublessee that intends to purchase the fee simple interest in the Subleased Property that is the subject of the Sublessee's Sublease, and, in the case of XXXXXXXXXX , XXXXXXXXXX will pay to the said Sublessee, whose Subleased Property is not used for the purpose of earning income and whose leasehold interest is not property of a prescribed class, an amount in respect of leasehold improvements to such Subleased Property equal to the cost of the leasehold improvements to the Sublessee. The refund of the unamortized portion of the prepaid rents and the payment of the leasehold improvements will be effected by XXXXXXXXXX and XXXXXXXXXX by issuance of demand promissory notes to each such Sublessee that will accept these promissory notes as absolute payments. Such reimbursement of the cost of leasehold improvements that is paid by XXXXXXXXXX to a Sublessee will be treated as the cost of improvements acquired by XXXXXXXXXX and would be added to the cost of the fee simple interest in the Subleased Property or will be treated as the cost of a separate property to the extent that an improvement is to be treated as a separate property for tax purposes.
Sublessee #1 and Sublessee #2 intend to purchase the fee simple interest in their Subleased Property and will accept promissory notes issued by XXXXXXXXXX as absolute payment for the refund of the unamortized portion of their prepaid rents. If the Proposed Transactions occur on XXXXXXXXXX , Sublessee #1 and Sublessee #2 would accept promissory notes of approximately $XXXXXXXXXX and $XXXXXXXXXX respectively, with respect to the unamortized balance of their prepaid rents.
(b) Sublessee #2 will accept a promissory note issued by XXXXXXXXXX as absolute payment for the cost of the leasehold improvements incurred by Sublessee #2 in the amount of approximately $XXXXXXXXXX (cost of Sublease minus the amount of rent prepaid by the original Sublessee unamortized at the date of acquisition of the Sublease by Sublessee #2).
Sublessee # 1 and Sublessee #2 will not receive a promissory note from XXXXXXXXXX as they have not entered into XXXXXXXXXX -year leases with XXXXXXXXXX as described in Paragraph 6.
15. The Sublessees whose leasehold interest in the Subleased Property is a property of prescribed class will not receive any reimbursement in respect of leasehold improvements to their Subleased Property.
Sublessee #1 will not receive any reimbursement in respect of leasehold improvements to its Subleased Property.
16. XXXXXXXXXX will sell the fee simple interest in the Subleased Property to a Sublessee at a price and on terms to be negotiated between the parties. The selling price will exceed the amount of the promissory notes issued to the Sublessee in Paragraph 14.
XXXXXXXXXX will sell and Sublessee #1 and Sublessee #2 will acquire the fee simple interest in their respective Subleased Property at a price and on terms to be negotiated between the parties. The price will exceed the amount of the promissory notes issued to Sublessee #1 and Sublessee #2 as described in Paragraph 14.
17. A Sublessee's consideration given to XXXXXXXXXX for the purchase price of the fee simple interest in a Subleased Property will consist of a combination of cash, set-off against the promissory notes issued by XXXXXXXXXX in Paragraph 14, and assignment to XXXXXXXXXX of any promissory notes issued by XXXXXXXXXX in Paragraph 14 to the Sublessee.
The consideration given to XXXXXXXXXX by each of Sublessee #1 and Sublessee #2 for the purchase price of the fee simple interest in their respective Subleased Property will consist of a combination of cash and set-off against the promissory notes issued by XXXXXXXXXX as referred to in Paragraph 14.
Purpose of the Proposed Transactions
18. The current sublease arrangements were entered into by XXXXXXXXXX as a result of XXXXXXXXXX originally leasing the XXXXXXXXXX Lands from an arm's length party. XXXXXXXXXX . In order to facilitate offering fee simple ownership to persons acquiring property in the future, XXXXXXXXXX believes that, to be fair to the existing Sublessees, the existing Sublessees must be offered the opportunity to acquire the fee simple interest in their existing Subleased Property. The Proposed Transactions will permit an existing Sublessee to acquire the fee simple interest in the Subleased Property.
Rulings
Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions and the purpose of the proposed transactions, and provided further that the proposed transactions are completed in the manner described above, our rulings, subject to the caveat set out below, are as follows:
A. On the transfer of the fee simple interest in the Subleased Property from XXXXXXXXXX to XXXXXXXXXX as described in Paragraph 13 there will be a merger of the fee simple interest and XXXXXXXXXX 's leasehold interest in the Subleased Property that will result in a disposition of the leasehold interest in respect of which XXXXXXXXXX will realize no gain pursuant to subparagraph 40(1)(a)(i).
B. The provisions of subsection 13(5.1) will apply to XXXXXXXXXX in respect of its acquisition at a particular time in a taxation year of the Subleased Property from XXXXXXXXXX with the result that:
(a) XXXXXXXXXX 's leasehold interest in the Subleased Property shall be deemed to have been disposed of by XXXXXXXXXX at the particular time for proceeds of disposition equal to the amount, if any, by which
(i) the capital cost immediately before the particular time of
XXXXXXXXXX 's leasehold interest in the Subleased Property
exceeds
(ii) the total of all amounts claimed by XXXXXXXXXX in respect of its leasehold interest in the Subleased Property and deductible under paragraph 20(1)(a) in computing XXXXXXXXXX 's income in previous taxation years;
(b) The Subleased Property shall be deemed to be depreciable property of a prescribed class of XXXXXXXXXX acquired by XXXXXXXXXX at the particular time and an amount equal to the capital cost of XXXXXXXXXX 's leasehold interest in the Subleased Property referred to in (a)(i) above will be added to the capital cost of the Subleased Property; and
(c) The total referred to in (a)(ii) above shall be added to the total depreciation allowed to XXXXXXXXXX before the particular time in respect of the prescribed class to which the Subleased Property belongs.
C. XXXXXXXXXX will be allowed a deduction pursuant to paragraph 20(1)(m.2) for the amounts of the unamortized portion of the prepaid rents referred to in Paragraph 14(a) (adjusted to the date of repayment) that are repaid to Sublessee #1 and Sublessee #2 and that have been included in computing XXXXXXXXXX 's income from a business, pursuant to paragraph 12(1)(a).
D. The provisions of subsection 13(5.1) will apply to Sublessee #1 in respect of its acquisition of the Subleased Property from XXXXXXXXXX as described in Paragraph 16.
E. On the transfer of the fee simple interest in the Subleased Property from XXXXXXXXXX to Sublessee #1, there will be a merger of the fee simple interest and the leasehold interest in the Subleased Property held by Sublessee #1 that will result in a disposition of the leasehold interest in respect of which Sublessee #1 will realize no gain pursuant to subparagraph 40(1)(a)(i).
F. On the transfer of the fee simple interest in the Subleased Property from XXXXXXXXXX to Sublessee #2, there will be a merger of the fee simple interest and the leasehold interest in the Subleased Property held by Sublessee #2 that will result in a disposition of the leasehold interest in respect of which Sublessee #2 will realize no gain, pursuant to subparagraph 40(1)(a)(i). The cost of the Subleased Property to Sublessee #2 will be the consideration given by Sublessee #2 to acquire the fee simple interest in its Subleased Property as described in Paragraph 17.
G. Provided that the leasehold interest of Sublessee #2 in respect of its Subleased Property is not property of a prescribed class for purposes of paragraph 20(1)(a) and Sublessee #2 did not deduct, in computing income under the Tax Act, any portion of the prepaid rents in respect of its Subleased Property, neither the provisions of subsection 13(5.1) nor those of subsection 13(5.4) will apply to Sublessee #2 in respect of the acquisition of the fee simple interest in its Subleased Property.
H. Pursuant to subparagraph 40(2)(g)(iii), any loss computed under subparagraph 40(1)(b)(i) by Sublessee #2 on the disposition of its leasehold interest in its Subleased Property will be deemed nil.
I. Provided that the leasehold interest of Sublessee #2 in respect of its Subleased Property is not property of a prescribed class for purposes of paragraph 20(1)(a), paragraph 12(1)(x) will not apply to the amount received by Sublessee #2 from XXXXXXXXXX in respect of the cost of the leasehold improvements as described in Paragraph 14(b).
J. An amount received by Sublessee #2 from XXXXXXXXXX in respect of the Sublessee #2's cost of leasehold improvements to its Subleased Property as described in Paragraph 14(b) will not reduce the cost to Sublessee #2 of the leasehold improvements.
Caveat
These rulings are given subject to the limitations and qualifications set out in Information Circular 70-6R5, issued by the CRA on May 17, 2002 and are binding on the CRA provided that the proposed transactions are completed on or before XXXXXXXXXX .
Except as expressly stated, this Advance Income Tax Ruling does not imply acceptance, approval or confirmation of any other income tax implications of the facts or proposed transactions described herein.
The above noted rulings are based on the Tax Act in its present form and do not take into account any proposed amendments to the Tax Act which, if enacted, could have an effect on the rulings provided herein.
Yours truly,
XXXXXXXXXX
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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