Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation] Corporation A signed a four-year lease in respect of a property, at the end of which it could exercise a purchase option on the property for $5. Corporation A transferred its leasing agreement to Corporation B, a related Corporation. Corporation B assumed the balance of the lease obligation and paid Corporation A an amount equal to the difference between the value of the property at the time of the transfer and the balance of the obligation. How should Corporation B treat the amount paid on the transfer?
Position: General comments. If it is determined that the true legal relationship of the transaction between the parties is a lease, a valuation would determine whether part of the lease amount is attributable to the acquisition of an option to purchase the property and whether the payment made by Corporation B is attributable to the acquisition of that option.
Reasons: Positions expressed in ITTN No 21
XXXXXXXXXX Danielle Bouffard
2004-009941
April 4, 2005
Dear Sir,
Subject: Request for a technical interpretation: Transfer of a leasing contract between related corporations
This is further to your letter of October 18, 2004 in which you requested our opinion on the applicable tax treatment in the context of a transfer of a leasing agreement between related corporations. We have taken into account additional information obtained during a telephone conversation on January 26, 2005 (XXXXXXXXXX/Bouffard). We apologize for the delay in responding to this request.
Facts
Corporation A leased property under a leasing agreement governed by the laws of the Province of Quebec.
In this leasing agreement, it was stated that a financial institution (lessor) remained the owner of the property and that Corporation A (lessee 1) would not have any right or interest in the property. At the end of the 48-month agreement, Corporation A could exercise an option to purchase the property for $5.
Corporation A deducted the rent paid as an expense and did not include the property in a depreciable class.
Corporation A transferred the leasing agreement to Corporation B, a related Corporation. The financial institution consented to the transfer of the agreement. At the time of the transfer, the property had a value of $20,000 and the balance of Corporation A's obligations under the agreement was $15,000.
Question
If Corporation B makes a $5,000 payment to Corporation A, how should Corporation B treat the $5,000 payment to Corporation A for tax purposes?
Our Comments
As stated in paragraph 22 of Information Circular 70-6R5 dated May 17, 2002, it is the practice of the Canada Revenue Agency (CRA) not to issue written opinions on proposed transactions otherwise than through advance rulings. Since your question appears to be related to an agreement that has already been made, we are providing only the following general comments.
In Income Tax Technical News No. 21 of June 13, 2001, the CRA announced that, in light of the Supreme Court of Canada's decision in Shell Canada Limited v. The Queen, 99 DTC 5682, it is our position that, in the absence of sham, the determination of whether an agreement between two parties is a lease or sale must be resolved according to the legal relationship created by the terms of the agreement.
If it is established that the true legal relationship of a transaction between the parties is a lease, the inclusion of, for example, a bargain purchase option will not, in itself, change the nature of the transaction. However, we are of the view that a portion of each rental payment could be treated as a payment in respect of the right to purchase the property in the future. Thus, this portion of the payment would be treated as the cost of the option to purchase the property for the lessee and a disposition of property by the lessor. The determination of the amount of rent attributable to the acquisition of the option to purchase the property is, in our view, a valuation issue that can only be determined after a review of all the facts and documents surrounding the transaction. Where there is an option to purchase a property at the end of the lease, we are of the view that the rules of section 49 of the Income Tax Act (the "Act") would apply.
Where the facts show that part of each rental payment is in respect of the option to purchase the property, that part of the payments will not be deductible by the lessee.
In the situation described, it is difficult to describe the tax consequences that might arise to Corporation B from a payment of $5,000 in connection with Corporation A's transfer of its rights and obligations under the leasing agreement as lessee, since no agreement describing the various transactions between the parties was provided to us.
Consequently, taking into account the only information available to us, including the fact that the transaction between the parties is a lease, it would be appropriate, in our opinion, to examine whether part of the rent paid by Corporation A to the lessor is attributable to an option to purchase the property, by applying, if applicable, the rules of section 49 of the Act to the lessee 1 and the lessor. As seems to us to be the most reasonable assumption, at the time of the transfer of the obligations arising from the leasing agreement between Corporation A and Corporation B, the payment of $5,000 made by Corporation B would, in all likelihood, be attributable to the option to purchase the property, which would constitute the acquisition cost of this option for Corporation B and the proceeds of disposition of this option to Corporation A.
These comments are not advance income tax rulings and do not bind the CRA with respect to any particular factual situation.
Best regards,
Ghislaine Landry, CGA
for the Director
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Planning Branch
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