16 April 2004 GST/HST Interpretation 48059 - Leasehold Interest in Ground Lease

Please note that the following document, although correct at the time of issue, may not represent the current position of the Agency. / Veuillez prendre note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'Agence.

Dear XXXXX:

Thank you for your letter XXXXX (with attachments), concerning the application of the Goods and Services Tax (GST) to the transactions described below.

All legislative references in this ruling are to the Excise Tax Act. Since the place of supply for the transactions referred to in this ruling do not take place in a participating province, this ruling refers only to the GST.

Statement of Facts

The facts, the transactions, and the purpose of the transactions stated in XXXXX are the same for purposes of this application ruling with the exception of the amended or additional facts provided in your letter XXXXX.

Our understanding of the amended and additional facts is as follows:

1. Assignment of Leasehold Interest in the Ground Lease (Use of the term "Leasehold Interest" in this ruling refers to the interest granted by the Land-owner to the Developer pursuant to the Ground Lease.)

Addition to Fact XXXXX: XXXXX (the Assignor), with the written consent of the XXXXX (the Land-owner), assigned its leasehold interest in the Ground Lease of the property (the subject property) to XXXXX (the Assignee). The effective date of this assignment was XXXXX. The Assignor remains jointly liable with the Assignee for performance under the Ground Lease. (Reference to the "Developer" in this ruling shall refer, in respect of the Ground Lease, to XXXXX prior to XXXXX and to XXXXX from XXXXX until the end of the lease term. In respect of all other GST matters pertaining to the subject property reference to the "Developer" in this ruling shall refer to XXXXX) XXXXX still remains the indemnifier.

2. Exterior Upgrades / Cladding - Rent Free Period

Amendment to Fact XXXXX: With respect to both the rent-free period and the exterior upgrade / cladding for the Building, these were both matter of pre-contractual negotiations between the parties [the Land-owner and the Developer] XXXXX, the results of which were incorporated into the Ground Lease signed XXXXX. Moreover, # 13 of the Statement of Facts, in reference to the XXXXX letter to the Developer XXXXX (a copy of which was included in the initial request for a ruling) that XXXXX is erroneous. Notwithstanding that the exterior cladding and the applicable costs are discussed, there is no mention of a XXXXX year rent-free holiday in the letter - rather a proposal to adjust the ground rent (For purposes of this ruling this reference to "ground rent" is viewed as equivalent to Base Rent.) payment is considered. The cladding and the rent-free period are two separate and distinct issues which can be explained as follows:

•   With respect to the exterior cladding, this was a matter of pre-contractual negotiations of the Ground Lease. Specifically, the Developer and the Land-owner agreed that the net present value of the Base Rent would be $XXXXX (reduced from $XXXXX) in consideration of the enhanced cladding. This would enable the Developer to maintain its cost forecasts for the project. Accordingly, no cash payment from the Land-owner to the Developer for part of the material costs of the exterior upgrade (equal to $XXXXX) was ever contemplated or transacted between the parties; and

•   With respect to the rent-free period as well as the Base Rent prepayment option (see below), once again this was a matter of pre-contractual negotiations between the parties [the Land-owner and the Developer] the results of which were embodied in the Ground Lease. The Land-owner agreed to the schedule of rental payments to assist the Developer from a cash flow perspective during the construction phase of the Building on the condition that the new present value of the rental stream (using the agree-upon discount rate) would be equal to $XXXXX. The Developer sought to have the payment delayed to a time where it was sure it would be receiving income from the development. As it turned out, the Developer's financing for the construction included the entire amount of Base Rent which was prepaid as set out below.

3. Prepaid Base Rent

Addition to Fact XXXXX: XXXXX the Developer elected to prepay the entire amount of the Base Rent as a single lump sum payment to the Land-owner in accordance with XXXXX the Ground Lease. The amount paid was as follows:

In a telephone conversation XXXXX, the CCRA (now CRA) verbally advised the Land-owner that the entire amount of the Base Rent prepayment would be subject to GST. Accordingly, XXXXX the Land-owner advised the Developer of same and requested payment of $XXXXX on account of the outstanding GST payable. The Developer paid this amount to the Land-owner on XXXXX. The Land-owner reported the total amount of GST XXXXX in its XXXXX GST/HST return.

Transaction(s)

Same as in the previous ruling except for the following:

1. The assignment of the Leasehold Interest in the Ground Lease, as detailed in paragraph (1) of the Statement of Facts, above.

2. All transactions between the Land-owner and the Developer concerning the exterior upgrades / cladding and the rent-free period, as detailed in paragraph (2) of the Statement of Facts, above.

3. The prepayment of the entire amount of the Base Rent by the Developer to the Land-owner XXXXX, as detailed in paragraph (3) of the Statement of Facts, above.

Ruling Requested

On behalf of your client [the Land-owner] you have requested that the CRA review its position in the previous ruling taking into consideration the additional / amended facts in the above Statement of Facts and confirm:

1. Whether the assignment of the Leasehold Interest in the Ground Lease to the Assignee varies the previous ruling;

2. Whether XXXXX - GST treatment of taxable supplies made by the Land-owner during Years XXXXX of the Ground Lease XXXXX - as it applies to the exterior upgrades or cladding must be reconsidered and, if so, provide the proper GST application; and

3. Whether the transactions carried out by the Land-owner (discussed in paragraph 3 of the Statement of Facts, above), i.e., charging and remitting GST on the full prepaid Base Rent, are in accordance with CRA's direction expressed verbally in our telephone conversation XXXXX.

Ruling Given

Based on the facts set out above XXXXX, we rule that

1. The assignment of the Leasehold Interest in the Ground Lease from the Assignor to the Assignee does not vary XXXXX.

The assignment of the Leasehold Interest is a sale of real property for GST purposes. Such a supply of real property and anything done by the supplier in the course of or in connection with making such a supply is a "commercial activity", unless the supply is an exempt supply. Since no exemption applies to the assignment of the Leasehold Interest, this supply is subject to GST.

Since the Assignee, as recipient of a taxable sale of real property, was registered for GST purposes at the time of the assignment, the Assignor is not required to collect GST from the Assignee in accordance with subsection 221(2). Since the Assignee acquired the Leasehold Interest for use or supply exclusively in commercial activities of the Assignee, the Assignee is required to self-assess the GST that became payable in accordance with paragraph 228(4)(a). In addition, the Assignee is entitled to claim an offsetting ITC equal to the tax payable on the assignment, reported on its XXXXX GST/HST return.

2. XXXXX - GST treatment of taxable supplies made by the Land-owner during Years XXXXX of the Ground Lease XXXXX - as it applies to the exterior upgrades or cladding is amended as follows.

The Land-owner's payment of $XXXXX to the Developer, the form of a rent reduction, is consideration for the supply of construction materials made by the Developer to the Land-owner. Since this supply of construction materials is a taxable supply, the Developer is required to charge the Land-owner GST in the amount of $XXXXX in respect of this supply.

The rent-free period represents a deferral of the Base Rent and not a rent-reduction. As a result there are no GST consequences arising from the rent-free period. GST on the Ground Lease becomes payable on each day that is the earlier of the day rent is paid and the day rent becomes due in accordance with subsection 168(2).

3. The transactions carried out by the Land-owner (discussed in paragraph 3 of the Statement of Facts, above), i.e., charging and remitting GST on the full prepaid Base Rent, are in accordance with CRA's direction expressed verbally in our telephone conversation XXXXX.

The Developer's pre-payment of the Base Rent in the amount of $XXXXX is fully subject to GST as consideration for a taxable supply of real property.

The prepayment of Base Rent is attributable to the balance of the lease term excluding Years XXXXX, since no Base Rent is payable until Year XXXXX. Assuming the construction of the complex will be substantially completed prior to the end of Year XXXXX, the prepayment of Base Rent is not attributable in whole or in part to Period I (Periods I, II and III were set out in the XXXXX referring to the following time periods under the Ground Lease with respect to the Residential Portion: Period I - from the date the Ground Lease is entered into until immediately before the Residential Units first come into existence; Period II - from the time the Residential Units first come into existence until immediately before a particular Residential Unit is assigned to a Purchaser; Period III - from the time a particular Residential Unit is assigned to a Purchaser until the end of the term under the Ground Lease.) Further, in respect of the Residential Portion, the Developer's lease term ends on Unit-by-Unit basis as Residential Units are assigned to Purchasers. As a result, the Developer has no Period III for those Units assigned (rather than sub-leased). Thus, the Developer's prepayment of the Base Rent is to be apportioned as follows.

The Base Rent is first to be apportioned on a reasonable basis between the Residential Portion and the Retail Portion. All of the Base Rent attributable to the Retail portion is subject to GST for the entire lease term. The Base Rent attributable to the Residential Portion is then further apportioned on a reasonable basis between those Residential Units that are supplied or held for supply by way of assignment and those Units supplied by way of sub-lease. However, since at the time of the Base Rent prepayment all of the Units were held for supply by way of assignment, all of the Base Rent prepayment attributable to the Residential Portion is also subject to GST.

This ruling is subject to the general limitations and qualifications outlined in section 1.4 of Chapter 1 of the GST/HST Memoranda Series. We are bound by this ruling provided that none of the above issues is currently under audit, objection, or appeal; that there are no relevant changes in the future to the Excise Tax Act, or to our interpretative policy; and that you have fully described all necessary facts and transaction(s) for which you requested a ruling.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 954-8852.

Yours truly,

Daryl J. A. Hooley, CGA
Real Property Unit
Financial Institutions and Real Property Division
Excise and GST/HST Rulings Directorate

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