15 November 1994 GST/HST Interpretation 11745-5[1] - Settlement of Grandfathered Leases

Dear XXXXX

I refer to your letter of October 6, 1993, addressed to the XXXXX wherein you request an Advance Ruling concerning the Goods and Services Tax (GST) treatment respecting the settlement of grandfathered leases. Additional information dated December 13, 1993, and March 11, 1994, has been received by this office following a request by Owen Newell of my staff on December 10, 1993, and March 1, 1994. Please accept my apologies for the delay in replying to your letter.

Due to insufficient documentation, an advance ruling cannot be provided. However, an interpretation of the relevant provisions is provided.

A copy of Settlement Agreement No. 1 and a Lease Agreement with the XXXXX were included with your submission of October 6, 1993. Although you state that Settlement Agreement No. 1 is a sample of the other settlement agreements with other lessors, this interpretation will only apply to Settlement Agreement No. 1.

Our understanding of the facts is as follows:

Statement of Facts

1. XXXXX eased XXXXX from various lessors. Certain leases ("the grandfathered leases") were entered into before August 8, 1989.

2. XXXXX and its subsidiaries, including XXXXX (collectively referred to herein as the ["]XXXXX") are in financial difficulty and have adopted a strategy of restructuring their financial obligations. On November 29, 1992, the XXXXX suspended payments to substantially all creditors and lessors, including to the lessors under grandfathered leases. The result of this action was that the XXXXX defaulted on a number of their obligations to creditors and lessors.

3. The XXXXX is proposing a comprehensive debt restructuring which, among other things, is intended to restore the ability of the XXXXX to service its financial obligations, as restructured, on an ongoing basis. As part of the restructuring process, the XXXXX has negotiated a rationalization of its existing aircraft fleet. In certain instances, this will involve the return of specific aircraft to lessors and lenders and the cancellation of future aircraft deliveries.

4. In the case of XXXXX as at December, 1992, it operated a XXXXX[.] It has been decided that these XXXXX are excess for XXXXX to be operated by XXXXX in the future, and a proposal has been sent by XXXXX with the objective of entering into settlement agreements to achieve an orderly return of XXXXX and settle any agreed deficiency amount. Certain of these XXXXX proposes to return are the subject of grandfathered leases. The grandfathered leases are as follows:

Lessor - XXXXX XXXXX

GST Registration Number XXXXX

Dates of Lease Agreements XXXXX

XXXXX

GST Registration Number - XXXXX

Date of Lease Agreement XXXXX

XXXXX[.] The following is proposed by XXXXX

1. v has entered into Settlement Agreement No. 1 with the XXXXX pursuant to which the grandfathered leases will be terminated and settled and the applicable XXXXX will be returned to the applicable lessor.

2. Settlement Agreement No. 1 has been entered into in accordance with the general terms and conditions of a comprehensive restructuring plan agreement ("Restructuring Agreement") dated as of July 23, 1993, between the XXXXX and its creditors and lessors.

3. Settlement Agreement No. 1 provides that in final settlement of its obligations under the grandfathered leases, XXXXX will:

(a) make a cash payment to XXXXX (Rent Payable in Cash) in respect of a portion of the Basic Rent due under the grandfathered leases for the period from XXXXX section 2.2 of Settlement Agreement No. 1. A portion of the Basic Rent (Rental Deficiency) shall not be paid in cash but shall be included in and satisfied by the issuance of shares as described in (b);

(b) deliver to XXXXX common shares of XXXXX in satisfaction of and in consideration of XXXXX in respect of XXXXX grandfathered leases. In the event the Restructuring Agreement does not close or is terminated, XXXXX of the delivery of such common shares XXXXX per section 2.3 of Settlement Agreement. No. 1;

(c) reimburse XXXXX for their costs and expenses incurred in connection with the default and settlement of the grandfathered leases, subject to a maximum cash XXXXX section 2.4 and Article 7 of the Settlement Agreement No. 1; and

(d) return XXXXX in full satisfaction of any remaining amounts owing b[y] XXXXX under the grandfathered leases per section 3.2 of the Settlement Agreements.

4. For the purpose of this request, the payments to be made and consideration to be delivered by XXXXX to the applicable lessor referred to in paragraphs (a) to (c) immediately above are hereinafter referred to as the Settlement Payments.

Based on the above statement of facts and proposed transactions, you wish to confirm that for the purposes of the Act, the Settlement Payments to be made by XXXXX [t]o terminate the grandfathered leases early will not attract the GST.

Interpretation

Where Agreements in writing were entered into prior to August 8, 1989, to supply tangible personal property by way of lease that is capital property of the supplier, no tax is payable in respect of any consideration for any supply of the property under the agreement. On August 16, 1991, the Minister of National Revenue clarified a number of situations in which certain changes to leases will not result in the payments under the leases becoming ungrandfathered. One of the changes addressed was the early termination of a grandfathered lease.

The original lease is between XXXXX[.] The Settlement Agreement submitted as part of the request indicates that XXXXX the successor to XXXXX, and secondly, that XXXXX is the successor of XXXXX by way of assignment.

In order to determine the status of the payments and issuance of shares under the Settlement Agreement, confirmation of the terms under which XXXXX and the subsequent assignment of the leases XXXXX was sought. On February 21, 1994, XXXXX of my staff contacted you. You informed XXXXX[.] Leasing was a name change for XXXXX. As part of the request for a copy of the documentation indicating how XXXXX replaced XXXXX as the lessor and the subsequent assignment of the leases to the XXXXX provided documentation.

The documentation consisted of an assignment agreement between XXXXX dated February 1, 1993. The submission also included a Dissolution Agreement between XXXXX dated February 1, 1993. In the dissolution agreement all property and assets were transferred to the XXXXX[.] In order for the leases to XXXXX to continue as grandfathered leases under the assignment and dissolution agreements, a novation of the original lease agreement must not have occurred. From the information provided, the latter cannot be determined. No information was available on the change in lessor from XXXXX Leasing. The interpretation will be provided based upon (a) the leases qualifying as grandfathered leases and (b) a novation to the leases.

(a) Grandfathered Leases

Where novation has not taken place as a result of the change in lessor XXXXX and the assignment and dissolution agreements, the original leases between XXXXX will continue to be grandfathered with XXXXX as the lessor. Pursuant to subsection 340(6) of the Act, no tax will be payable on certain payments made by XXXXX to the XXXXX under the terms of Settlement Agreement No. 1.

In the event that the change in lessor or the assignment agreement and the dissolution agreement do not create a novation of the original grandfathered leases, the GST treatment would vary depending upon the form of payment under the Settlement Agreement.

Basic Rent - Rent Payable in Cash and Rental Deficiency

Rent Payable in Cash in the amount XXXXX and the Rental Deficiency in the amount of XXXXX were to be paid to the XXXXX as part of the Settlement Agreement (Schedule B-1). The latter amount is included in the determination of common shares to be issued in lieu of XXXXX[.]

These payments would retain their grandfathered status. The GST would not apply.

Issuance of Common Shares

With respect to the XXXXX and the debt amount as set out in section 2.3 of the Settlement Agreement, these amounts were arrived at by negotiation between the parties.

As explained in your letter of December 13, 1993, the grandfathered leases contained liquidated damages provisions which had subjective elements. The liquidated damages provisions were used as initial reference point to negotiate the number of shares which were acceptable to both parties. XXXXX XXXXX[.]

The only amount of the XXXXX obligation to be satisfied through the issuance of common shares which will be grandfathered under subsection 340(6) is the amount representing the rental deficiency of XXXXX[.]

With respect to the remaining amount of the Settlement Payment, represented by the issuance of common shares, subsection 182(2) states that

"where at any time, as a consequence of the breach, modification or termination after 1990 of an agreement for the making of a taxable supply (other than a zero-rated supply) of property or a service in Canada by or to a registrant, a debt or other obligation (other than the consideration for the supply) of the registrant to a person is reduced or extinguished without payment on account of the debt or obligation,

(a) the registrant shall be deemed to have made to the person, and the person shall be deemed to have received from the registrant, a taxable supply of the property or service for consideration equal to the consideration fraction of the amount extinguished or by which the debt or obligation was reduced, as the case may be; and

(b) except where the agreement was entered into in writing before 1991, the debt or obligation is reduced or extinguished, as the case may be, after 1992 and tax in respect of the amount was not contemplated in the agreement, the registrant shall be deemed to have collected, and the person shall be deemed to have paid, at that time tax in respect of the supply calculated on that consideration."

Therefore, the remaining amount of the XXXXX payment made through the issuance of XXXXX common shares will not be grandfathered under subsection 340(6). In accordance with subsection 182(2), XXXXX is deemed to have made a taxable supply of property for consideration equal to the consideration fraction of the amount by which the obligation was reduced, in this case, 100/107ths of $ XXXXX is deemed to have collected GST on this amount and OEL is deemed to have paid GST in the amount of 7 per cent of this amount. As a registrant XXXXX is entitled to an input tax credit for the amount deemed to have been paid.

(b) Novation

In the event that the change in lessors or the assignment and dissolution agreements have created a novation of the original lease agreements, lease payments for periods after the signing of the agreements on February 1, 1993, would no longer be grandfathered. The portion of the Rent Payable in Cash representing consideration for lease periods prior to February 1, 1993, would be grandfathered as well as the portion of XXXXX representing rental deficiencies for the period up to February 1, 1993. The portion of the Rent Payable in Cash representing payment for lease periods commencing February 1, 1993, and the portion of the Rental Deficiency (which is included as part of the issuance of common shares) for lease periods commencing February 1, 1993, would not be grandfathered. XXXXX of Canada as supplier of the leased aircraft would be responsible for charging GST on the monthly leases.

In the event that the grandfathered leases are no longer grandfathered commencing February 1, 1993, the GST treatment will be similar to that explained above for grandfathered leases. However, only a portion of the rental deficiency payment for periods prior to February 1, 1993, will be grandfathered.

The foregoing comments represent our general views with respect to the subject matter of your letter. Unannounced proposed or future amendments to the legislation may result in changes to the legislation may result in changes to our interpretation. These comments are not rulings and, in accordance with the guidelines set out in GST Memorandum 100-3, do not bind the Department with respect to a particular situation.

Should you require any further clarification, please contact Mr. XXXXX[.]

Yours truly,

H.L. Jones
Director
General Tax Policy
Excise/GST
Policy and Legislation