1 November 1997 GST/HST Interpretation HQR0000188 - Whether a Lease with an Option to Purchase at a Bargain Price of $1 is to be Treated as a Lease or a Conditional Sale

                                                                        GST/HST Rulings and
 Interpretations Directorate
Place Vanier, Tower C, 10th Floor
25 McArthur Road
Vanier, Ontario
 XXXXX                                                                                K1A 0L5

Dear XXXXX

Thank you for your letter concerning the treatment of an equipment lease with a bargain purchase option of $1.00. A copy of the equipment lease was provided.

Our understanding of the facts is as follows:

•   The leasing company (lessor) is an XXXXX corporation.

•   The lessor and the customer (lessee) enter into a long-term lease for equipment to be used by the lessee in a taxable manner. The lease is dated XXXXX , 19 xx , and, as stated in XXXXX (Equipment Lease Agreement), the lessee must pay XXXXX equal monthly principal payments of XXXXX plus interest on the outstanding balance, plus all applicable taxes, commencing thirty days from XXXXX 19 XXXXX and continuing on the same day each and every month thereafter until all amounts owing are fully paid.

•   The agreement clearly describes this transaction as a lease, using the terms "lease", "lessor" and "lessee" throughout the agreement.

•   Ownership of the equipment is retained, throughout the lease term, by the lessor.

•   The lessee will obtain the use of the equipment for the stated period of time and will make monthly lease payments to the lessor for this privilege.

•   The Purchase Option Agreement, also dated July 14, 1995, states that the "Lessee, upon payment in full of all rents and obligations due under the Lease Agreement Schedule ... dated July 14, 1995 ... shall have the option to purchase from the Lessor the equipment ... for the sum of One Dollar in Canadian funds ($1.00CDN), plus all applicable sales or use tax (the "Purchase Price"), on an "as is", "where is" basis."

•   The Purchase Option Agreement also states that the "Lessor shall execute and deliver to Lessee all documents necessary and proper to effect the transfer of ownership of said Equipment upon payment by Lessee of the full amount of the Purchase Price". Although title will not pass to the lessee unless and until the $1.00 purchase option is exercised, it is anticipated that the option will be exercised and that the equipment will become the property of the lessee at that time.

Interpretation Requested

1. For the purposes of GST, would such a contract be treated as a conditional sale? That is, would GST be due and payable in full at the time the contract is entered into?

2. If such a contract is treated as a conditional sale for GST purposes, would tax be calculated based on the sum of the entire stream of lease payments (including the floating rate interest) or just on the principal amount (the cost of the equipment)?

3. If such a contract is treated as a lease, would GST be payable monthly on the entire amount of each monthly lease payment (both principal and interest)?

Interpretation Given

Based on the information provided, the equipment lease is to be treated as a lease. GST would be payable monthly on the entire amount of each monthly lease payment i.e., both the principal and the interest.

As defined in subsection 123(1) of the ETA, a "sale", in respect of property, includes any transfer of the ownership of the property and a transfer of the possession of the property under an agreement to transfer ownership of the property. Generally, a lease is an agreement whereby one party relinquishes a right to possession of property for a specified period of time, while retaining title to the property both during and after the lease period. It is possible, under the terms of a lease, for the lessee to take title to the property after the lessee has satisfied additional conditions (e.g., exercising a buyout option). However, unlike a conditional sales contract, title does not pass automatically to the lessee upon completion of the installment payments. A conditional sale is an agreement in writing in which the vendor agrees to sell tangible personal property to the purchaser and, pursuant to the agreement, the purchaser agrees to make payments over a specified period of time. Although the purchaser takes possession of the goods, the vendor retains title to the goods until the purchaser makes all payments required under the agreement, at which point legal title passes to the purchaser.

The Department's position is that a lease, whether it is a capital lease or an operating lease, will not be considered as an acquisition of an asset and an assumption of an obligation (i.e., a sale) for GST purposes solely on the basis that it is considered to be a sale or acquisition under generally accepted accounting principles or the Income Tax Act. This is based on the fact that an agreement to transfer ownership generally does not include an agreement that merely contains an option to purchase, regardless of the terms. A bargain purchase option lease, where the agreement is considered to be a lease at law (i.e., the agreement is in form and substance a lease), will be treated as a lease for GST purposes, and not in the same manner as a conditional sales agreement. The GST would apply to each lease payment and any consideration paid to exercise a buy-out option is also subject to the GST.

Subsection 136(1) of the Act stipulates that a supply by way of lease, licence, rental or other similar arrangements for the use or right to use real property or tangible personal property is deemed to be a supply of that property. Subsection 136.1(1) provides that supplies of property by way of lease, licence or similar arrangement will be treated as a series of separate supplies for each period (referred to as a "lease interval") to which a particular lease payment is attributable. For each lease interval, the supplier is deemed to have made, and the recipient is deemed to have received, a separate supply of the property on the earliest of the first day of the lease interval, the day on which the payment for that interval becomes due, and the day on which the payment attributable to the lease interval is paid. This new subsection is particularly relevant for purposes of the place of supply rules set out in new Schedule IX in order to determine the appropriate amount of tax applicable to each separate lease payment. This subsection applies to lease intervals that begin on or after April 1, 1997.

In determining whether the HST applies first requires a determination of whether a given supply is made in Canada such that GST would normally apply and if so, section 144.1, which refers to Schedule IX which contains the place-of-supply rules, governs whether the HST applies. We do not have any information detailing where this supply takes place.

Section 2 of Part II of Schedule IX and section 4 of Part I of Schedule IX outline three rules governing the supply of tangible personal property by any means other than sale (e.g., lease). The first rule applies to periods of three months or less, the other two for longer periods.

Under the second rule, where the property is a specified motor vehicle, it is considered to be leased in the province in which it must be registered under provincial motor vehicle legislation. Specified motor vehicles are most motor vehicles other than certain racing cars and prescribed vehicles.

Under the third rule, where the item is not a specified motor vehicle, it is considered to be rented in the province in which the item is ordinarily located. The lessor and lessee can agree on the ordinary location of an item, and this will be deemed to be its ordinary location for HST purposes.

The HST will not apply to any part of the consideration for a supply of property by way of lease, licence or similar arrangement that is attributable to a period before April 1, 1997, provided the amount becomes due or is paid before August 1, 1997. Nonetheless, provincial retail sales tax will apply to the amount if the property is subject to that tax.

The HST will apply to consideration for a supply in participating provinces by way of lease, licence or similar arrangement that becomes due from a person who is not a consumer to the extent that the consideration is attributable to a period after March 31, 1997, and becomes due after October 23, 1996, but before February 1, 1997. The person will be subject to the self-assessment rules as if the goods were brought into the participating province by the person after March 31, 1997. Accordingly, the person may be required to self-assess the provincial component of the HST on those payments. Where self-assessment is required, the person would have to account for this tax in the person's first return filed after March 31, 1997, or by August 1, 1997, whichever is earlier, and remit the tax at the same time.

The HST will also apply to any consideration for a taxable supply by way of lease, licence or similar arrangement attributable to a period after March 31, 1997, that becomes due after January 31, 1997, but before April 01, 1997. In these cases, the provincial component of the HST will be considered to have become collectible by the supplier on April 1, 1997. The supplier will therefore be required to account for this tax by the due date of the supplier's return for the first reporting period ending after March 31, 1997.

The foregoing comments represent our general views with respect to the subject matter of your letter. Proposed amendments to the Excise Tax Act, if enacted, could have an effect on the interpretation provided herein. These comments are not rulings and, in accordance with the guidelines set out in section 1.4 of Chapter 1 of the GST Memoranda Series, do not bind the Department with respect to a particular situation. For your convenience, find enclosed a copy of section 1.4 of Chapter 1 of the GST Memoranda Series.

Should you have any further questions or require clarification on the above matter, please do not hesitate to contact me at (613) 952-9577 or Duncan Jones at (613) 952-9210.

Yours truly,

Marilena Guerra,
C.M.A. Rulings Officer
Financial Institutions and Real Property Division
GST/HST Rulings and Interpretations Directorate

Policy and Legislation Branch