2014-0552291R3 Paragraph 1102(5)(a) of the Regulations

Principal Issues: Whether paragraph 1102(5)(a) of the Regulations would apply to reallocate the costs of the construction of the Apartment Finishes to Class 1 of Schedule II of the Regulations.

Position: Yes.

Reasons: Paragraph 1102(5)(a) of the Regulations will apply to the proposed transactions to prevent the lessee from classifying what would otherwise be considered the cost of a building or structure, or part of a building or structure, as a Class 13 leasehold improvement.

Author: XXXXXXXXXX
Section: Subsection 245(2) of the Act; Paragraph 1102(5)(a) of the Regulations, Class 1 and Class 13 of Schedule II of the Regulations

XXXXXXXXXX
                                                                                                                                               2014-055229

XXXXXXXXXX, 2015

Dear XXXXXXXXXX:

Re:   Advance Income Tax Ruling - XXXXXXXXXX

We are writing in response to your letter of XXXXXXXXXX wherein you requested an advance income tax ruling on behalf of the above-referenced taxpayer.  We also acknowledge the additional information provided in your subsequent correspondence concerning the facts and the proposed transactions described in your original letter.  Any information you have provided to us forms part of this ruling only to the extent it is expressly referred to or described herein.

You have advised that to the best of your knowledge, and that of the above-referenced taxpayer involved, none of the issues contained herein is:

(i)   dealt with in an earlier tax return of the taxpayer or a related person;

(ii)  being considered by a tax services office or taxation centre in connection with any tax return previously filed by the taxpayer or a related person;

(iii) under objection by the taxpayer or a related person;

(iv)  before the courts, or if a judgment has been issued, the time limit for appeal to a higher court has expired; or

(v)   the subject of a ruling previously issued by the Income Tax Rulings Directorate.

You have also advised that to the best of your knowledge, and that of the responsible officers of the taxpayer, the Proposed Transactions will not result in the taxpayer or any related person described herein to be unable to pay any existing outstanding tax liabilities.

DEFINITIONS

In this letter, all monetary amounts are expressed in Canadian dollars unless otherwise indicated, and the following terms or expressions have the meaning specified:

(a)   “Act” means the Income Tax Act (Canada), R.S.C.  1985 (5th Supp.) c.1, as amended from time to time and consolidated to the date of this letter and the Income Tax Regulations thereunder are referred to as the “Regulations”, unless otherwise expressly stated, every reference herein to a part, section or subsection, paragraph or subparagraph and clause or subclause is a reference to the relevant provision of the Act;

(b)   “adjusted cost base” or “ACB” has the meaning assigned by subsection 248(1) and section 54;

(c)   “affiliated persons” has the meaning assigned by subsection 251.1(1);

(d)   “agreed amount” means the amount agreed on by the transferor and transferee in respect of the transfer of an eligible property in a joint election filed pursuant to subsection 97(2);

(e)   “ACo” means XXXXXXXXXX as more fully described in Paragraph 1;

(f)   “ACo PartnerCo” is a corporation to be incorporated under the XXXXXXXXXX, as described in Paragraph 4;

(g)   “ALP” means arm’s length partner, an entity to be determined that will be at arm’s length from ACo;

(h)   “ALP PartnerCo” is a corporation to be incorporated by ALP as described in Paragraph 5;

(i)   “arm’s length” has the meaning assigned by subsection 251(1);

(j)   “Canadian Controlled Private Corporation” or “CCPC” has the meaning assigned by subsection 125(7);

(k)   “Canadian Partnership” has the meaning assigned by subsection 248(1) and subsection 102(1);

(l)   “capital property” has the meaning assigned by section 54;

(m)   “CRA” means the Canada Revenue Agency;

(n)   “fair market value” or “FMV” means the highest price available in an open and unrestricted market, between informed, prudent parties, acting at arm’s length and under no compulsion to act, expressed in terms of cash;

(o)   “Lot 1” is land in XXXXXXXXXX identified by the Lot Number XXXXXXXXXX;

(p)   XXXXXXXXXX;

(q)   “OpGP” is a general partnership to be formed under the laws of XXXXXXXXXX as described in Paragraph 12;

(r)   “Paragraph” refers to a numbered paragraph in this letter;

(s)   “Proposed Transactions” means the transactions described in paragraphs 4 to 20;

(t)   XXXXXXXXXX;

(u)   “related person” has the meaning assigned by subsection 251(2);

(v)   “RealLP” is a limited partnership to be formed under the laws of XXXXXXXXXX as described in Paragraph 7;

(w)   “RealLPGPCo” is a corporation to be incorporated under the XXXXXXXXXX, as described in Paragraph 6; and

(x)   “taxable Canadian corporation” has the meaning assigned by subsection 89(1).

Our understanding of the facts, proposed transactions, and purpose of the proposed transactions is as follows:

FACTS

1.    ACo is a taxable Canadian corporation and a CCPC incorporated under the XXXXXXXXXX.  ACo’s taxation year ends on XXXXXXXXXX.  ACo deals with the XXXXXXXXXX Tax Services Office and files its tax returns with the XXXXXXXXXX Taxation Centre.

2.    ACo owns land in XXXXXXXXXX that it purchased in XXXXXXXXXX.  The land, which has been remediated over the past several years, is subdivided into XXXXXXXXXX separate parcels.  Lot 1, which is zoned for residential development, is one of these XXXXXXXXXX separate parcels.  Lot 1 is held as a capital property by ACo.

3.    A foundation has been excavated and shored on Lot 1.

PROPOSED TRANSACTIONS

4.    ACo will incorporate ACo PartnerCo under the XXXXXXXXXX.  ACo PartnerCo will be a taxable Canadian corporation and a CCPC and will have a XXXXXXXXXX taxation year-end.  ACo will subscribe for common shares of ACo PartnerCo for $XXXXXXXXXX and will hold the shares as capital property.  ACo PartnerCo will not carry on any business other than as a partner of OpGP as described in Paragraph 12.

5.    ALP will incorporate ALP PartnerCo under the XXXXXXXXXX.  ALP PartnerCo will be a taxable Canadian corporation and a CCPC and will have a XXXXXXXXXX taxation year-end.  ALP will subscribe for common shares of ALP PartnerCo on incorporation for $XXXXXXXXXX and will hold the ALP PartnerCo shares as capital property.  ALP PartnerCo will not carry on any business other than as a partner of OpGP as described in Paragraph 12.

6.    ACo and ALP will incorporate RealLPGPCo under the XXXXXXXXXX.  RealLPGPCo will be a taxable Canadian corporation and a CCPC and will have a XXXXXXXXXX taxation year-end.  ACo and ALP will each subscribe for XXXXXXXXXX common shares of RealLPGPCo on incorporation for $XXXXXXXXXX each and each will hold the RealLPGPCo shares as capital property.  RealLPGPCo will not carry on any business other than as the general partner of RealLP as described in Paragraph 7.

7.    ACo, ALP and RealLPGPCo will form RealLP under the laws of XXXXXXXXXX.  RealLP will be a Canadian Partnership and will have a XXXXXXXXXX taxation year-end.  ACo and ALP will each be XXXXXXXXXX% limited partners in RealLP and RealLPGPCo will be a XXXXXXXXXX% general partner.

8.    On the formation of RealLP, ACo will transfer Lot 1 to RealLP in exchange for a XXXXXXXXXX% limited partnership interest.  The interest in RealLP issued to ACo will have a FMV equal to the FMV of Lot 1 at the time of the transfer.

9.    ACo will jointly elect with RealLP, in prescribed form and within the time allowed by subsection 96(4), to have the rules of subsection 97(2) apply to the transfer of Lot 1 to RealLP.  The agreed amount in respect of Lot 1 transferred will be the lesser of the FMV of Lot 1 and ACo’s ACB of Lot 1.

10.   ALP will acquire its XXXXXXXXXX% limited partnership interest in RealLP by funding RealLP’s cash requirements until such time as the cash contributions by ALP are  equal to the FMV of Lot 1 transferred by ACo as described in Paragraph 9.  Once ALP has contributed cash equal to the FMV of Lot 1 transferred by ACo to RealLP, all future cash requirements will be funded by the partners pro rata based on each partner’s relative interest in RealLP.

11.   RealLPGPCo will acquire its XXXXXXXXXX% general partnership interest in RealLP for cash consideration.

12.   ACo PartnerCo and ALP PartnerCo will form OpGP under the laws of XXXXXXXXXX.  OpGP will be a Canadian Partnership having a XXXXXXXXXX taxation year-end.  ACo PartnerCo and ALP PartnerCo will be equal partners of OpGP and will each contribute $XXXXXXXXXX for a XXXXXXXXXX% interest.

13.   RealLP will enter into various contracts for the construction of the base of a residential apartment complex (“Apartment Base”) on Lot 1.  The completed residential apartment complex will consist of XXXXXXXXXX levels of underground parking and XXXXXXXXXX stories with XXXXXXXXXX apartment units including common areas (hallways, garbage chute, lobby, gym, underground storage units, etc.).

14.   It is estimated that the total cost of the Apartment Base (excluding land) will be $XXXXXXXXXX.  Once complete, the Apartment Base will include:

* Landscaped grounds;
* Paving and sidewalks;
* Above ground visitor parking (XXXXXXXXXX spots);
* XXXXXXXXXX levels of underground parking (XXXXXXXXXX spots);
* XXXXXXXXXX above-ground stories of completed exterior including ceilings, windows, glass, cladding and masonry;
* Completed roofing system;
* Completed elevator system including shaft, cars, doors on each floor, and related mechanical and electrical;
* Concrete slab on each floor supported by various pillars and shear walls;
* Concrete balconies and terraces;
* Rooftop ventilation unit;
* Main plumbing stack connection to municipal services;
* Main electrical room connection to municipal services;
* Metals stair cases;
* All exterior entry systems; and
* Emergency lighting.

15.   OpGP will enter into a lease agreement with RealLP whereby OpGP will lease the Apartment Base on a XXXXXXXXXX net basis.  Under the XXXXXXXXXX net lease OpGP will be responsible for the property taxes, repairs and maintenance, and common area costs related to the Apartment Base.  Further to the agreement:

a.    The rent to be paid by OpGP to RealLP under the lease agreement will be at FMV;

b.    The initial lease term for the Apartment Base will be XXXXXXXXXX years, with XXXXXXXXXX-year renewal terms at OpGP’s option; and

c.    Upon the expiry of the lease (assuming OpGP chooses to not renew) the Apartment Finishes undertaken by OpGP will become the property of RealLP.

16.   The lease between RealLP and LeaseGP will also specify that OpGP is solely responsible for the cost of completing the constructing of the residential apartment complex (“Apartment Finishes”).  The Apartment Finishes will result in the completion of the XXXXXXXXXX apartment units and the common areas on each floor including the hallways, garbage chute, lobby, gym, underground storage units, etc.

17.   OpGP will enter into various contracts for the construction of the Apartment Finishes.  It is estimated that the total cost of the Apartment Finishes will be $XXXXXXXXXX and will include:

*     Interior architectural;
*     Interior HVAC mechanical and plumbing;
*     Electrical wiring related to the interior structure;
*     Soundproofing between units;
*     Metal studs and drywall for all interior walls;
*     Finish carpentry, cabinets, countertops, doors and trim;
*     Interior masonry;
*     Flooring, tile, painting and wall coverings;
*     Interior glass and mirrors;
*     Toilets, sinks, faucets and vanities;
*     Hot water heaters, bathtubs and showers;
*     Mail boxes and storage lockers;
*     Pavement markings and parking lot lights; and
*     Garbage chute.

18.   OpGP will also be responsible for the costs relating to appliances, signage, security/access system, intercom and cameras.

19.   OpGP will enter into lease agreements with end user tenant occupants (“the tenants”) whereby the tenants will lease individual apartment units.  OpGP’s business will be the operation of the residential rental units and will include, among other things:

*     Advertising and marketing;
*     Lease negotiations with end user tenants;
*     Repairs and maintenance;
*     Unit turnover;
*     Snow removal;
*     Rent collection; and
*     Provision of an on-site superintendent.

OpGP may choose to contract out the management of its residential rental business.

20.   RealLP will have the ability to terminate the lease, as is standard commercial practice.  In the event RealLP elects to terminate the lease with OpGP it will be required to give OpGP XXXXXXXXXX months’ notice of its intent to terminate the lease.  Additionally, RealLP will be required to pay OpGP FMV for the Apartment Finishes as at the lease termination date.

ADDITIONAL INFORMATION

21.   ACo and ALP will not be affiliated persons or related persons and will deal with each other at arm’s length.

PURPOSES OF THE PROPOSED TRANSACTIONS

22.   The purpose of the Proposed Transactions is to provide asset protection by segregating the assets of RealLP from the known and potential creditors of OpGP and by segregating the assets of OpGP from the known and potential creditors of RealLP.

RULING GIVEN

Provided that the preceding statements constitute a complete and accurate disclosure of all the relevant facts, proposed transactions, additional information and purpose of the proposed transactions, and provided further that the proposed transactions are carried out in the manner described above, we rule as follows:

Paragraph 1102(5)(a) of the Regulations will apply to the capital costs that are incurred by OpGP for the completion of the construction of the residential apartment complex, and generally described as Apartment Finishes in Paragraphs 16 and 17, with the effect that such costs will be included in Class 1 as described in Schedule II of the Regulations.

The above ruling is subject to the limitations and qualifications set out in Information Circular 70-6R6 dated August 29, 2014 and is binding on the CRA provided that the proposed transactions are commenced prior to XXXXXXXXXX.  The above ruling is based on the law as it presently reads and does not take into account any proposed amendments to the Act and Regulations which, if enacted, could have an effect on the ruling provided herein.

COMMENTS

The CRA does not imply acceptance, approval or confirmation of any income tax implications of the facts or proposed transactions unless otherwise confirmed in the above ruling.  In particular, nothing in this letter should be construed as implying that the CRA has agreed to, reviewed or has made any determination in respect of:

(i)   the determination of the FMV, ACB, cost or capital cost of any property referred to in this letter or whether any such property is capital property;

(ii)  the classification for capital cost allowance purposes of, or allocation between, among other things, building and equipment costs to be incurred by the taxpayers or persons or partnerships described herein, the reasonableness of those costs or the timing of any such deduction except as confirmed above;

(iii) whether any of the taxpayers, persons or partnerships referred to in this letter are related persons, affiliated persons or are dealing at arm’s length; and

(iv)  any other tax consequences relating to the facts and proposed transactions described herein or any transaction or event taking place either prior to the proposed transactions or subsequent to the proposed transactions, whether described in this letter or not.

As stated above, paragraph 1102(5)(a) of the Regulations will apply to the cost of the Apartment Finishes incurred by OpGP for the completion of the construction of the residential apartment complex.  However, if subsection 1102(5) of the Regulations did not apply, the CRA is of the view that the general anti-avoidance rule contained in section 245 of the Act would apply to include the cost of the Apartments Finishes in Class 1.

XXXXXXXXXX.

Yours truly,

XXXXXXXXXX
For Director
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

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