10 April 2001 External T.I. 2001-0070365 - CCA CLASS FOR BLD. ON LEASE

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Question 1: Whether a new building on leased land is to be written off over 20 years as a class 13 leasehold improvement or as a class 1 building?

Question 2: During the term of a 20-year lease, the franchisee pays a contractor to build an addition to the building, which has to be approved by the franchisor. Is the addition a class 13 leasehold improvement to be written off over the remainder of the 20-year lease or is it a class 1 building?

Question 3: During the term of the 20-year lease, the franchisee sells its location to a third party. Does the third party acquire the building and the addition thereto on the same terms as the seller reported it, i.e., as either a class 13 or class 1 property?

Position: (1) No comment. (2) Class 13. (3) The addition is class 13.

Reasons: (1) Not enough information to determine if subsection 1102(5) of the Regulations applies. (2) Subparagraph 1102(5)(a)(ii) of the Regulations applies. (3) Paragraph 1102(5)(b) of the Regulations applies.

XXXXXXXXXX 	J. Gibbons, CGA
		2001-007036
April 10, 2001

Dear XXXXXXXXXX:

Your facsimile dated February 15, 2001, to the Edmonton Tax Services Office was forwarded to us for reply. In your letter, you requested our comments on the income tax treatment by a franchisee of building costs in connection with a franchise agreement with XXXXXXXXXX (the "franchiser").

As requested, we have considered the situation outlined in your letter and have provided some comments below. However, we cannot confirm the tax implications of particular transactions unless the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R4. Thus, our comments are of a general nature only.

Facts

1. The franchiser owns the land and constructs the building.

2. The franchisee reimburses the franchiser for the building and pays directly for all equipment, furniture and other items.

3. The franchisee pays the franchiser for a 20-year franchise on the building

Question 1: Is the building to be written off over 20 years as a class 13 leasehold improvement or as a class 1 building?

Question 2: During the term of the 20-year lease, the franchisee pays a contractor to build an addition to the building, which has to be approved by XXXXXXXXXX. Is the addition a class 13 leasehold improvement to be written off over the remainder of the

20-year lease or is it a class 1 building?

Question 3: During the term of the 20-year lease, the franchisee sells its location to a third party. Does the third party acquire the building and the addition thereto on the same terms as the seller reported it, i.e., as either a class 13 or class 1 property?

Our comments

Subsection 1102(5) of the Income Tax Regulations (the "Regulations") provides the following:

Where the taxpayer has a leasehold interest in property, a reference in Schedule II to a property that is a building or other structure shall include a reference to that leasehold interest to the extent that the interest

(a) was acquired by reason of the fact that the taxpayer

(i) erected a building or structure on leased land,

(ii) made an addition to a leased building or structure, or

(iii) made alterations to a lease building or structure that substantially changed the nature of the property; or

(b) was acquired after 1975 or, in the case of any property of class 31 or 32, after November 18, 1974, from a former lessee who had acquired it by reason of the fact that he or a lessee before him

(i) erected a building or structure on leased land,

(ii) made an addition to a leased building or structure, or

(iii) made alterations to a lease building or structure that substantially changed the nature of the property; or

As discussed in our telephone conversation (Gibbons/XXXXXXXXXX) on March 23, 2001, we were unable to provide comments on the first question without a copy of the franchise agreement and other relevant documentation. However, with regard to question 2, it is our view that the addition to the building would fall under class 1 pursuant to subparagraph 1102(5)(a)(ii) of the Regulations.

Finally, in regard to the income tax treatment of the original building and the addition thereto in the hands of a third party who might acquire these properties from the lessee, we could only comment on the latter since we were unable to determine the income tax treatment of the original building. In this regard, it is our view that the addition should be treated as a class 1 property to the third party pursuant to paragraph 1102(5)(b) of the Regulations.

Yours truly,

John Oulton, CA
for Director
Business and Partnerships Division
Income Tax Rulings Directorate

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