5-911536
Re: Subsection 1100(1.1) and (1.2) of the Income Tax Regulations (the "Regulations") Deferral of Lease Payments
We are writing in reply to your letter of May 29 and August 19, 1991, in which you requested our comments on the application of the specified leasing rules where scheduled payments under a lease are deferred.
You have requested an opinion on whether an agreed deferral of lease payments would constitute a "material change" in a lease, thereby causing it to be subject to the provisions of subsection 1100(1.1) of the Regulations. You have also requested our opinion on whether, in subsection 1100(1.2) of the Regulations, "in respect of a period" refers to each individual lease payment period or to the term of a lease and whether an agreed deferral of lease payments would constitute an alteration of "the amount paid or payable by the lessee.. in respect of a period" thereby causing a lease to be deemed to be a new lease subject to the provisions of subsection 1100(1.1) of the Regulations at the time of the alteration.
Your letters indicate that your request concerns the situation of a particular taxpayer. We are unable to comment specifically on the consequences of a particular proposed arrangement, other than in response to a fully documented request for an advance income tax ruling. We can, however, advise you of our general views on the matters you have raised.
Pursuant to the applicable coming into force provision in subsection 6(4) of SOR/91-196, subsections 1100(1.1) and (1.2) of the Regulations are applicable in respect of leases entered into after 10:00 p.m.
Eastern Daylight Saving Time, April 26, 1989 (the "specified time") and leases entered into before the specified time if a material change in respect of the lease had been agreed to by the parties after the specified time. Subsections 1100(1.1) and (1.2) of the Regulations would apply in the latter case from the time the material change becomes effective. Our general view is that, in circumstances where there is in fact a lease entered into before the specified time, an amendment to the amounts payable under the lease or a significant change in the time when the amounts payable are due, or a combination of both, would be viewed as a material change to the lease agreement
If a lease is renegotiated, subsection 1100 (1.2) of the Regulations will deem the existing lease to have expired and the renegotiated lease to be a new lease entered into at the time of the renegotiations if, among other criteria, as a result of the renegotiation, the amount paid or payable by the lessee of the property is altered in respect of a period after the renegotiation. It is our general view that this condition, which is set out in paragraph 1100(1.2)(b) of the Regulations, would not be satisfied if an existing lease, entered into or deemed by subsection 6(4) of SOR/91-196 to have been entered into after the specified time, is subsequently altered with respect to the due dates of amounts payable under the lease, provided the amounts that are paid or payable in respect of a period after the renegotiation of the lease are not altered as a result of the renegotiation. Whether the renegotiation of a lease alters the amounts payable in respect of a period, as opposed to merely altering the due dates of the amounts so payable, is a question of fact
Our comments are provided in accordance with the practice referred to in paragraph 21 of Information Circular 70-6R2
Yours truly,
for DirectorFinancial Industries DivisionRulings Directorate
Attachment
24(1)
5-911536
STATEMENT OF PRINCIPAL ISSUES
The request for a technical interpretation concerns a taxpayer who wants to negotiate with the lessors of equipment used in its business, the deferral of certain lease payments in order to improve its cash flow (i.e., certain lease payments would be temporarily deferred with interest but all lease payments would be made within the current term of the lease). The lease was entered into before 10:00 p.m. Eastern Daylight Savings time on April 26, 1989. There would be no extension of the lease and no change in the option price of the leased property. The deferred payments with interest would be made at the maturity of the lease or would be prorated over the other lease payments.
ISSUE: Would an agreed deferral of lease payments constitute a "material change" in the lease so that ITR 1100(1.1) would apply to the lease?
ITR 1100(1.1) applies to a specified leasing property as defined in ITR 1100(1.11). In order for a property to be a specified leasing property it must (among other criteria) be a depreciable property that is the subject of a lease. Because there is an option price is involved, there may be a question as to whether there is in fact a lease or whether there was a disposition of the equipment from the "lessor" to the taxpayer. If there was a disposition, the depreciable property would not be the subject of a lease and therefore not a specified leasing property. ITR 1100(1.1) would not apply. However, CCA on the equipment would only be deductible by the taxpayer. The "lessor" would have had income from the sale of the equipment. However, as there is not sufficient information to determine whether there is in fact a lease, the answer to question must be made on the assumption that there is a lease.
Therefore, assuming that there is in fact a lease, would an agreed deferral of lease payments constitute a "material change" in the aircraft lease? Q. 8 of the 1986 Round Table discusses our position with respect to amendments of leases and the grandfathering provisions of paragraph 12(1)(x). Our position stated that an amendment to a lease with respect to the amount of rent to be paid would be viewed not as a minor adjustment to a binding agreement, but as the entering into a new or revised agreement. This position is discussed in our July 19, 1987 memorandum on Version 9 of draft IT-359R3 (7-3762). In that memorandum it states that whether or not a change is material enough to cause a new or revised agreement is a question of fact and that it is our view that the changes outlined in Q. 8 (the change in the amount of rent being one of them) appear material enough to result in a new or revised agreement.
23
However, G.H.L. Fridman in The Law of Contract in Canada, Second Edition, states in the Chapter on Performance at p. 489 that
"Generally speaking the parties to a contract are obliged to perform in accordance with the express and implied terms of the contract. The duty to perform must be carried out precisely and exactly. Anything less than such performance is a breach of contract and may preclude the party in default from enforcing the provisions of the contract that are for his benefit, for example, the payment of the price agreed upon for goods or services. The strictness of the duty to perform, however is modified in certain circumstances........ Performance may be dispensed with completely, or its character altered, by virtue of some subsequent agreement between the parties..."
In the 24(1) example the lessee is obliged to make specific lease payments. In the example the parties to the lease would subsequently agree to alter the timing of the lease payments.
At p. 491 Fridman states that "...a trivial deviation from proper performance of a contract will not amount to a breach" and gives a case, B. & R. Holdings Ltd. v. Western Grocers Ltd.: Westfair Foods Ltd. v. B. & R. Holdings Ltd., (1982), 25 R.P.R. 121 (Sask. Q. B.) where in the facts of the case "it appeared, somehow, the tenants were guilty of a shortfall of three cents per annum in payment of rent over a period of years. This was held not to be a breach of the tenants' contractual duty to pay a stipulated sum by way of rent." The case illustrates that a lessee has a contractual obligation to make lease payments as stipulated in a contract and, unless any shortfall is trivial, the contract would be breached. This would suggest that any changes to the payment terms would be a material change to a lease.
At p. 508 Fridman discusses the topic of "Modification of duty to perform" and at p. 510 he discusses the sub-topic of "Change of duty". Fridman at p. 510 states
"Two important methods of changing the original duty to perform created by a contract are by variation of the contract and waiver of rights arising thereunder. These two methods must be carefully distinguished. In cases of variation what happens is that, by mutual agreement, for the benefit or convenience of both parties, there is a later alteration of the original agreement. Where waiver is alleged to have occurred, however, the change is for the benefit or convenience of one party only, and the other party is said to acquiesce in such change in the original terms of their contract. In both situations there is a later agreement between the parties affecting their earlier transaction. Where variation is the allegation, such agreement, whether written or oral, is express. Where waiver is alleged, the suggested alteration is, at the most, implicit from what has occurred. Furthermore, where the original agreement has been varied by the later one, then, to the extent to which such variation is operative, the first agreement must now be considered to have been completely changed in respect of the variation in question. If waiver is alleged, however, the original rights and duties of the parties remain unchanged, save that, by virtue of the waiver, insofar as it is operative and effective, the party acquiescing in the change cannot enforce his original rights to the extent to which they conflict with the change suggested or initiated by the other party and acquiesced in by the former."
It would appear that in the 24(1) example the change to the lease payments would be by mutual agreement and the agreement would be express. The first agreement would then be considered to have been completely changed in respect of the variation in question, i.e., the original rights and duties of the parties have been changed.
"Material change" was discussed in a September 4, 1987 memo from W.W.Webb to C. Savage in respect of the grandfathering rules for prescribed shares and the at risk rules as they applied to At page 3, the memo reviews some of the cases where the issue as to what would constitute a material alteration has been discussed.
Although these cases appear to have dealt with the effect of alterations to the written documents (see Fridman's discussion of "Alteration of documents" at p. 446 of The Law of Contract in Canada) they may provide guidance as to what would be considered a material change to a lease agreement. The September 4, 1987 memo quotes Brett, L.J., in Suffel v. The Bank of England (1882), 9 Q.B.D.555 (C.A.) at p. 568 that
"any alteration of any instrument seems to me to be material which would alter the business effect of the instrument if used for any ordinary business purpose for which such an instrument or any part of it is used."
These general principles as stated above have been referred to and applied in numerous cases. (See, for example, Clement v. Renaud (1956), 1 D.L.R. (2d) 695 (Ont. C.A.); Roberto v. Bumb, (1943) 2 D.L.R. 613 (Ont. C.A.); Langley v. Ravers (1913), 13 D.L.R. 697 (N.S.S.C.).
In the case of R. v. Hannah (1919, 46 D.L.R. 122 (Sask. C.A.) Ramont, J.A. stated at p. 124 that
"it would, therefore, appear that, if the legal rights and obligations of the parties (if effect were given to the instrument as altered) would be the same as if there had been no alteration in the instrument, the alteration is not a material one."
Laidlaw, J.A. of the Ontario Court of Appeal in the case of Roberto v. Bumb stated at 618 that
"a material alteration is one which varies the rights, liabilities or legal position of the parties as ascertained by the deed in its original state, or otherwise varies the legal effect of the instrument as originally expressed or may otherwise prejudice the party bound by the deed as originally executed."
Lamont. J.A. stated in the case of McCoy v. Hop, (1923) 3 D.L.R. 873 (Sask. C.A.) at p. 876 that:
"an instrument is altered in a material particular if the rights and obligations of the parties under it, if effect were given to it in its altered condition, would be different from that which the law would imply if no alteration had taken place. If, however, the alteration does not affect the contract, wither by increasing or decreasing the rights or obligations of the parties respectively, the alteration is not material."
In Halsbury's Laws of England 4th ed. volume 12, at p. 552 it is stated that
"a material alteration is one which varies the rights, liabilities, or legal position of the parties as ascertained by the deed in its original state, or otherwise varies the legal effect of the instrument as originally expressed, or reduces to certainty some provision which was originally unascertained and as such void, or which may otherwise prejudice the party bound by the deed as originally executed."
In the 24(1) example, if the lease payments are deferred the rights and obligations of the parties will have been changed, i.e., the lessee will not be obligated to make the lease payments as set out in the original agreement and the lessor would not have the right to sue for the payments that are deferred. This would, therefore, appear to be a material change to the lease.
Other cases are noted under "material alteration" in Words and Phrases Legal Maxims Canada.
ISSUE: Does "in respect of a period" in ITR 1100(l.2) refer to each individual lease payment period or to the term of the lease?
ITR 1100(1.2)(b) states that certain rules will apply if (among other criteria) as a result of the renegotiation (at any time), the amount paid or payable by the lessee of the property....is altered in respect of a period after that time (otherwise than by reason of an addition or alteration to which subsection (1.19) applies). ITR 1100(1.2)(d) states that paragraph (1.13)(b) shall not apply in respect of any period before that time during which the property was leased by the lessee........
Firstly, it would appear that ITR 1100 (1.2) would not apply to the example given by 24(1) as pursuant to subsection 6(4) of the coming into force legislation, the Regulation is applicable only to leases signed after 10:00 p.m., Eastern Daylight Saving Time, April 26, 1989 and to leases signed before that time but which were materially changed after that time. Regulation 1100(2.1) would only apply from the time that the material change was effective.
Secondly, Regulation (1.2) will apply if amounts paid or payable are altered in respect of a period. It will not apply if amounts payable in respect of subsequent periods under the lease are unchanged but the due dates for the payment of such amounts are deferred. Whether amounts are "due" or "paid or payable in respect of a period" is a question of fact and will depend on the facts of the situation.