For accounting purposes, a leasehold inducement received is usually netted against the cost of the leasehold improvement. This is because for accounting purposes, the revenue of the inducement is properly matched and recognized evenly with the depreciation expense of the leasehold improvement over the term of the lease. This situation is typically found in retailers who lease spaces in shopping malls or other outlets for their retail operations.
The tax treatment does not automatically follow the accounting treatment for leasehold inducements. There is an established line of cases which stand for the proposition that generally accepted accounting principles ("GAAP") shall serve only as an interpretive tool to determine the tax treatment for a particular issue. However, these cases clearly state that GAAP should not be assumed to be the tax treatment for a particular issue.
For income tax purposes, an election must be filed pursuant to subsection 13(7.4) of the Act in the lessee's tax return, for its taxation year when the inducement received is netted against the leasehold. There is no prescribed form for this election; it can be done as a free form letter or attachment to the lessee's tax return for the year. If such an election is not filed, the entire amount of the inducement is taxable immediately as income in the year of receipt pursuant to paragraph 12(1)(x) of the Act.
If no election is made by the taxpayer, the capital cost of the leasehold improvement is higher than it would be if the leasehold was netted against the capital cost. The leasehold inducement would be income to the recipient. This tax result may be desirable where, for instance, there are losses that are about to expire.
It should be further noted that the subsection 13(7.4) election applies to inducements received in the taxation year. If a leasehold inducement receivable is netted against the leasehold then the taxpayer must wait for the subsequent year when the amount is received to elect for income tax purposes.
TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.