9 October 2015 APFF Roundtable Q. 3, 2015-0595761C6 F - Application of ss. 18(3.1) -- translation

Principal Issues: When applying ss. 18(3.1), will the CRA follow the reasoning adopted in the Janota case?

Position: General comments. It is primarily a question of fact whether certain expenses must be capitalized under ss. 18(3.1).

Reasons: Subsection 18(3.1) applies to costs attributable to the period of construction, renovation or alteration of a building that are otherwise deductible and that are related to such construction, renovation or alteration. It is primarily a question of fact as to whether certain costs are related to the construction, renovation or alteration of a building.

9 OCTOBER 2015 FEDERAL TAX ROUNDTABLE
2015 APFF CONFERENCE

Question 3

Application of subsection 18(3.1) of the Act

In the case of Janota v. The Queen 2010 TCC 395 ("Janota"), the judge analyzed in detail the intent of the legislator in enacting subsection 18(3.1). Thus, in light of the Explanatory Notes, this paragraph dealt with "soft costs" such as interest, taxes and fees.

In an audit context, however, auditors tend to capitalize all expenditures incurred during the construction or renovation period.

Several recent judgments in Quebec (Gauthier 2014 QCCQ 1668, Bargiel 2014 QCCQ 1371 and Petitclerc 2014 QCCQ 5537) confirm that only soft costs must be capitalized.

Question to CRA

What is the CRA's position on the interpretation to be accorded to subsection 18(3.1) of the Act? Does the CRA intend to apply the position that emerges from the Janota judgment and confirm what was stated in the Explanatory Notes?

CRA Response

By virtue of subsection 18(3.1) and subject to a few exceptions, no deduction shall be made in respect of an outlay or expense made or incurred by a taxpayer that can reasonably be regarded as a cost attributable to the period of the construction, renovation or alteration (such three activities, “Construction”) of a building and that relates to such Construction. To the extent that it is otherwise deducible in the computation of the income of the taxpayer, the amount of such expense is instead included, by virtue of paragraph 18(3.1)(b), in computing the capital cost of the building.

The Explanatory Notes of the Department of Finance for subsection 18(3.1) indicate that the object of the provision is to capitalize certain soft costs related to the Construction, such as legal, accounting and financing costs, and realty taxes.

The Janota case, which you cited above, concerned general expenses of repairing and maintaining a building. In that case, the Tax Court of Canada determined that such expenses did not come within subsection 18(3.1) because they were not soft costs. According to the Court, soft costs include bank interest, realty taxes, costs of public services (such as electricity), professional fees and insurance premiums but do not include repair and maintenance costs. Note however that this judgment is an informal decision and not a jurisprudential precedent.

Two principal conditions must be satisfied for subsection 18(3.1) to apply: first, the expenses must be attributable to the period of Construction of a building; and, secondly, the expenses must be related to such Construction. Thus, the general expenses of repair and maintenance which are incurred during the period of Construction of a building but which are otherwise not related to such Construction do not come within subsection 18(3.1). However, the question of whether a particular expense is related to the Construction of a building is, in our view, one principally of fact.

Furthermore, as previously noted, subsection 18(3.1) does not apply to costs which were not otherwise deductible. For example, the costs of construction of a building which are not deductible by virtue of paragraph 18(1)(b), because they are of a capital nature, remain non-deductible even if they are not costs described by subsection 18(3.1).

Yves Grondin
2015-059576