7958501 Canada Inc. – Court of Quebec finds that software whose development was deducted under s. 37 could be stepped up on a related-party transfer notwithstanding s. 13(7)(e)

A private company (“SherWeb”), which provided the use of software developed by it to paying subscribers, transferred its software and other IP to a newly-formed sister company (“501”) at a gain for creditor-proofing reasons (with the IP licensed back to it for continued use in its software services business). Although 501 treated the acquired IP as depreciable property, it considered that Taxation Act s. 99 (equivalent to ITA s. 13(7)(e)) did not apply to reduce the capital cost to it of the acquired IP because, in SherWeb’s hands, the IP had been eligible capital property rather than depreciable property.

Boutin JCQ found that the contrary position of the ARQ foundered on the Quebec equivalent of Reg. 1102(1)(d) (which excludes, from depreciable property, any property that was acquired by expenditures in respect of which the taxpayer was allowed a deduction under s. 37), stating that “SherWeb has consistently claimed the salaries of its employees, first and foremost those of its programmers, as its main expense, and has claimed SR&ED credits year after year.”

Although he considered this to be a largely sufficient ground, he went on to refer to the definition of eligible capital property (which, similarly to the federal definition, relevantly required in effect that the amount to which the taxpayer is entitled for the property’s disposition is “not included in computing the taxpayer's income or any gain or loss of the taxpayer from the disposition of a capital property” - and found that this condition had been met as SherWeb had not reported any disposition of a capital property, and had instead correctly treated the costs of developing its software (its employees’ salaries) as “a recurring and current expense in and of themselves.”

Neal Armstrong. Summary of 7958501 Canada Inc. v. Agence du revenu du Québec (500-80-034604-174, Court of Quebec, 4 June 2020) under s. 13(7)(e).