30 June 2003 External T.I. 2003-0014995 - UNDEPRECIATED CAPITAL LOST

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 CCRA.

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

Principal Issues:

1. Whether paragraph 13(7)(e) of the Act applies to a disposition of property from a US sister company to a Canadian sister company.

2. Whether the half-year rule exception in subsection 1100(2.2) of the Regulations applies to the Canadian company when they acquire the property from the US company.

Position: 1. Yes.

2. No.

Reasons:

1. The property acquired by the Canadian company is considered to be a "capital property of the transferor" such that all of the requirements in paragraph 13(7)(e) of the Act are satisfied.

2. Since the property is considered to be a "depreciable property" of the transferor, the requirement in paragraph 1100(2.2)(f) of the Regulations are satisfied and the exception to the half-year rule applies.

XXXXXXXXXX 2003-001499
A. Seidel
(613) 957-2058

June 30, 2003

Dear XXXXXXXXXX:

Re: Non-arm's Length Acquisitions

This is in reply to your letter dated April 24, 2003 in which you requested our views on certain issues related to a non-arm's length acquisition of computer "applications software".

You describe a situation where a non-resident company has developed applications software the cost of which the non-resident company has expensed in computing income. The non-resident has owned the software for more than a year and licenses its use to arm's length parties. You query whether paragraph 13(7)(e) of the Income Tax Act (the "Act") or subsection 1100(2.2) of the Income Tax Regulations would apply if a Canadian sister company acquired the applications software at its fair market value, packages it with some of its own computer software and licenses its use to arm's length parties.

The particular circumstances in your letter on which you have asked for our views appear to be a factual situation involving a specific taxpayer. As explained in Information Circular 70-6R5, it is not this Directorate's practice to comment on transactions involving specific taxpayers other than in the form of an advance income tax ruling. To the extent that you require confirmation of the tax consequences of proposed transactions, you should be requesting an advance income tax ruling. However, we would point out that advance income tax rulings are not provided in respect of transactions that are substantially completed. The tax consequences of completed transactions can only be determined after a review of all of the relevant facts and documentation, which is the responsibility of the Verification and Enforcement Division of the local tax services office.

Although we cannot provide any specific comments with respect to the situation described in your letter, the following general comments may be of assistance.

In general, where a taxpayer resident in Canada has acquired a property for use in the taxpayer's business, the nature, purpose and anticipated life of the property will be considered in determining whether the acquisition cost should be written off in the year the property is acquired or, because of its enduring nature, the acquisition cost of the property should be capitalized.

The proper classification of applications software is discussed in Interpretation Bulletin IT-283R2 ("IT-283R2"). Paragraph 10 of IT-283R2 states that "computer software" includes a right or license to use computer software and that "software" is considered to be of an "enduring nature" where its useful life is anticipated to last beyond one year. "Applications software" that is a capital property and a depreciable asset is included in Class 12 of Schedule II of the Regulations.

Paragraph 13(7)(e) of the Act applies to, among other things and "notwithstanding any other provision of this Act", a non-arm's length acquisition of a depreciable property of a prescribed class provided "the property was a capital property of the transferor". Even though the non-resident transferor may have been allowed to expense the cost of developing the applications software, it is our view that the applications software would be considered to be a capital property of the transferor for purposes of computing income under Part I of the Act. The capital cost of the applications software to the Canadian company would therefore be determined under subparagraph 13(7)(e)(ii) of the Act.

Subsection 1100(2.2) of the Regulations provides an exception to the "half-year rule" applicable to depreciable property acquired in a taxation year in certain situations. One of those situations is where a property of a class in Schedule II of the Regulations is acquired by a taxpayer from a person with whom the taxpayer was not dealing at arm's length at the time the property was acquired, the property was depreciable property of the person from whom it was acquired and the property was owned by the transferor for a period of at least one year. The rules in section 1100 of the Regulations determine the deduction allowed, "for the purposes of paragraphs 8(1)(j) and (p) and 20(1)(a) of the Act", in computing a taxpayer's income under Part I of the Act. Since the applications software would be "depreciable property" pursuant to paragraph (o) of Class 12 of Schedule II of the Regulations, all of the conditions enumerated in subsection 1100(2.2) of the Regulations are satisfied and the exception to the half-year rule would apply to the acquisition of the applications software by the Canadian company.

Yours truly,

John Oulton
for Director
Business and Publications Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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