8 July 2003 Internal T.I. 2003-0015997 - Classification of Internet Equipment

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: classification of Internet equipment in the telecommunications industry

Position: generally excluded from class 10(f) as being electronic communications control equipment

Reasons: analysis of use of equipment

								July 8, 2003

	Claude Englehart					Income Tax Rulings
	Director	Directorate
	Technical Applications and			T. Harris
	Valuations Division				(613) 957-2114

								2003-001599

Classification of Internet Equipment in the Telecommunications Industry

This is in reply to your memorandum of April 29, 2003, requesting our comments concerning a report prepared by Bob Seney, the Media, Telecommunications and Utilities Specialist, concerning the classification of Internet equipment in the telecommunications industry for capital cost allowance purposes.

We have reviewed your report, the various submissions made by XXXXXXXXXX in their letters of June 4, 1999, January 21, 2000 and November 27, 2000, as well as the memorandum of June 18, 2003 prepared by the Financial Legislative Application Section of the SR&ED Directorate.

Issue

At issue is whether such telecommunications equipment qualifies for inclusion in Class 10 by virtue of paragraph (f) thereof as "general-purpose electronic data processing equipment and systems software therefor, including ancillary data processing equipment" or whether such equipment falls into the exclusion found in that paragraph for property that is principally or is used principally as:

(i) electronic process control or monitor equipment,

(ii) electronic communications control equipment,

(iii) systems software for a property referred to in subparagraph (i) or (ii), or

(iv) data handling equipment unless it is ancillary to general-purpose electronic data processing equipment.

To the extent that such equipment falls into one of the exclusions described in (i) to (iv) above, it would be classified in Class 8 by virtue of paragraph (i) thereof, i.e. "tangible capital property that is not included in another class" in Schedule II.

Taxpayers' Position

In their submissions, XXXXXXXXXX maintain that Internet equipment falls into Class 10(f) under the definition of general-purpose electronic data processing equipment or, alternatively, as ancillary data processing or data handling equipment. They rely primarily on the Tax Court decision in Funtronix Amusements [89 DTC 545] which provided a working definition for general-purpose electronic data processing equipment. In addition, they argue that the exception in Class 10(f) for electronic communications control equipment should be interpreted narrowly, akin to a thermostat for a furnace. Finally, they argue that any Internet equipment, which does not otherwise qualify as general-purpose electronic data processing equipment in its own right, should qualify as ancillary data processing equipment or ancillary data handling equipment under Class 10(f).

Your Position

It is your view that most of the Internet equipment is excluded from Class 10(f) by virtue of paragraph (ii) thereof, i.e. as electronic communications control equipment. You believe that "electronic communications control equipment" refers to any equipment used by the telecommunications industry to manage, control or direct telecom traffic. You have referred to the following comments of Brian Neil, a Science Advisor at the Halifax TSO, which were made on March 22, 2001 in response to XXXXXXXXXX's submissions:

In data communications, just as in voice telephony, routing of the data, or voice signal is commensurate with controlling the data. Regardless of where instructions are located, any device that changes or directs a packet of data to another device is exerting control over that piece of data....

In communications, especially data communications, moving data and directing its movement from one device to another is the only type of control possible that can be exercised on the data during the communications process. Since this is exactly what any of the devices listed actually do, I find it interesting that they failed to see this as a form of control. This is especially true since the Webster's dictionary definition included states: "control is power of authority to guide or manage". This seems to obviously describe what a switch, router, multiplexer etc. does.

The types of equipment considered in your report are as follows:

• Channel Service Units/Data Service Units ("CSU/DSU's")
• Data sets
• HDSL equipment
• Hubs
• Integrated systems
• Modems
• Multiplexers
• Remote Access Servers or Access Concentrators
• Routers
• Servers
• Switches
• Telecom equipment, in general
• Terminal equipment

XXXXXXXXXX have made the following submission on the classification of a server:

XXXXXXXXXX.

You agree with the XXXXXXXXXX analysis that a server would be considered general-purpose electronic data processing equipment. You believe that web servers appear to be add-on devices that are outside of the telecommunications network and, therefore, would not be included in the exception for communications control equipment. Consequently, the servers would be included in Class 10.

With respect to terminal equipment you have concluded that such equipment would not fit within the definition of communications control equipment and would, therefore, not be excluded from Class 10 on that basis alone. However, such equipment would have to be considered individually to see whether it otherwise fits within Class 10. If not, it would fall within Class 8.

It is your view that the other types of equipment listed above, with the exception of web servers and terminal equipment, would be specifically excluded from Class 10 by virtue of the exception for communications control equipment. Appendix A includes a more detailed description of the various types of equipment referred to above.

Our Comments

Based on our understanding of the facts and our review of the various submissions, we are in agreement with your conclusions on the classification of the various types of equipment referred to above.

Director
Reorganizations and Resources Division
Income Tax Rulings Directorate
Policy and Legislation Branch

APPENDIX A

Classification of Internet Equipment in the Telecommunication Industry

The various pieces of equipment will be analyzed individually to provide details on the functionality of each piece of equipment. For ease of reference, the analysis is presented alphabetically, covering the following equipment types:

• Channel Service Units/Data Service Units ("CSU/DSU's")
• Data sets
• HDSL equipment
• Hubs
• Integrated systems
• Modems
• Multiplexers
• Remote Access Servers or Access Concentrators
• Routers
• Servers
• Switches
• Telecom equipment, in general
• Terminal equipment

CSU/DSU's

AT&T's website glossary of telecommunication terms provides the following definition:

CSU/DSU

A CSU/DSU (Channel Service Unit/Data Service Unit) is a hardware device about the size of an external modem that converts a digital data frame from the communications technology used on a local area network (LAN ) into a frame appropriate to a wide-area network (WAN) and vice versa. For example, if you have a Web business from your own home and have leased a digital line (perhaps a T-1 or fractional T-1 line) to a phone company or a gateway at an Internet service provider, you have a CSU/DSU at your end and the phone company or gateway host has a CSU/DSU at its end.

The Channel Service Unit (CSU) receives and transmits signals from and to the WAN line and provides a barrier for electrical interference from either side of the unit. The CSU can also echo loopback signals from the phone company for testing purposes. The Data Service Unit (DSU) manages line control, and converts input and output between RS-232C , RS-449, or V.xx frames from the LAN and the time-division multiplexed (TDM ) DSX frames on the T-1 line. The DSU manages timing errors and signal regeneration. The DSU provides a modem-like interface between the computer as Data Terminal Equipment (DTE) and the CSU.

CSU/DSUs are made as separate products or are sometimes part of a T-1 WAN card. A CSU/DSU's Data Terminal Equipment interface is usually compatible with the V.xx and RS-232C or similar serial interface. Manufacturers of separate unit or integrated CSU/DSUs include Adtran, Cisco, and Memotec

The CSU originated at AT&T as an interface to their nonswitched digital data system. The DSU provides an interface to the data terminal equipment (DTE) using a standard (EIA/CCITT) interface. It also provides testing capabilities.

CCRA considered the classification of CSU's and DSU's in technical interpretation E9713677 dated August 19, 1997, and concluded that they are essentially modems for higher speed digital lines and should be included in class 8.

CSU/DSU's appear to also fit within the exception to Class 10(f) for communications control equipment and thus properly fit within Class 8.

Data Sets

XXXXXXXXXX's letter of January 21, 2000 provides the following comments on data sets:

XXXXXXXXXX.

In the view of the CCRA all of this equipment is communications control equipment. The ancillary data processing equipment argument ignores the exception for communications control equipment in Class 10(f)(ii) and overstates the relative importance of the web server.

HDSL Equipment

XXXXXXXXXX's makes the following observation in their letter dated June 4, 1999:

XXXXXXXXXX.

CCRA disagrees with XXXXXXXXXX's submission that such equipment is ancillary data processing equipment and maintains that it is part of the communication network. To the extent that such equipment is a cable or wire, it would fall under Class 3 or 42. Otherwise, the equipment would be included in Class 8.

Hubs

XXXXXXXXXX's provide the following comments in their January 21, 2000 letter:

XXXXXXXXXX.

The CCRA considers that hubs are similar to routers and should be included in Class 8.

Integrated Systems

CCRA has considered the classification of integrated systems in a technical interpretation dated August 19, 1997: Document No. E9713677 and stated that if the modems, CSU/DSU, the switches, the routers ... are part of an integrated system, such that they would not be functional on their own, they would be viewed as a single asset, which would likely be included in class 8.

This characterization is not consistent with industry's approach to telecommunication assets, which are not generally treated as an integral system. Rather, the individual assets are included in separate classes, subject to depreciation on a class-by-class basis. Accordingly, we would not ordinarily expect to find aggregated assets in a major telecommunications company.

Modems

In a 1992 textbook entitled "Understanding Telecommunications and Lightwave Systems - An Entry-Level Guide" by John Nellist, the following description of modems is provided:

A Modem, which is an acronym for Modulator-Demodulator, is the interfacing device that couples the output of the digital data to the telephone lines. The sending modem converts the digital data to an analog format that can be readily handled by voice-grade telephone circuits, and the receiving modem changes the format back to the original signal....

AT&T's website glossary of telecommunication terms provides another definition:

Modem.

A modem modulates outgoing digital signals from a computer or other digital device to analog signals for a conventional copper twisted pair telephone line and demodulates the incoming analog signal and converts it to a digital signal for the digital device.

CCRA considered the classification of modems in a technical interpretation dated August 19, 1997 Document No. E 9713677 and stated the following:

Modems are used to transform digital data from a computer terminal to analog form for transmission over communication lines. In our opinion, modems would not qualify for inclusion in class 10, either as general-purpose electronic data processing equipment, as defined in subsection 1104(2) of the Income Tax Regulations (the "Regulations"), or as ancillary data processing equipment.

This latter term generally refers to equipment such as tape drives and disc drives if they are used in conjunction with general-purpose electronic data processing equipment that qualifies for inclusion in class 10. Since no other class applies, modems should be included in class 8, per paragraph (i) of that class, which, subject to some exceptions, encompasses any tangible capital property not specifically included in any other class.

While it could be debatable whether a modem is data processing equipment that is ancillary to a server, the better view seems to be that a modem is part of the telecom network. However, it appears that modems serve the telecom network, rather than the EDP equipment itself. On this basis, to the extent that modems fit within Class 10(f) as general-purpose EDP equipment, they are probably also electronic communications control equipment and thereby excluded from Class 10. By default, they fall into Class 8.

Multiplexers

AT&T's website glossary of telecommunication terms provides the following definition:

multiplexing

Multiplexing is sending multiple signals or streams of information on a carrier at the same time in the form of a single, complex signal and then recovering the separate signals at the receiving end. Analog signals are commonly multiplexed using frequency-division multiplexing (FDM ), in which the carrier bandwidth is divided into subchannels of different frequency widths, each carrying a signal at the same time in parallel. Digital signals are commonly multiplexed using time-division multiplexing (TDM ), in which the multiple signals are carried over the same channel in alternating time slots. In some optical fiber networks, multiple signals are carried together as separate wavelengths of light in a multiplexed signal using dense wavelength division multiplexing(DWDM).

XXXXXXXXXX's provided the following description of multiplexing in their letter dated November 27, 2000:

XXXXXXXXXX.

In the CCRA's view, multiplexers are clearly excluded from Class 10 by virtue of the exception for communications control equipment and fall into Class 8 by default.

Remote Access Servers or Access Concentrators

XXXXXXXXXX provided the following description in their letter dated June 4, 1999:

XXXXXXXXXX

Remote Access Servers or Access Concentrators are clearly communications control equipment and would be excluded from Class 10 by virtue of the exception in Class 10(f)(ii). They would fall into Class 8 by default.

Routers

AT&T's website includes the following definition for "routers" in its glossary of telecommunication terms:

router

Also see bridge , gateway , hub , and switch .

On the Internet, a router is a device or, in some cases, software in a computer, that determines the next network point to which a packet should be forwarded toward its destination. The router is connected to at least two networks and decides which way to send each information packet based on its current understanding of the state of the networks it is connected to. A router is located at any gateway (where one network meets another), including each Internet point-of-presence. A router is often included as part of a network switch. A router may create or maintain a table of the available routes and their conditions and use this information along with distance and cost algorithms to determine the best route for a given packet. Typically, a packet may travel through a number of network points with routers before arriving at its destination. Routing is a function associated with the Network layer (layer 3 ) in the standard model of network programming, the Open Systems Interconnection (OSI ) model. A layer-3 switch is a switch that can perform routing functions. An edge router is a router that interfaces with an asynchronous transfer mode (ATM) network. A brouter is a network bridge combined with a router.

CCRA considered the classification of routers in a technical interpretation E 9713677 dated August 19, 1997 and stated:

Based on our understanding, routers are devices used in complex networks, where there are many pathways between users in the network, to select an appropriate travel path and route a message accordingly. It is not clear to us whether routers are a type of switch or something else. If they are switches, they should be included in class 8 for the reasons mentioned above. If they are not switches, they are likely "electronic communication control equipment," which is specifically excluded from class 10. Since there is no class specific to routers, they should also be included in class 8.

CCRA believes that routers constitute "electronic communications control equipment" and would be excluded from Class 10 by clause (ii). By default, the equipment would be included in Class 8.

Servers

AT&T's website glossary of telecommunication terms includes the following:

server

1) In general, a server is a computer program that provides services to other computer programs in the same or other computers.

2) The computer that a server program runs in is also frequently referred to as a server (though it may contain a number of server and client programs).

3) In the client/server programming model, a server is a program that awaits and fulfills requests from client programs in the same or other computers. A given application in a computer may function as a client with requests for services from other programs and also as a server of requests from other programs.

Specific to the Web, a Web server is the computer program (housed in a computer) that serves requested HTML pages or files. A Web client is the requesting program associated with the user. The Web browser in your computer is a client that requests HTML files from Web servers.

In their submission dated June 4, 1999, XXXXXXXXXX provided the following arguments on the classification of a server:

XXXXXXXXXX.

In Document No. E9830375 dated December 4, 1998, the CCRA provided comments on the classification of servers used to provide data communications.

CCRA agrees with the XXXXXXXXXX analysis that a server would be considered general-purpose EDP equipment. Web servers appear to be add-on devices that are outside of the telecommunications network. As a result, such equipment would not be included in the exception for communications control equipment. Such equipment would therefore be included in Class 10. CCRA does not agree with the classification of routers as Class 10 equipment, for the reasons previously outlined. While such equipment may meet the definition of general-purpose EDP equipment, it would be excluded from Class 10 by virtue of the exception for communications control equipment.

Switches

AT&T's website includes a definition of "switches" in its glossary of telecommunication terms:

Switch

Also see bridge , gateway , hub , and router .

In telecommunications, a switch is a network device that selects a path or circuit for sending a unit of data to its next destination. A switch may also include the function of the router, a device or program that can determine the route and specifically what adjacent network point the data should be sent to. In general, a switch is a simpler and faster mechanism than a router, which requires knowledge about the network and how to determine the route.

In CCRA's view, these telecom switches are clearly excluded from Class 10(f) by virtue of the exception for communications control equipment. CCRA considered the classification of particular kind of switch in a technical interpretation (E 9713677) dated August 19, 1997.

Telecom Equipment, in General

In Question 19 at the 2000 Congress of the APFF (document F 2000-0038025), the CCRA was asked whether telephone equipment with several components that are similar to software was included in Class 10. CCRA responded that telephone equipment not included in Class 17 would be included in paragraph (i) of Class 8.

Terminal Equipment

AT&T's website glossary of telecommunication terms includes the following definition:

Terminal

1) In data communications, a terminal is any device that terminates one end (sender or receiver) of a communicated signal. In practice, it is usually applied only to the extended end points in a network, not central or intermediate devices. In this usage, if you can send signals to it, it's a terminal.

2) In telephony, the term Data Terminal Equipment (Data Terminal Equipment ) is used to describe the computer end of the DTE-to-DCE (Data Communications Equipment) communication between a computer and a modem .

3) In computers, a terminal (sometimes qualified as a "dumb" terminal) is an end-use device (usually with display monitor and keyboard) with little or no software of its own that relies on a mainframe or another computer (such as a PC server) for its "intelligence." IBM's 3270 Information Display System was a widely-installed system of such terminals in corporations. Many applications designed for the 3270 or other "dumb" terminals are still in use at PCs that emulate or act like a 3270. The VT-100 from Digital Equipment Corporation is another example of a widely-used so-called "dumb" terminal. A variation of this kind of terminal is being revived in the idea of the thin client or network computer.

4) The term is sometimes used to mean any personal computer or user workstation that is hooked up to a network.

CCRA concludes that such equipment would not fit within the definition of communication control equipment and would, therefore, not be excluded from Class 10 on that basis alone. However, such equipment would have to be considered individually to see whether it otherwise fits within Class 10. Failing that, it would fall within Class 8.

ENDNOTES

XXXXXXXXXX