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.
Principal Issues: Whether the expenditures incurred to replace the distribution line in the existing on-site sewage disposal system should be on capital account or current account.
Position: Question of fact but, based on supplied information, likely on income account
Reasons: IT-128R, paragraphs 4(b)-(d).
2008-028072
XXXXXXXXXX André Gallant
(613) 957-8961
September 3, 2008
Dear XXXXXXXXXX :
Re: Repairs to Part of a Motel Sewage Installation
This is in response to your email of June 5, 2008, and is further to our telephone conversations (Gallant/XXXXXXXXXX ), regarding the proper classification of expenditures for the replacement of part of the distribution line of a motel's sewage installation.
Our understanding of the facts is as follows:
1. The distribution line of the existing on-site sewage disposal system of the XXXXXXXXXX (the "Motel") was damaged XXXXXXXXXX . The Motel was built over XXXXXXXXXX years ago, and was purchased by you in early XXXXXXXXXX .
2. The Motel filed a claim with its insurance company in XXXXXXXXXX . The claim was closed by the insurance company on XXXXXXXXXX on the basis that no excavation of the land in issue had yet been done by the Motel for which the adjuster could evaluate the damage which occurred. The Motel had contacted four different excavation contractors in XXXXXXXXXX , but they were all busy with bigger projects at the time.
3. On XXXXXXXXXX , an Order from a provincial inspector of health was sent to the Motel ordering the Motel to do the following:
a. By XXXXXXXXXX take action to prevent any further sewage discharge from reaching the ground surface, including (but not limited to):
i. Diverting septic tank outflow to other, pre-existing on site sewage discharge fields/pits,
ii. Plugging the septic tank outlet and having all wastes pumped and hauled to an approved sewage disposal plant; and
b. By XXXXXXXXXX make the appropriate repairs or upgrades to the onsite sewage disposal system as to meet current requirements under the provincial statute and its regulations.
4. In XXXXXXXXXX , the Motel incurred $XXXXXXXXXX (plus GST) to replace the distribution line of its existing on-site sewage disposal system. This amount was broken down in the invoice from the contractor: $XXXXXXXXXX was charged for "Supply & Install Sewage System as per XXXXXXXXXX specifications," $XXXXXXXXXX for "Supply and Place XXXXXXXXXX cubic yards of Peat & Sand mixture," $XXXXXXXXXX for "Supply only XXXXXXXXXX cubic yards of Peat & Sand," $XXXXXXXXXX for "Electrical Permit fee," and $XXXXXXXXXX for "Electrical Labour." The amount of $XXXXXXXXXX will not be recovered from the insurance company.
You asked whether the amount of $XXXXXXXXXX to replace the distribution line in the existing on-site sewage disposal system should be on capital account or current account.
Our Comments
Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office (the "TSO"). In your situation, since the transactions are completed, a request for an opinion should be addressed to the local TSO. We are, however, prepared to offer the following general comments, which may be of assistance.
There are no fixed rules when determining whether an expenditure is on account of income or on account of capital. The courts often look to what, from a practical and business perspective, was the purpose of the expenditure. The jurisprudence suggests a number of guidelines that may be relevant, but also suggests that no one guideline is determinative. The main four guidelines that the courts have identified as being relevant to the determination are "enduring benefit", "maintenance or betterment", "integral part or separate asset" and "relative value". These guidelines, along with some others, are explained in the Canada Revenue Agency's (the "CRA") Interpretation Bulletin IT-128R, paragraph 4.
Of particular importance to your situation is the guideline in paragraph 4(b) of IT-128R. This paragraph provides a discussion on whether an expenditure is considered to be maintenance because it restores a capital property to its original condition (likely a current expense) or a betterment because it materially improves a capital property beyond its original condition (likely a capital expenditure). Further as indicated in paragraph 4(b), where all of the expenditure, but for a minor part, is of current nature, the CRA is prepared to treat the whole expenditure as being of a current nature.
The guideline dealing with relative value in paragraph 4(d) of IT-128R would also appear to be helpful in determining whether in your situation the expenditure was on capital or current account. This guideline looks at the maintenance and repair costs in issue in relation to the value of the whole property or in relation to previous average maintenance and repair costs. The courts have found the repair cost to be a current expenditure, generally, in cases where this cost only represented a low percentage (lower single digit) of the fair market value of the whole property (including integral components).
Finally, we would mention that the fact that a taxpayer is required to incur expenditures in order to comply with an order made by a municipal, provincial or federal authority is not determinative of the issue of whether the expenditures are on income or capital account.
Applying the above to the situation you presented, it would appear that the amount of $XXXXXXXXXX to replace the distribution line of the septic tank is on income account. Based on the facts and information you provided by telephone, there was no betterment or improvement of the sewage installation system beyond its original condition; rather the amount of $XXXXXXXXXX was incurred to repair and return the distribution line, which had been damaged XXXXXXXXXX , to its original condition.
We trust that these comments will be of assistance.
Yours truly,
S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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