18 June 1990 Internal T.I. 44907 F - Classification of Relocation Costs

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.

SUBJECT:  24(1)

We are writing in response to R. Cloutier's memo to US dated November 2, 1989, wherein he asks for our comments on the above issues which are discussed in a memo he received from the Edmonton District Office.

Facts

The facts as we understand them are as follows:

24(1)

24(1)

District Office Analysis

A.  Capital Cost Allowance

(i)     As noted in paragraph 2 of IT Bulletin 128R and subject to the exceptions noted below, CCA may only be claimed in respect of capital expenditures made in respect of property owned by the taxpayer or in which the taxpayer has a leasehold interest.

     24(1)

(ii)     Regulation 1102(5) which pertains to a building or other structure on leased property has no application to this case as we are not concerned with leased land.

(iii)     Regulation 1102(18) pertains to payments to the crown which would be class 10(1) if the property was purchased by the taxpayer. In this case  24(1)

(iv)     Regulation 1100(8) is applicable to the construction of railway sidings which do not become property of the taxpayer. 24(1)

(v)     Class 12(q), designated overburden removal cost is defined in Regulation 1104(2).

     24(1)

     Class 12 may be applicable but only if all other classifications fail.

B. Eligible Capital Expenditures ("ECE")

Department policy appears to favour ECE treatment for the construction of highways on other than the taxpayer's  property.  This may be found in IT 143R2, paragraph 30 and IT 501, paragraph 7.  This was also reinforced in the Notes of Mining Industry Information Session, Toronto, 1983, wherein a question raised by the Penticton D.O. was responded to by "The costs of roads on non-owned or non-leased property are ECE."

21(1)(b)

Reference is made to Oxford 81 DTC 5065 and Inskip 86 DTC 1837.  Both cases look at the end result.  Did the expenditure improve or expand the taxpayer's business (and then it is a capital expenditure) or did it merely preserve it (justifying income treatment)?

24(1)

C.  Canadian Development Expenses ("CDE")

24(1)

D.  GAAP and Deferred Charges

Industry views these expenses as neither a fixed asset nor a current operating expense.  Rather, these expenses are deferred to be matched with the corresponding revenue derived from the 24(1)   IT 417R, paragraph 2 states the Department requires the accounting for prepaid expenses and deferred charges be in accordance with the matching principle as required by GAAP, subject to any contrary provision of the Act.

Deferred charges are defined in Income Taxation In Canada, Prentice Hall Canada Inc., 14014, as an expenditure, other  than a capital expenditure, the benefit of which will extend over a period of years.

The relevant expenses are not deferred charges for tax purposes.

E.  Current Operating Expense

This classification is supported because the taxpayer's business was not expanded or improved in any way and because  of the ongoing nature of these types of expenditures.  It is further supported by comparing it to our position concerning reclamation costs.  Here we disallow the taxpayer's annual accrual for future reclamation, allowing instead the expense when the actual payment is made. 24(1)

If we accept that these are costs of reclamation, the expenditures would be deductible as incurred.

D.O. Conclusion

The classification of the relocation costs in order of preference should be as follows:

1)     Current operating expenses,

2)       Reclamation cost (current expense), or

3)       Class 12(q).    

Rulings' Comments  

We reviewed the costs of   24(1)  and the costs of constructing the new assets to determine whether each of the expenditures was on account of capital or on account of income.

Based on this review we offer the following comments:

     24(1) (Refer to the words utilized in the definitions or undepreciated capital cost at paragraph 13(21)(f) and depreciable property at paragraph 13(21)(b), where property must be "acquired" by the taxpayer in order to meet the definitions.)

     Black's Law Dictionary defines "acquired" as follows:

     "... to get as one's own; to obtain ... come to have ... to become owner of property; to make property one's own.  To gain ownership of ...".  

     This definition is consistent with the opening comments in paragraph 2 of IT 128R where it states that CCA may only be claimed in respect of capital expenditures made in respect of property owned by the taxpayer or in which the taxpayer has a leasehold interest.

     It is also our view that the taxpayers have not "acquired"  the Assets for the purposes of Classes 1, 3 and 17 and are therefore precluded from adding the relocations costs therein

(ii)      24(1)  and that paragraph 5 of IT 464R states that the capital cost or a leasehold interest of Class 13 property includes an amount a tenant expends in respect of improvements or alterations to a leased property that are capital in nature, it is our view that paragraph (a) of Class 13 excludes the relocation cost of the Assets from inclusion therein (i.e. the Asset relocation costs would be in respect of property relating to the 24(1) and are specifically excluded from Class 13).

(iii)     We also consider that the Assets would not be "structures"  for the purposes of subsection 1102(5) of the Regulations   and therefore the relocation costs of the Assets would not  be included therein. This position was originally adopted in 1976  23 Our position has not changed since that date.            

(iv)     We agree that subsection 1102(18) does not apply in this instance because                                            24(1)

(vi)     Although the analogy made by the District Office, of the Asset relocation costs to mine reclamation costs, has some merit   24(1)

Based once above comments we are left to consider whether the relocation costs are current expenses, deferred charges, eligible capital expenditures ("ECE"), designated overburden removal costs for the purposes of Class 12(q), or the cost   24(1)               for the purposes of subsection 1100(8) of the Regulations.

(vii)     We view the demolition costs of the old Assets as being on  income account. 24(1)

     This position would appear to be consistent with the decision in the Johns-Manville case (85 DTC 5373) in that the expenditures were incurred in the course of regular day-to-day business operations and did not have the semblance of a once and for all acquisition.

(viii)      We do not view these demolition costs as designated overburden removal costs (Class 12(q)) for the  following reasons:

(a)     Subsection 1104(2) of the Regulations defines designated overburden removal cost of a taxpayer, for  the purposes of Part and Schedule II of the Act, to mean "any cost incurred by him in respect of clearing or removing overburden from a mine...".

     In the Dictionary of Mining "overburden" is defined as "the surface waste or worthless rock overlying a flat  or moderately inclined economic deposit; it is thin enough to warrant its removal to expose and mine the deposit by opencast".

     In the Concise Oxford Dictionary "overburden" is defined as "(Mining etc.) rock etc. that is to be removed in order to expose the deposit sought".

     Overburden usually includes earth and vegetation. 24(1)

(b)       As the demolition costs are current operating costs they are specifically excluded from Schedule II virtue of paragraph 1102(1)(a) of the Regulations.

(ix)     Although the matter is not without doubt, it is our view that the construction costs of the new Assets is also on income account in line with the Johns-Manville decision noted above   24(1)

     This would preclude these expenditures from ECE, Class 12(q) and railway siding treatment by virtue of subparagraph 14(5)(b)(i), paragraph 1102(1)(a) of the Regulations and subsection 1100(8) of the Regulations, respectively (i.e. once the expenditures are determined to be current in nature then they do not meet the capital expenditure requirements of these provisions).

(x)     We agree with the District Office comments that GAAP  requires the present relocation expenditures to be deferred and matched with the corresponding revenue derived from the  if these expenditures are expected to benefit future periods substantially.  This position is supported at paragraph 3 of IT-417R where it states

     "... it is considered that the Income Tax Act always required and continues to require that all costs that could clearly be related to future periods be expensed in those periods, if they are material and if failure to defer the expense would distort the net profit not only of the year during which the expense was incurred but also of the subsequent year or years to which the benefit relates."

     Whether the relocation Costs at issue will result in material subsequent year benefits to,  24(1) and what a reasonable rate of amortization of those costs would be are questions of fact which would be best determined by Audit.

     Although we have not reviewed this matter in detail, in response to the District Office's query concerning  legislative authority for following GAAP in respect of  deferred charges, we would-refer them to.the decision in H.M.T.Q. v Metropolitan Properties Co. Ltd. (85 DTC 5128).  Generally speaking, the Court found that GAAP should normally be followed for tax purposes unless it is contrary to a specific provision in the law.

Summary

24(1)

If you have any questions on the above please contact the writer.

DirectorBilingual Services & ResourceIndustries DivisionRulings Directorate