22 May 1990 Ruling 59383 F - Costs Relating to Construction

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.

May 22, 1990

Dear Sirs:

Re:  Technical Interpretation - Subsection 18(3.1)

We are writing in reply to your letter of January 10, 1990 wherein you requested a technical interpretation of subsection 18(3.1) of the Income Tax Act (the "Act") as it applies to the following hypothetical situation.

Situation

1.     A taxpayer corporation will construct a building having a cost of $1.2 million before considering the application of subsection 18(3.1).

2.     The taxpayer has $200,000 of available cash which could be used as equity in the project.  The funds were raised from the issuance of common shares.

3.     In order to borrow the required funds for the project the taxpayer will place $200,000 on deposit as security with a financial institution in an account earning interest at a 10% rate.

4.     The financial institution loans the taxpayer $1.2 million which will be used to construct the building.  The taxpayer will incur interest at a rate of 12% on $1 million of the borrowings and at a rate of 10% on $200,000 of the borrowings.  The financial institution will apply the interest on the deposit against the interest on the loan.

5.     The construction period of the building is one year. Interest incurred on the loan during the construction period is $140,000 calculated on the following basis:

6.     Interest earned on the deposit during the construction period which is applied toward interest on the loan is $20,000.

Your Comments

In your opinion, subsection 18(3.1) of the Act should apply on the basis that net interest of $120,000 will added to the cost of the building as follows:

In support of your position you have referred to two instances where Revenue Canada - Taxation has adopted an administrative position which allows for the netting of income from related expenses.

Our comments

In our opinion, interest retains its identity and in the hypothetical situation as described above, the $20,000 interest earned on the $200,000 security deposit is interest income to be included in income under paragraph 12(1)(c) of the Act and the interest expense of $140,000 on the loan totalling $1,200,000 would be deductible under paragraph 20(1)(c) of the Act. However, subsection 18(3.1) which prohibits certain deductions overrides paragraph 20(1)(c) with the words "notwithstanding any other provision of this Act" in the preamble.

Paragraph 18(3.1)(a) then denies a deduction in respect of any outlay or expense that may reasonably be regarded as a cost attributable to the period of the construction, renovation or alteration of a building and relating to the construction, renovation or alteration or a cost attributable to that period and relating to the ownership during that period, of land.  In the hypothetical situation set out above, the cash security deposit seems unusual and may well require a closer examination of all the surrounding circumstances.  However, in our opinion, it is quite possible that only $120,000 of the $140,000 interest expense may reasonably be regarded as a cost relating to the construction, renovation or alteration of the building after consideration of all the relevant facts.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, this opinion is not a ruling and accordingly, it is not binding of Revenue Canada, Taxation.

We trust that these comments will be of assistance.

Yours truly,

for DirectorBusiness and General DivisionSpecialty Rulings DirectorateLegislative and Intergovernmental Affairs Branch