9 February 1984 Income Tax Severed Letter 7-2894 - [840209]

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.

February 9, 1984

HALIFAX DISTRICT OFFICE

Mr. H. Ley Basic Files

HEAD OFFICE Corporate Rulings Directorate K.H. Major (613) 995-1787

XXXX

At the request of Head Office Tax Avoidance and Foreign Operations Division we are replying to your memorandum of October 11, 1983 to that Division.

You were concerned about the availability of a deduction of soft costs to the investor in respect to situations where XXXX purchased existing MURB's and then sold units in them to investors.

It is our view that the same criteria are used in the determination of deductibility for soft costs in the purchase and resale of an existing MURB as are used in the initial creation and sale of a MURB.

The guidelines used by Corporate Rulings Directorate when deciding whether or not to rule on the deductibility of soft costs are set out in Legislation Branch Letter 79-12 dated September 24, 1979 and in Legislation Branch Letter Addendum 79-12 dated December 22, 1981 (the Branch Letters). The Branch Letters should be helpful to the auditor when he is determining the deductibility of soft costs for the investor but an audit is required so that any reassessment will be based on the particular facts of each case. The guidelines are somewhat arbitrary and are not intended to be audit instructions or to deter a particular District Office auditor from using his own ingenuity to determine the reasonableness of a specific amount.

The highlights of the Branch Letters are as follows:

(1) The soft costs charged to the investor must not be in effect a carving out of the capital cost of project to the vendor.

(2) Each component of the soft costs must be reasonable. The general test for reasonableness of an expenditure is based on whether a prudent investor could be expected to pay such an amount for the particular item of service if it was available from an independent supplier of such goods and services.

(3) Any costs incurred by the promoter prior to an investor becoming an owner and paid by the investor to obtain his ownership in the project will be part of the investor's cost of land and depreciable property rather than deductible expenses.

(4) The timing of the deductibility of prepaid expenses incurred after December 11, 1979 will be in accordance with subsection 18(9) and the guidelines described in IT-417R . For example the cash flow guarantee fee will meet the requirements of paragraph 18(1)(a) for deduction over the period of time covered by the guarantee fee.

The following comments are made for your perusal.

XXXX

(1) It is our view investors who are not partners are not allowed a pro rata share of third party selling expenses on the basis that each investor is acquiring an interest in a "syndicate" (i.e. paragraph 21(e) does not apply). XXXX This portion is considered to be capital cost to the investor and a selling expense to the promoter. Most costs of merchandising a MURB are usually incurred before the investor owns his unit.

(2) The timing of the legal expenses and the initial service and financing fee should be considered in relation to the time that the investor is considered to own his unit. To be deductible they should be incurred after the investor owns his unit. There is also, a possibility that these expenses are simply a carve out of capital cost to XXXX as it is questionable that some of the initial services as listed are required for an existing project.

(3) The reasonableness of the leasing fee is questionable for an existing project. It appears that some of the initial service fee (printing of brochures) are really part of this cost with the possible result that costs to the investor are in effect duplicated.

(4)(a) It appears that the guarantee fee of the first and second mortgage debt, provision of indemnity agreement with respect to mortgages against the property and the committment fee to grant a wrap-around mortgage are in effect charging the investor at least double if not in part triple for the same service which is the mortgage guarantee. The reasonableness of these fees should be considered as they represent in total XXXX of the mortgage debt. It should be noted that there are also finance fees in the initial service and financing fees.

XXXX When considering reasonableness of the cash flow guarantee consideration could be given to excluding the mortgage payments because the payment of these is guaranteed by the mortgage guarantee given by XXXX.

(5). Provided that the fair market value of a unit was XXXX consideration should be given to allowing the investor to capitalize any portion of the soft costs considered not deductible in XXXX or subsequent taxation years. Such capitalization could be pro rata over land, building and furniture and fixtures.

(6) Has XXXX set up an appropriate breakdown of capital cost between land, building, furniture and fixtures?

(7) Should an audit be done on the operation of the XXXX as well as its setting up? For instance is interest expense claimed properly? In this regard XXXX should explain the difference between the mortgage retirement schedule in XXXX of the prospectus and the retirement schedule for the same mortgage as set out on XXXX.

In conclusion any deduction available to the investors can only be determined after an examination of all the facts including the taxpayer's representations.

for Director Specialty Corporations Rulings Division Corporate Ruling Directorate Legislation Branch

c.c.: E.E. Gauthier Tax Avoidance Section, East Tax Avoidance and Foreign Operations Division Policy and Systems Branch