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 Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Whether a licence to use computer software should be allowed as a current expenditure or capitalized.
Position TAKEN:
Question of fact to be determined on a case by case basis. In this case the cost of a license to use computer software would be capitalized.
Reasons FOR POSITION TAKEN:
Regulation 1104(2) defines computer software to include a license to use computer software and the licences in issue are of enduring benefit.
October 17, 1994
Vancouver District Office Head Office
K. F. Slawson Rulings Directorate
Assistant Director, Audit B. Kerr
(613) 957-8953
Attention: B. Westerlund
Large Files
941517
XXXXXXXXXX Periodic Payments for Computer Software
This is in reply to your memorandum of June 6, 1994, wherein you requested our opinion with respect to monthly or annual payments for computer software licences. We also acknowledge our telephone conversations (Kerr/Westerlund) further clarifying the situation and issue.
Our understanding of the facts are as follows:
XXXXXXXXXX
XXXXXXXXXX
You have asked for our opinion as to whether the monthly or annual license fees should be allowed as a current expenditure or whether they should be capitalized. We understand that you are not concerned with the proper class, although you have indicated that most of the items in question represent systems software and would fall in class 10 of Schedule II of the Income Tax Regulations.
Taxpayer's Opinion
XXXXXXXXXX has suggested that perpetual license fees are added to class 10 if related to system software, class 8 if system software related to network equipment and class 12 if related to application software. They have also indicated that upgrade fees are likely to be associated with longer licenses and would therefore be capital in nature, and would be included in the applicable class. However, they believe that monthly and annual license fees should be expensed as incurred, except where the initial license fee is greater than the subsequent renewal fee, in which case the initial fee would be capitalized. They have also indicated that if the Department requires capitalization of the monthly or annual license payments that XXXXXXXXXX should be allowed to capitalize the total future license payments in the current period so as to obtain an equivalent CCA deduction.
XXXXXXXXXX feels that the monthly and annual software charges are of a current nature and has also stated "
XXXXXXXXXX
"
District Office Opinion
You have compared the issue to that of a patent and Regulation 1100(9) and have concluded that the capital cost of a patent can consist of a lump sum payment, a series of payments based upon the use of the patent or a combination of each. You postulate that this conclusion also applies to licenses to use computer software. You are of the view that recurring monthly or annual charges in lieu of or in addition to lump sum payments are included in capital cost even where there is no specified term to the licence and where renewals or extensions are within the control of the grantee, notwithstanding that either party may terminate the licence upon giving the requisite notice.
Before an expenditure referred to in paragraph 18(1)(a) of the Income Tax Act (the "Act") that has been incurred for the purpose of earning income can be deducted it would also have to be determined whether it was an amount referred to in paragraph 18(1)(b) of the Act. Paragraph 18(1)(b) provides, inter alia, that in computing the income of a taxpayer from a business no deduction shall be made in respect of a payment on account of capital or an allowance in respect of depreciation or obsolescence except as expressly permitted. Accordingly, the first fact that must be determined is whether the expenditure in question is a current expenditure or is on account of capital. In the case of a current expenditure, it would have to be deductible under generally accepted accounting principles and not otherwise prohibited from being deducted under another provision of the Act. In the case of a capital expenditure, it would then have to be determined which class, if any, of schedule II of the Income Tax Regulations it would be included, before the amount of the deduction referred to in paragraph 20(1)(a) of the Act can be calculated.
Interpretation Bulletin IT-283R2 specifically dealing with computer software states in paragraph 10 that "Computer software" is defined in subsection 1104(2) of the Regulations to include systems software and a right or license to use computer software.
Interpretation Bulletin IT-128R, entitled Capital Cost Allowance-Depreciable Property, outlines some of the factors that may be used in determining whether an expenditure is capital in nature or whether it is currently deductible. Paragraph 4(a) concerning "enduring benefit" states "Decisions of the courts indicate that when an expenditure...is made "with a view to bringing into existence an asset or advantage for the enduring benefit of the trade", then that expenditure is normally looked upon as being of a capital nature. Where, however, it is likely that there will be recurring expenditures for replacement or renewal of a specific item because its useful life will not exceed a relatively short time, this fact is one indication that the expenditures are of a current nature."
IT-283R2 also states in paragraph 10 that "in the case of computer software that has been acquired primarily for use in the taxpayer's business or for leasing, its nature, purpose and anticipated life should be considered in determining whether the acquisition cost should be written off in the year the cost was incurred or, because the software is of an enduring nature, capitalized...For the purpose of this bulletin, "software" is considered to be of an "enduring nature" where its useful life is anticipated to last beyond one year. Where software that is a depreciable asset is acquired, it will be included in class 12 if it is computer software other than systems software, or in class 8, 10, 29, 39 or 40 if it is computer software that is systems software." The relevant class would depend on all of the circumstances pertaining to each particular computer software license. In this regard we would refer you to the definition of "computer software" in Regulation 1104(2) and the appendix in IT-283R2 for additional comments on each particular class.
In the case of property that is a licence, paragraphs 15-17 of Interpretation Bulletin IT-477 provide comments in determining its life such as "The provisions of a...license concerning renewal or extensions following the original term are relevant in determining the life of the property...Where such renewals are automatic or within the control of the taxpayer, that is they do not require any further negotiation with or the concurrence or consent of the grantor, the life of the property includes such additional periods...Where the taxpayer has an option to renew only if certain conditions are met...the circumstances of the particular case must be examined to determine whether or not, when he acquired the property, it was reasonably certain that these conditions would be met. If so, the additional periods are included in the life of the property." and "Provisions, including force majeure and contingency termination clauses, which may result in an early termination of the life of a property are not considered relevant in determining the life of the property...Where renewal or extension periods are considered part of the life of the property...and where the number of such renewals or extensions is indefinite, the life of the property may be hard to determine, however, the number of renewals or extensions may, in fact, be limited in certain circumstances even if the relevant agreement does not expressly provide such limits." For instance, a licence under a Canadian patent under which the licensee has unlimited rights of renewal has a limited life because of the life of the patent itself which is limited to 17 or 20 years depending on the date of issuance. Of course, whether a particular licence is issued under the particular law dealing with a patent, copyright, invention etc. is a question of fact.
In our view, it appears that most of the licenses do have enduring benefit since it appears that the taxpayers have a history of continually renewing the licenses in question, and in most cases the one-time charges or the initial fees exceed 12 times the monthly charges or the annual charges. These facts would suggest that the life of the software has a life in excess of 1 year. In addition in all cases the renewal of the licenses is automatic or within the control of the taxpayer such that the renewal periods must be included in determining its life. As you have stated most of the software licenses would fall in class 10, this factor would also suggest a life in excess of 1 year since in coming up with the proper classification of property and its CCA rate, the life of an asset is one of the factors that is considered by the Department of Finance. In addition, in our view the fact that the contract for a computer software license provides for its termination if thirty or ninety days notice is given has no bearing on the estimated life of the property nor does the fact that a particular software may be upgraded regularly render its life terminated and therefore limited to a period of less than 1 year.
Accordingly we agree with you that the monthly or annual licenses fees as incurred by the taxpayer for the computer software would be included in the capital cost of the property. In this regard we refer you to paragraph 1 of Interpretation Bulletin IT-178R where it states the term capital cost of property generally means the full cost to the taxpayer of acquiring the property.
We cannot agree with the taxpayer's argument that the total future license fees should be included in the capital cost since, in our view, no amount has yet been paid or incurred. In this regard we refer you to the comments in Canadian Tax Paper No. 71 entitled Timing and Income Taxation: The Principles of Income Taxation by B.J. Arnold where at pages 207 and 208 he categorizes the deductions allowed by the Act into four types: amounts paid, amounts payable, expenses incurred and allowances. Also the terms cost and expense incurred are discussed on pages 210 and 211 where it states "The term cost is the term of greatest breadth and denotes any liability incurred or disbursement made by an enterprise to obtain goods or services. In contrast, the term "expense" has a more limited meaning of "cost properly identifiable with the operations or with revenues earned during that period or that is not identifiable with the operations or revenues of a future period", and on page 224 he states "it is well established for income tax purposes that a cost or expense is incurred only when the taxpayer has a clearly legal, though not necessarily immediate obligation to pay an amount." In addition, paragraph 18(1)(e) of the Act also prohibits a deduction for contingent liabilities.
As a final note concerning computer software licenses, we refer you to the Department of Finance, Release 83-110 dated August 8, 1983 entitled "Amendments to the Income Tax Regulations Affecting Capital Cost Allowances for Computer Software" where it states "The proposed amendments specify that a reference in the regulations to computer software or systems includes the cost of a license to use such software. These changes will provide a 100 per cent capital cost write-off over two years for applications software acquired under a licensing arrangement and 20 per cent or 30% for systems software acquired under similar licensing arrangements. The proposed amendments will be retroactive to May 26, 1976, when the capital cost allowance rates for computer software were last modified." In addition, we also refer you to the explanatory note attached to SOR/83-855 dated November 4, 1983 concerning the definitions of computer software and systems software where it states "This amendment clarifies that a licence to use computer software is included in the same class as computer software that is purchased." In our view, these comments suggest that the intention of Parliament in 1983 was that the cost of a licence to use computer software would be capitalized and included in the same class as computer software that is purchased outright.
R. Albert
for Director
Business and General Division
Rulings Directorate
Policy and Legislation Branch
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