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.
November 23, 1995
HEADQUARTERS HEADQUARTERS
Appeals Branch A.M. Brake
L. C. Tremblay (613) 957-8953
Director
Attention: Dave Turner
952090
XXXXXXXXXX
This is in reply to your memorandum of August 2, 1995 referring to ours of October 17, 1994 (file #941517) dealing with the treatment of periodic payments for the use of computer software by XXXXXXXXXX.
Rather than arbitrate comments made regarding the contents or positions taken in our memorandum, we will make additional comments in an attempt to clarify some of the misconceptions that exist mainly because of the involved nature of the transactions under consideration.
While it is true that actual ownership of the various software may not have been acquired outright, the rights or licence to use the software was acquired and such rights or licences to use computer and/or systems software do fall within prescribed classes for capital cost allowance ("CCA") purposes. For example, Regulation 1104(2) of the Income Tax Act (the "Act"), in part reads,
"Computer software includes systems software and a right or licence to use computer software"
"Systems software means ... and includes a right or licence to use systems software"
Property not included as depreciable property is dealt with in Regulation 1102 which reads, in part,
"(1) The classes of property described in this part and in Schedule II shall be deemed not to include property
(a) the cost of which is deductible in computing the taxpayer's income;"
It might be noted that the definition of systems software, "... right or licence to use systems software" does not place a time frame with respect to the duration of the right or licence. In other words, a right or licence for a 6 month period, subject to Regulation 1102(1)(a), would fit within the definition as would a right or licence for a 6 year period. The definition is probably based on the premise that any and all systems software is developed to have application for a longer rather than shorter duration and it is difficult to accept that the initial costs incurred in developing unique systems software for a specific application would be an outlay that would not benefit the user for more than the current accounting period.
Since the right or licence to use systems software is described within a prescribed class, the question to be answered, at the time of making a payment or incurring a definite obligation, is whether the acquisition would benefit only the current fiscal period in which case the relevant cost could be expensed and therefore be excluded from a prescribed class by virtue of Regulation 1102(1)(a) or whether the nature of the acquisition was such that it would provide benefits beyond the current year, in which case the acquisition should be considered capital in nature. One might argue that from an accounting perspective, that this is not unlike the payment for a 3 year fire insurance policy the cost of which is set up as a deferred expenditure and amortized over the life of the policy. This is acceptable for a fire insurance policy because it is not described in a prescribed class but in the case of an outlay that is described in a prescribed class, the capital cost allowance system dictates the method of allowances in respect of such write-offs.
In determining whether a particular outlay is on account of capital or income, it should be remembered that the method of payment is not the sole criteria in making such a determination. The question to be answered is whether a payment or a legal obligation to pay was related to the acquisition of a depreciable capital asset, within the provisions of the Act, or whether the payment was simply a current expense. An expenditure will be considered to have been made at the time a payment is made unless the taxpayer has entered into a legal obligation to make a future payment(s). It is the treatment of the payment or the debt giving rise to the legal obligation to pay which must be determined at the time of payment or when a definite obligation to make the payment has been entered into.
In dealing with whether a payment can be considered to be a current expense in the form of a monthly rental payment or whether the individual payments or total obligation should be treated as a depreciable property within the definition contained in Regulation 1104(2), as "... a right or licence to use systems software" having regard for the exclusion contained in Regulation 1102(1)(a) in respect of a current expense, for discussion purposes, let us assume that a user needs the use of computer software and has to make a choice between a guaranteed 5 year commitment or a month-to-month agreement. The two hypothetical situations are as follows:
Situation #1.
A guaranteed agreement provides for the right or licence to use computer software for a 5 year period, with no opting out provision in the agreement. The supplier in the negotiations offers the user three options and upon signing the agreement the user has to choose one option as forming a clause of the agreement by placing a tick mark beside either the A, B, or C option. The options are,
A.An immediate payment of $500,000 upon signing the agreement.
B.An immediate payment of $250,000 together with a payment of $260,000 on the first day of year 2.
C.$9,000 monthly payment to be paid on the first day of each month for the entire 5 years.
It would seem clear that what the user has acquired is the licence or right to use systems software for a period of 5 years, notwithstanding that it may become totally obsolete, say, after 3 years. The method of payment is the only decision to be made because, he has, in fact acquired the rights or licence to use software for 5 years at a price of $500,000. The method he chooses to pay for the acquisition does not materially change the overall obligation and neither does it change the nature of his acquisition. Under either option, the user acquires the right or licence to use the software for 5 years, even though it could happen that the user may only use it for 1, 2, or 3 years. In this regard he will have acquired $500,000 in depreciable property at the time he signs the agreement. Should he choose the C option to pay the debt in $9,000 monthly payments for total consideration of $540,000, the additional $40,000 could be treated as finance charges as could the additional $10,000 in payment option B. While it might be argued that the $9,000 per month is merely a rental expense, in our view, it is not the individual payments which have to be considered but rather the total obligation to pay in relation to that which was acquired, namely, "a right or licence to use systems software" for a period of 5 years. This fits the description of property of a prescribed class that is not precluded from being a depreciable property by Regulation 1102(1)(a) of the Act.
Situation #2.
A non-guarantee month-to-month agreement to use the same software as in situation #1 provides for monthly payments of $11,000 to be made on the first day of each month. The agreement also provides that either party can terminate the agreement by giving the other party one months notice.
In such a month-to-month arrangement, the user will not be required to make payments should he decide not to use the software after, say 2 or 3 years, as he may terminate the agreement with a month's notice. Since it is the supplier that holds the risk for the obsolescence, the price is, therefore, higher. It could very well be argued that the software in question can be valued but there is no debt obligation created and no total anticipated future value or cost to be capitalized. It will be necessary, as in the case of the other payments, to determine at the time, whether the payments in a particular year would be in respect of the current use as a rental expense or whether it was in part for use in a future year(s). One must conclude that the $11,000 payment made at the beginning of each month is for the use of the software for that month and the next payment for the next month's use and on and on until notice is given by one of the parties to terminate the agreement. Let us now look back on a situation where the agreement was terminated after paying 39 regular monthly payments plus the one month's notice payment for the 40 months' use. In our view, the payments in question benefited only the period in which they were made and did not benefit future periods and, therefore, were on account of current expense and precluded from being depreciable property by virtue of Regulation 1102(1)(a) of the Act. There is nothing to support nor reason to believe that these monthly payments will benefit future periods. Hence, there is no basis to capitalize these payments.
We conclude as follows:
1.An amount cannot be expensed or capitalized in respect of the present value of anticipated use unless there is a definite legal obligation to make future payments. In which case, it is the sum total of the entire obligation that has to be considered at the time of making the obligation as to whether it is a current expense or whether it will accrue some benefit for a future year(s).
2.In order to be considered an amount in respect of depreciable asset (right or license to use software), it is only necessary to establish that some part of the amount relates to use in a future year(s). The capital cost allowance system overrides the deferred expense accounting treatment where the property is described in a prescribed class.
3.In an agreement where there is no time guarantee for the use of the software and the payments are on a month to month basis with no time guarantee, the monthly payments in question can be considered to be current rental charges where it is reasonable to assume that the cost in respect a future year(s)' use is not being paid up front.
R. Albert
for Director
Business and General Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch
All rights reserved. Permission is granted to electronically copy and to print in hard copy for internal use only. No part of this information may be reproduced, modified, transmitted or redistributed in any form or by any means, electronic, mechanical, photocopying, recording or otherwise, or stored in a retrieval system for any purpose other than noted above (including sales), without prior written permission of Canada Revenue Agency, Ottawa, Ontario K1A 0L5
© Her Majesty the Queen in Right of Canada, 1995
Tous droits réservés. Il est permis de copier sous forme électronique ou d'imprimer pour un usage interne seulement. Toutefois, il est interdit de reproduire, de modifier, de transmettre ou de redistributer de l'information, sous quelque forme ou par quelque moyen que ce soit, de facon électronique, méchanique, photocopies ou autre, ou par stockage dans des systèmes d'extraction ou pour tout usage autre que ceux susmentionnés (incluant pour fin commerciale), sans l'autorisation écrite préalable de l'Agence du revenu du Canada, Ottawa, Ontario K1A 0L5.
© Sa Majesté la Reine du Chef du Canada, 1995
Email this Content