14 January 1997 Internal T.I. 9624927 - CAPITAL V. REPAIRS

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:

Taxpayer undertook massive upgrading to XXXXXXXXXX old buildings to bring them up to modern day standards.

Position:

Taxpayer's position is that the amounts represent current expenses on account of repairs and maintenance. The expenditures improved the utility of the buildings and extended the life of the asset. This constitutes betterment as set out in the CICA Handbook, 3060.29 and should be capitalized.

Reasons: GAAP

		January 14, 1997

	XXXXXXXXXX Centre Tax Service Office	HEADQUARTERS
	XXXXXXXXXX	A.M. Brake
	XXXXXXXXXX	(613) 957-8953

		962492

Capital v. Repairs and Maintenance Expense

This is in reply to your memorandum of July 16, 1996, referred to us by you at the request of the taxpayer's representative for our comments with respect to the treatment of expenditures relating to the overall improvement of XXXXXXXXXX The fact situation can be summarized as follows:

Facts

XXXXXXXXXX

It is your position that the outlays to the contractor, recorded as repair expense, were made to effect improvements to the building that, with a few possible exceptions, are not repairs, either in the judicial interpretation or the layman's understanding of the meaning of the word "repair". You made reference to the CICA Handbook, paragraph 3060.29 "Betterment", which states, in part:

"The cost incurred to enhance the service potential of a capital asset is betterment. Service potential may be enhanced when there is an increase in previously assessed physical output or service capacity, associated operating costs are lowered, the life or useful life is extended, or quality of output is improved. The cost incurred in the maintenance of the service potential of a capital asset is a repair, not a betterment. If a cost has the attributes of both a repair and a betterment, the portion considered to be a betterment is included in the cost of the capital asset."

XXXXXXXXXX

responded that repairs were properly recorded because they were essentially restorative rather than ameliorative in nature and did not constitute betterment or improvement as those terms are generally understood in jurisprudence.

The taxpayer's representative quoted Tom M. McLaughlin v. M.N.R., 92 DTC 1030 (TCC) in support of the position that outlays made to restore a building to its original state could be properly expensed. You referred to Charney v. HMQ 1966 (court file #95-3738 {IT}). Also, Gino Fiore and Francois Fiore v. Queen, 93 DTC 5215 (FCA), referred to by you, relates to a situation similar to the McLaughlin and Charney situations.

Our Comments

The Charney decision (while Methe v. M.N.R., 86 DTC 1360, was quoted therein) is in line with the FCA decision in Fiore and the situation in all four cases (Fiore, Charney, Methe and McLaughlin) relates to taxpayers who acquired run down properties and commenced major renovations to improve their property. The decision in McLaughlin is contrary to the decisions in the other three cases. The Fiore decision in the Federal Court of Appeal was subsequent to the McLaughlin decision (TCC), and is a further confirmation of earlier jurisprudence which apparently was not followed in McLaughlin. In our view, therefore, McLaughlin, as put forward by the taxpayer's representative, is outweighed by the other decisions. The comments in Methe at page 1363, as quoted on page 6 of your referral, clearly support your position that repairs and maintenance cannot be misconstrued to include outlays where an older building is acquired in a dilapidated state and renovated to the extent that it is almost entirely in new original condition, with additional upgrades, as in the case at hand.

Whether or not a particular outlay should be treated as a current expense or capitalized is a determination to be made in accordance with GAAP and is not dealt with by any specific provision of the Income Tax Act. The comments on betterment, as set out in the CICA Handbook would have to be interpreted in relation to the facts in any given situation. With regard to the case at hand, the buildings in question were approximately 25 years old when acquired by XXXXXXXXXX and used by it for 10 to 12 years before construction commenced. The condition of the buildings at the time they were acquired is not known. What is known is that buildings that are now 35 years old never did resemble the state of the XXXXXXXXXX In our view, the general nature of the outlays related to upgrading these buildings represents overall improvements which constitute betterment and an extension in the life of the asset for the purpose for which it is being used. In particular, in our view, the overall intent of the larger expenditures was betterment and, while this list is not exhaustive, the larger expenditures include new and improved wiring and lighting, structural strengthening of the roof, changing floor space, moving bathrooms, wider and better windows and doors, new improved heating, air conditioning and ventilation systems together with engineering, and architectural fees. We do concede that certain amounts could relate to repairing or replacing without there being overall improvement (i.e., replacing carpet or floor tile with similar carpet or tile, repairing of existing stucco, or washing and painting walls that still exist). However, since the general nature of what took place was betterment, we agree with your proposal that amounts that cannot be identified as specifically relating to actual repairs and maintenance, should be capitalized.

Your file is attached hereto.

R. Albert
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch