17 March 1998 External T.I. 9705835 - - WHETHER EQUIPMENT "USED"

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:

1) Whether equipment used 2 months while waiting for a closing for its transfer, is used equipment for the purpose of Class 43.1;
2) what is the starting point for the 5 year period referred to in Class 43.1

Position:

1) Used equipment is used equipment, even if used only 2 months.

2) The 5 year period starts at the point in time when the equipment was available for use, which cannot be later than the date the equipment was used to earn income.

Reasons:

"Used" is not defined in the Act. Must rely on the general meaning. To operate the facility, the taxpayer had to use the equipment. Reconditioned or remanufactured equipment does not qualify. Therefore, position concerning substantial renovations is not relevant.

Class 43.1 refers to "available for use" This is the earliest of the various times referred to in subsection 13(27). The latest point is when the equipment is used to earn income, i.e. used in the function for which it was intended that it would contribute to earning income.

XXXXXXXXXX 970583

N. Mondou, M.Fisc.

Attention: XXXXXXXXXX

March 17, 1998

Dear Sirs:

Re: Class 43.1 additions

This is in reply to your letter dated February 28, 1997, in which you requested our views with respect to additions to the Class 43.1 of Schedule II of the Income Tax Regulations (the "Regulations"). We apologize for the delay in replying to your letter.

The circumstances you described in your letter are as follows. In 1994, a taxpayer began construction of a co-generation facility. The taxpayer also entered into certain contracts to sell electricity and steam produced by the facility and to purchase natural gas for use at the facility.

Physical construction of the facility was completed in all material respects by September 1996. The testing and commissioning of the facility was however not completed until January 29, 1997, at which time the taxpayer took possession.

Prior to the completion of the testing and commissioning of the facility, the taxpayer vendor began discussions and negotiations with an arm's length third party to sell the facility and contracts. The closing of the sale was scheduled to occur some months later. Until that time, the taxpayer operated the facility for its own account.

In light of the short period of time between the date the facility was commissioned and the date of closing mentioned above, you wish to know if we will consider the facility to be "used" for the purpose of the changes introduced by the 1997 Federal Budget tothe description of Class 43.1. You submit that the facility should not be considered to be "used" since its useful life , which is expected to be 40 years, will not be materially different at the date of the transfer from what it was before the commissioning.

If on the other hand, the facility is considered to be "used", you further submit that the facility equipment should not be considered to have been "first placed in service" until the purchaser has acquired the equipment.

Our comments

The situation outlined in your letter involves an actual fact situation. To the extent that it relates to a past transaction you should contact the appropriate tax services office, since the review of such transactions falls within their responsibility. If it relates to a proposed transaction, assurance as to the tax consequences of actual proposed transactions will only be given in the context of an advance income tax ruling. The procedures for requesting an advance income tax ruling are outlined in Information Circular 70-6R3 dated December 30, 1996, issued by Revenue Canada. However, we offer the following general comments.

The description of the assets to be included in Class 43.1 originally allowed used equipment. In a News Release issued jointly by the Department of Finance and Natural Resources Canada on June 27, 1996, amendments to the description were announced. From that date, used or reconditioned equipment would no longer be eligible for inclusion in this class. The News Release indicated that the proposed amendments were to ensure that the incentive provided by the tax system would be targeted towards current energy efficient technology.

The 1997 Federal Budget proposed to relax some of the June 27, 1996 restrictions relating to the eligibility of used equipment. Proposed amendments to the Regulations released on September 16, 1997, (the "Draft Regulations") provide that to qualify as a Class 43.1 asset, 1) the asset must not have been used for any purpose before it was acquired by the taxpayer, or 2) if so used, the asset must meet the following three conditions:

a) it was depreciable property described in Class 34 or 43.1 of the vendor,

b) it was acquired by the taxpayer (the "purchaser") not more than five years after it became available for use for the purpose of subsection 13(26) of the Income Tax Act (the "Act") by the vendor, and

c) it remains at the same site in Canada as that at which the vendor used it.

Where the purchaser acquires the Class 43.1 asset under the conditions described in 2) of the preceding paragraph, subsection 1102 (21) of the Draft Regulations provides that the amount to be included in the Class with respect to used assets will not exceed the capital cost of the property to the vendor. Essentially, this subsection places the purchaser of the used asset in the same situation as if the purchase had occurred at the time the vendor acquired the asset. Any excess of the capital cost of the property to the purchaser over the amount that can be included in Class 43.1 would have to be included in another class.

To avoid the restrictions provided in subsection 1102(21) of the Draft Regulations, the asset must not have been "used for any purpose" before it was acquired. To be considered not to have been used, the property must be new when the taxpayer acquires it. As stated in Interpretation Bulletin IT-151R4 which concerns capital expenditures qualifying for the scientific research and experimental development incentives, the Department will consider that new equipment that is demonstrated for or tested by a prospective purchaser of that particular piece of equipment will not normally be considered to have been used for a purpose. Our Technical Interpretation dated March 9, 1992, to which you referred in your letter is consistent with this view.

Therefore, the testing and commissioning of the facility prior to January 29, 1997 would not affect the status of the equipment as new equipment on that date. However, as soon as the taxpayer started operating the facility for its own account, the equipment was, in our view, used by the taxpayer.

The word "used" is not defined in the Act. We must therefore refer to the general meaning of this word. The Oxford English Dictionary, Second Edition defines the words "used" and "use" as meaning respectively "that is or has been made use of; utilized", "the act of employing a thing for any (esp. a profitable) purpose, the fact, state or condition of being so employed; utilization or employment for or with some aim or purpose, application or conversion to some (esp. good or useful) end".

The taxpayer necessarily utilized the equipment while operating the facility for its own account.

You referred to a Technical Interpretation dated May 31, 1994, concerning whether renovated equipment would qualify as new equipment. In the particular case of the facility, there is no indication that the equipment will have undergone renovations.

Moreover, reconditioned and remanufactured equipment is expressly excluded from Class 43.1, and this is so whether or not the reconditioning makes the equipment energy efficient by current standards. We believe that this express exclusion supports the view that only brand new equipment qualifies, except in the very narrow circumstances allowed for used equipment.

With respect to the starting point of the five year period, the Draft Regulations which were published after your letter was sent to us, expressly refer to the time the equipment "became available for use (by the vendor) for the purpose of subsection 13(26)" of the Act. Therefore, this five year period will start at the earliest of the various times listed in paragraph 13(27) of the Act, the latest of which is the time the property is first used for the purpose of earning income, i.e. used in the function for which it was intended that it would contribute to earning income.

In the circumstances described above, the taxpayer operated the facility and the assets were used at one point for the purpose of earning income. Consequently, the five year period would begin, at the latest, on the day the taxpayer started using the equipment to earn income.

We trust that these comments are of assistance.

Yours truly,

P. Spice
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

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