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 dollar amount specified on certificate issued by NRCan in respect of Class 34 property determinative of property qualifying for inclusion in Class 34.
Position: No.
Reasons: The final determination of whether property is included in the proper Class for CCA purposes is the responsibility of Revenue.
971190
XXXXXXXXXX A. Seidel
(613) 957-8974
Attention: XXXXXXXXXX
October 15, 1998
Dear Sirs:
Re: XXXXXXXXXX
This is in reply to your letter dated April 29, 1997 and our subsequent telephone conversations concerning the issue of whether certain costs related to the construction of a hydro electric project for the XXXXXXXXXX (the “Partnership”) would be on account of capital and whether they would be included in Class 34 of Schedule II of the Income Tax Regulations (the “Regulations”).
Notwithstanding the fact that certain of the outlays enumerated in (a) through (j) below could be considered to be on account of capital, paragraph (k) of Class 34 of Schedule II of the Regulations would preclude property that would otherwise qualify as Class 34 property pursuant to clause (j)(i)(B) from inclusion in Class 34 where the property is “property in respect of which a certificate has not been issued under paragraph (d) or (g) before the time that is the later of the end of 1995 and 2 years after the property is acquired by the taxpayer.” Pursuant to paragraphs (d) and (g) of Class 34, the certificate for projects that qualify for inclusion in Class 34 is issued by the Minister of Energy, Mines and Resources, now Natural Resources Canada. In this case, a certificate was issued for the Project with a dollar amount specified therein. Certain outlays, which in your opinion are part of the cost of the Project, were not included in the amount on the certificate.
Although paragraphs (d) and (g) of Class 34 of Schedule II of the Regulations require certification of a project by Natural Resources Canada, the certificate issued by Natural Resources Canada, in and by itself, does not preclude particular amounts from being included in the undepreciated capital cost for the Class 34 project that was certified, provided of course, that the amounts so qualify.
As discussed in our various telephone conversations (Seidel/XXXXXXXXXX), the determination of whether an outlay is an expense or on account of capital is a question of fact. While no single definition or test exists to make such a determination, a number of criterion, which are set out in paragraph 4 of Interpretation Bulletin IT-128R, have been established by the Courts.
The following comments deal with the tax treatment of the outlays described in your letter and may be of assistance in determining whether these outlays could be included in Class 34.
The criteria set out in paragraph 4 of Interpretation Bulletin IT-128R, are as follows:
(1) Enduring Benefit --- when an expenditure is made “with a view to bringing into existence an asset or advantage for the enduring benefit of a trade,” that expenditure normally is 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.
(2) Maintenance or Betterment --- where an expenditure made in respect of a property serves only to restore it to its original condition, that fact is one indication that the expenditure is of a current nature. Where, however, the result of the expenditure is to materially improve the property beyond its original condition, such as when a new floor or a new roof clearly is of better quality and greater durability than the replaced one, then the expenditure is regarded as capital in nature. Whether or not the market value of the property is increased as a result of the expenditure is not a major factor in reaching a decision.
(3) Integral Part or Separate Asset --- another point that may have to be considered is whether the expenditure is to repair a part of a property or whether it is to acquire a property that is itself a separate asset. In the former case, the expenditure is likely to be a current expense and in the latter case, it is likely to be a capital outlay. For example, the cost of replacing the rudder or propeller of a ship is regarded as a current expense because it is an integral part of the ship and there is no betterment; but the cost of replacing a lathe in a factory is regarded as a capital expenditure because the lathe is not an integral part of the factory but is a separate marketable asset. Between such clear-cut cases, there are others where a replaced item may be an essential part of a whole property yet not an integral part of it.
(4) Relative value --- the amount of the expenditure in relation to the value of the whole property or in relation to previous average maintenance and repair costs often may have to be weighed. This is particularly so when the replacement itself could be regarded as a separate marketable asset. On the other hand, the relationship of the amount of the expenditure to the value of the whole property is not, in itself, necessarily decisive in other circumstances, particularly where a major repair job is done which is an accumulation of lesser jobs that would have been classified as current expense if each had been done at the time the need for it first arose; the fact that they were not done earlier does not change the nature of the work when it is done, regardless of its total cost.
You have described the following outlays in your letter:
(a) Head Office Costs
The head office costs allocated to the XXXXXXXXXX dam total $XXXXXXXXXX. From this amount, $XXXXXXXXXX was deducted in prior years as site investigation expenses under paragraph 20(1)(dd) of the Income Tax Act (the “Act”). The remaining portion of $XXXXXXXXXX represent the allocation of the expenses incurred in connection with the supervision and construction of the dam.
(b) Mobilization and Demobilization
The general contractor doing the civil work at the XXXXXXXXXX site incurred mobilization and demobilization expenses that were included in the civil work contract. These costs include the setting up of the camp and the costs incurred for bringing the machinery to build the dam on the site. These costs were paid for by XXXXXXXXXX when they acquired the dam.
(c) Environmental Studies
The environmental studies were requested by the “ XXXXXXXXXX ” The cost of these studies was incurred in light of the erection of the dam.
(d) Deforestation
The total cost of clearing is $XXXXXXXXXX . The general contractor doing the civil work at the site incurred clearing costs that were included in the civil work contract. In the present situation, all the clearing is related to depreciable assets. The cost of clearing can be split between two components. It is estimated that half of these costs were incurred for constructing access roads and parking area. As such, these costs should be included in class 17 assets along with the cost of the road and parking area. The other half of the deforestation costs are related to the construction of the dam structure. These costs should then be included in the cost of the dam in class 34.
(e) Expertise Fees re: Turbine Shaft
The dam started operations in XXXXXXXXXX. In XXXXXXXXXX, the shaft of the turbine broke. XXXXXXXXXX incurred expertise fees to examine the source of the problem. These fees are not of a current nature but are related to the installation and usage of the turbine. The fees cannot be classified as a repair and maintenance which are more of a recurring type of expense. The expertise was not related to normal wear-out of the turbine.
(f) Running Water Installation
The running water installation was a separate contract from the main dam construction contract. The running water is for the washroom and faucets which are part of the dam installation. The installation is an integral part of the structure of the dam. It is not a separate asset that can be removed or sold by itself. It is not included in either class 10 or 17. The cost of the installation is then included in the structure of the dam and included in Class 34.
(g) Supervision During Construction
The cost of the accommodation of the resident engineer was incurred to permit the supervision of the construction of the dam. It is an expense incurred for and during the construction.
(h) Bonding
The bonding is to cover any stub period between the completion and sale of the dam by the contractor and the acquisition by XXXXXXXXXX. Theses costs were incurred before the dam started producing electricity and should be included in the cost of the dam.
(i) Engineering Reports During Construction
These fees were paid to an escrow agent who was safe-keeping the cash during the construction of the dam. The amounts were released to the contractor based on the engineering reports regarding the advancement of the construction.
(j) Capitalization of Interest and Financing Fees
During the construction of the dam, XXXXXXXXXX incurred interest and financing fees. These expenses were deductible under paragraphs 20(1)(c), (d), (e) or (e. 1) of the Act. The elections to capitalize these expenses pursuant to subsections 21(1) and (3) of the Act were filed with the tax returns. The effect of the elections is to add these amounts to the capital cost of the depreciable property acquired. The amounts added will then increase the amount of the Class 34 depreciable assets even though it will not be included in the Certificate issued by Natural Resources Canada.
During our telephone conversation (XXXXXXXXXX/Seidel) you indicated that the construction of the Project was a “turn-key contract” whereby the Partnership acquired legal title to the Project after construction was completed. You also indicated that the mobilization and demobilization costs described in (b) above, the deforestation costs described in (d) above and the running water installation described in paragraph (f) above were all incurred prior to the Partnership acquiring the assets of the Project.
As outlined in paragraph 5 of Interpretation Bulletin IT-475 (“IT-475”), it is the Department’s general view that any outlays “which are directly linked to the creation or acquisition of a capital asset form part of the capital cost of that asset.” We would generally consider the outlays described in (b), mobilization and demobilization, (d), deforestation, and (f), the running water installation, to be outlays on account of capital since they would be outlays made “with a view to bringing into existence an asset ... for the enduring benefit of a trade.”
Paragraph 8 of Interpretation Bulletin IT-285R discusses the meaning of the expression “capital cost of property” and states that it “generally means the full cost to the taxpayer of acquiring the property.” Generally, the costs incurred by the Partnership such as the head office costs allocated to the Project as described in (a) above, the cost of the resident engineer as described in (g) above, the bonding payment described in paragraph (h) above and the fees paid to the escrow agent during the construction of the dam as described in (i) above that are related to the construction of the Project and were incurred “with a view to bringing into existence an asset ... for the enduring benefit of a trade,” would be on account of capital.
The costs described in (c) above related to environmental studies are usually incurred prior to making the decision of whether or not to proceed with a project and may therefore not be considered to be a part of the capital cost of acquiring an asset. However, as discussed in paragraphs 4, 5 and 6 of IT-475, some of the costs related to these environmental studies may otherwise be deductible in computing the income of the Partnership.
Outlays such as the expertise fees and costs of replacing the turbine shaft described in (e) above would generally be considered to be on account of capital where they result in “materially improving the property beyond its original condition.” Therefore, provided that the replacement turbine shaft was “of better quality and greater durability than the replaced one” it would be an outlay on account of capital.
As stated in paragraph 1 of Interpretation Bulletin IT-121R3 (“IT-121R3”), subsections 21(1) and (3) of the Act allow a taxpayer to elect to capitalize the cost of money borrowed for the purpose of acquiring depreciable property. These provisions also provide that these capitalized costs “shall be added to the capital cost to the taxpayer of the depreciable property.” As discussed in paragraph 6 of IT-123R3, “cost of borrowed money” includes interest and annual financing fees as referred to in paragraph 20(1)(e.1) of the Act. Provided that valid elections have been filed, the capitalized interest and financing fees described in (j) above could form part of the capital cost of the depreciable property acquired.
These comments are provided in accordance with the guidelines set out in paragraph 22 of Information Circular IC 70-6R3 and are therefore not binding on Revenue Canada.
Yours truly,
for Director
Resources, Partnerships and Trusts Division
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
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