15 October 1997 Internal T.I. 9712367 - INVESTMENT TAX CREDIT, QUALIFIED PROPERTY

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 property is qualified property and specified percentage under 127(9)

Position:

question of fact and law

Reasons:

intended use, not actual use, must be determined; question of fact whether taxpayer had requisite intent; full service charter is an intended use; must intend to use in Canada (primarily in prescribed area re specified percentage);

							October 15, 1997

	HALIFAX TAX SERVICES OFFICE		HEADQUARTERS
							Resource Industries Section
	Attention: Kevin McGuigan		Denise Dalphy
         	    Technical Advisor		(613) 957-9231
	         Audit Services   

							971236

Qualified property - Paragraph 127(9) of the Income Tax Act (the "Act")

This is in reply to your memorandum of May 8, 1997 wherein you requested our opinion on the availability of investment tax credits on capital additions to certain vessels.

FACTS

XXXXXXXXXX

ISSUES

You have enquired about the proper interpretation of portions of the definitions of the terms "qualified property" and "specified percentage" in subsection 127(9)(c) of the Act (as the Act provided in respect of taxation years commencing before 1996). The relevant portions are set out below:

Qualified property

"qualified property" of a taxpayer means property ...that is

...

"(c) to be used by the taxpayer in Canada primarily for the purpose of"

...

(ii) operating an oil or gas well, extracting petroleum or natural gas..."

...

(vii) exploring or drilling for petroleum or natural gas,"

Specified percentage

"specified percentage" means

(a) in respect of a qualified property

...

(v) acquired primarily for use in a prescribed offshore region..."

Position/RATIONALE

I.THE DEFINITION OF "QUALIFIED PROPERTY"

A.Interpreting "to be used by the taxpayer in Canada"

1. Intended use - not actual use

The Canadian case law provides that, in determining whether an expenditure is a "qualified property", it is the intended use of the property, not its actual use, that is relevant. In addition to the Capilano case cited by Ms Jain, we would refer you to the comments of Hugessen, J.A., of the Federal Court of Appeal in M.N.R. v. Donohue Normick Inc., 96 DTC 6061:

"Second, with respect for McNair, J.'s opinion (in Stearns Catalytic), I feel that the interpretation he proposed was too narrow. He seemed to base his interpretation exclusively on the word "used"/"utiliser" and to disregard the important qualifiers "to be", "qu'il compte" and "devant être". In my opinion, the wording of these provisions permits and even requires a much more flexible interpretation. Each of the expressions relates to property that is not necessarily used immediately after it is purchased. In my view, it is sufficient if there is a reasonable expectation that the property will be used in the future (emphasis added). I do not have to decide if Stearns was correct to exclude the use of the parts in issue before him as purely contingent, but I am firmly convinced that a future and reasonable foreseeable use is a use that Parliament intended to cover."

2. Determining intent

As stated above, the test in the definition of "qualified property" is one of intention, and is not a use test. Further, based on the comments of the Court in Donohue Normick, it would appear that this test is an objective test - a "reasonable man" test, and not a subjective test.

Whether a particular property was "to be used by a taxpayer in Canada" is a question of fact which can only be decided after reviewing all relevant facts. In order to determine whether a taxpayer had a reasonable expectation that he would use a property, one should look to both documentary evidence (which would include statements made by the taxpayer in seeking government funding or a Remission Order) as well as parole evidence.

In our view, the most important factor in determining whether a taxpayer truly intended to use a property as described in the definition of "qualified property", or whether the taxpayer was creating false and self-serving evidence for the purpose of avoiding or evading income tax will often be the credibility of the taxpayer. That is, it is important to try to determine whether the taxpayer's testimony will be believed by an objective person or a court of law. In this context, your knowledge of the taxpayer's history with the Department might be useful.

Although the use that the taxpayer actually made of the property would appear to be of little or no import in ascertaining the taxpayer's intention, based on the comments in Donohue Normick, we would probably be safe to assume that, where the property was actually used by the taxpayer in Canada primarily for one of the listed purposes, the taxpayer had the requisite intent to do so.

3. Intended use by taxpayer - Chartering

In order for a property to be a qualified property, the taxpayer must have intended that he himself would use the property in Canada.

Our interpretation of the law, which is described in ruling #932483 and is discussed in document #9324831, has not changed. In our view, a vessel that is chartered out by a taxpayer who supplies the vessel and its crew and generally pays operating expenses may be a "qualified property" for the purposes of the definition of that term in subsection 127(9) of the Act. (Of course, the taxpayer must have the requisite intent that the property be used primarily for one of the purposes listed in the subparagraphs in paragraph (c) of that definition.) In our view, carrying on a chartering business, where taxpayer operates the vessel and supplies the vessel as well as the crew (a "full service charter"), is a "use", as that term is used in the definitions of "qualified property" and "specified percentage".

We would caution you, however, that we would not adopt this position where a taxpayer merely leases property or provides "bare boat" charters; in those situations, we are of the view that the taxpayer would not be considered to "use" the property for the purposes of ITCs. This position is supported by the decision of the Federal Court - Trial Division in Labrador Offshore Shipping Company Ltd. v. The Queen (90 DTC 6096) where the court held that leasing a vessel was not a "use" by the taxpayer within the meaning of the definition of "specified percentage", which at that time was in paragraph 127(9)(a.1) of the Act. (It is important to note that this case does not, in our view, serve as a precedent for a position that a full-service charter is not a "use" for the purposes of paragraph (c) of the definition of "qualified property". In Labrador, the Court was limited by an unusual "Agreed Statement of Facts", where the Crown and the taxpayer stated that paragraph (d) of the definition of "qualified property" applied; that is, the parties do not appear to have considered the differences between bare boat and full service charters and they seem to have taken it as a given fact that the charter was a "lease". It is our opinion that, for the purposes of the definitions of "qualified property" and "specified percentage", unlike a bare boat charter, a full service charter is not a "lease" by the taxpayer who is chartering the vessel, but is a "use" by that taxpayer (even if the taxpayer contracts with an agent to manage the vessel).

4.Intended use in Canada

In Capilano, the Tax Court of Canada considered the interpretation of the words "to be used ... in Canada primarily for the purpose of..." in paragraph (c) of the definition of "qualified property" in subsection 127(9) of the Act. In that decision, Mogan, T.C.C.J., concluded that the word "primarily" does not modify "in Canada". He stated:

"In my opinion, however, the word "primarily" in paragraph 127(9)(c) modifies only the purpose for which the equipment was to be used;"

In our view, the same interpretation would be required in this case since, in the definition of "qualified property", the words "in Canada" are not modified.

The legislation merely requires the taxpayer to have an intent to use the property "in Canada". Therefore the fact that a property was intended to be used outside Canada (even if it was intended to be used primarily outside Canada) would not preclude the property from being a "qualified property", provided that the taxpayer also intended to use that property in Canada. (However, the "intended location of use" test in the definition of "specified percentage" is more stringent.)

B. Interpreting "to be used...primarily for the purpose of...operating an oil or gas well... (or)... exploring or drilling for petroleum or natural gas"

In Lor-Wes, the Court interpreted similar wording and noted that the words "primarily for the purpose of logging" are not followed by the words "by him". The Court held that the words "by him" only modified the "use" of the property and not the purpose, since the description of the purpose is not followed by the words "by him". Similarly, in this case, the phrase "by the taxpayer in Canada" modifies the verb "used"; the words "primarily for the purpose of...operating an oil or gas well... (or)... exploring or drilling for petroleum or natural gas"" in paragraph (c) of the definition of "qualified property" are not followed by the words "by him" (or otherwise restricted) and the purpose must be interpreted broadly, as in Lor-Wes.

II.THE DEFINITION "SPECIFIED PERCENTAGE"

Interpreting "acquired primarily for use in a prescribed offshore area"

Like the definition of "qualified property", the definition of "specified percentage" requires an intent to use the property in a particular location, not that it actually be used in that area. However, unlike the definition of "qualified property", this definition also requires the taxpayer to have intended to use the property "primarily" (emphasis added) in a certain location, in this case, in a prescribed offshore area. In our view, the fact that the evidence may reveal a secondary intended use of a property would not necessarily mean that the other intended use of the property was its primary intended use.

Please contact the writer if we may be of further assistance.

John Chan
Manager
Resource Industries Section
Resources, Partnerships and
Trusts Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch