21 November 1997 External T.I. 9719225 - "YEAR 2000" EXPENDITURES.

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 costs to upgrade or modify software to make it "year 2000" compatible would be considered current or capital expenditures that would be deductible through the capital cost allowance system.

Position:

Question of fact.

Reasons:

Depends upon nature of expenditurs.

J. Gibbons
XXXXXXXXXX 5-971922

Attention: XXXXXXXXXX

November 21, 1997

Dear XXXXXXXXXX:

We are replying to your letter of July 10, 1997, concerning the income tax treatment of costs to upgrade or modify software to make it “Year 2000” compatible. More specifically, you inquire whether these costs would be considered to be current expenditures or capital expenditures that would be deductible through the capital cost allowance system. If our position is that they are capital expenditures, you request our view regarding their classification as class 10 or class 12 assets or some other class.

Written confirmation of the tax implications inherent in particular transactions are given by this Directorate only where the transactions are proposed and are the subject matter of an advance ruling request submitted in the manner set out in Information Circular 70-6R3. The following comments are, therefore, of a general nature only.

As indicated in your letter, the Emerging Issues Committee (EIC) of the Canadian Institute of Chartered Accountants (CICA) has provided guidance concerning the accounting treatment for internal and external costs incurred in modifying internal use computer software to correct the millennium bug. In its abstract EIC-80, dated April 10, 1997, the EIC determined that:

It is a matter of professional judgement, based on all the facts, whether specific internal use software modification costs, including costs for year 2000 compliance, enhance the service potential of the software and should be accounted for as a betterment, or whether the costs merely maintain the service potential of the software and should be expensed. For example, if the software modifications merely ensure the continued effectiveness of the affected software for its originally assessed useful life, the costs would be expensed. If, however, year 2000 software compliance is effected by rewriting software applications that enhance their service potential by extending the life of the software beyond its originally assessed useful life, the costs would be accounted for as a betterment.

Similarly, for tax purposes, the determination of whether a particular expenditure should be expensed or treated as a capital expenditure is a question of fact that is to be determined based on an appreciation of all of the surrounding circumstances. The Department’s position on the tax treatment of expenditures that are of a capital nature versus those that are of a current nature is generally covered in Interpretation Bulletin IT-128R. To determine whether expenditures incurred to eliminate the millennium bug are of a capital or current nature, consideration should be given to whether the expenditure was made with a view to bringing into existence an asset or advantage of enduring benefit.

For instance, if a particular software program is only restored to its original condition so that it performs the same applications but the problems of the millennium bug have been eliminated, the expenditures incurred to eliminate the bug would normally be considered to be of a current nature. However, any expenditure that would improve or enhance the software would usually be looked upon as being on account of capital.

In this respect, the pronouncement of the Emerging Issues Committee appears to be consistent with our position.

As for expenditures for the acquisition of new software, or other assets acquired to ensure the adaptation of existing software for the arrival of the year 2000, the amount of these expenditures should be added to the appropriate prescribed class which would be eligible for capital cost allowance (CCA) at prescribed rates. In the case of computer software other than system software, the amount of the expenditure would likely be added to class 12(o). As for the class or classes in which the expenditures to acquire other types of depreciable property are included, it would depend on the type of property that is acquired.

You also mention in your letter that there is precedence, in the form of Revenue Canada’s 1977 policy with respect to the costs of metric conversion, for treating year 2000 costs as a current expenditure. However, unlike costs for metric conversion, the costs to adapt computer software for the arrival of the year 2000 do not result from an initiative of the federal government. The year 2000 costs were predictable and probably economically evaluated when designing these software programs. As a result, it would therefore be more difficult to justify an administrative position allowing these costs to be treated as a current expense.

We trust that these comments will be of assistance.

Yours truly,

C. Chouinard
for Director
Business and Publications Division
Income Tax Rulings and
Interpretations Directorate
Policy and Legislation Branch

.../cont'd

- 2 -

.../cont'd

- 3 -

- 3 -