14 March 2011 External T.I. 2010-0386121E5 - Deductibility of soft cost

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.

Principal Issues: Is subsection 18(3.1) applicable to soft costs incurred on vacant land?

Position: Question of fact.

Reasons: If the costs relate to the construction period, then subsection 18(3.1) will be applicable. If they are pre-construction costs, then subsection 18(3.1) is not applicable, however, subsection 18(2) may be applicable. In which period an expense is considered to have been incurred, is a question of fact.

XXXXXXXXXX
									2010-038612
									V. Srikanth

March 14, 2011

Dear XXXXXXXXXX :

Re: Subsection 18(3.1)

This is in response to your correspondence dated November 5, 2010 wherein you requested our views on the applicability of subsection 18(3.1) of the Income Tax Act (the "Act"). Specifically, you would like to know if subsection 18(3.1) is applicable to costs incurred in a situation where a land developer, after the acquisition of land, finds that the land cannot be developed any further or is considered worthless.

Our Comments

Written confirmation of the tax implications inherent in actual proposed transactions is given by this Directorate only where the transactions are the subject of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5, entitled 'Advance Income Tax Rulings'. This Information Circular and other Canada Revenue Agency ("CRA") publications can be accessed on our website at http://www.cra-arc.gc.ca. If, however, the particular transactions are completed or partially completed, the enquiry should be addressed to the relevant Tax Services Office. Your request was not submitted in the format required for an advance income tax ruling request, however, as stated in paragraph 22 of IC 70-6R5, we do provide written opinions on general enquiries which are not binding and we are prepared to provide you with the following comments.

Subsection 18(3.1) of the Act denies the deduction, on a current basis, of certain outlays and expenses incurred in the construction, renovation or alteration of a building or in respect of the ownership of the related land. These outlays and expenses are commonly referred to as "construction period soft costs" and include, among other items, interest, legal and accounting fees, and property taxes. These soft costs are required to be added to the cost or capital cost, as the case may be, of the building to which they relate. Subsection 18(3.1) of the Act applies only to those soft costs that are attributable to the period of construction, renovation or alteration and not to the pre-construction period.

As stated at the 2009 conference of the Association de planification fiscale et financière (APFF), "...an expense is attributable to the period of construction of a building when the expense so incurred relates to the period of construction irrespective of the fact that such was incurred during the pre-construction period, or during or after the construction of the building. This expense will be related to the construction of the building if it is incurred for construction purposes." Whether a specific expense falls within the purview of subsection 18(3.1) is a question of fact.

While subsection 18(3.3) of the Act provides for the determination of the date on which the construction, renovation or alteration is completed, the Act does not define when construction is considered to commence for purposes of subsection 18(3.1). In our view, this is a question of fact that can only be determined on a case-by-case basis. Paragraph 8 of Interpretation Bulletin IT-153R3, entitled 'Land Developers - Subdivision and Development Costs and Carrying Charges on Land', states that "site development is considered to begin with the installation of services" and further states "where serviced lots are acquired site development is considered to begin at the earlier of the date the taxpayer starts to install further services to the lots or the date he starts to pour footings".

Subsection 18(2) of the Act, as reproduced below, denies the deduction of interest and property taxes incurred in connection with the holding of vacant land unless the land is held primarily for the purpose of gaining or producing income from the land for the year or is to be used in the course of a business of the taxpayer in the year, other than the business of resale or development of such land.

"Notwithstanding paragraph 20(1)(c), in computing the taxpayer's income for a particular taxation year from a business or property, no amount shall be deductible in respect of any expense incurred by the taxpayer in the year as, on account or in lieu of payment of, or in satisfaction of,

(a) interest on debt relating to the acquisition of land, or

(b) property taxes (not including income or profits taxes or taxes computed by reference to the transfer of property) paid or payable by the taxpayer in respect of land to a province or to a Canadian municipality,

unless, having regard to all the circumstances (including the cost to the taxpayer of the land in relation to the taxpayer's gross revenue, if any, from the land for the particular year or any preceding taxation year), the land can reasonably be considered to have been, in the year,

(c) used in the course of a business carried on in the particular year by the taxpayer, other than a business in the ordinary course of which land is held primarily for the purpose of resale or development, or

(d) held primarily for the purpose of gaining or producing income of the taxpayer from the land for the particular year,

except to the extent of the total of

(e) the amount, if any, by which the taxpayer's gross revenue, if any, from the land for the particular year exceeds the total of all amounts deducted in computing the taxpayer's income from the land for the year, and

(f) in the case of a corporation whose principal business is the leasing, rental or sale, or the development for lease, rental or sale, or any combination thereof, of real property owned by it, to or for a person with whom the corporation is dealing at arm's length, the corporation's base level deduction for the particular year."

Whether the above-stated exceptions under paragraphs 18(2)(c) and (d) apply to vacant land, is a question of fact. Where it is determined that the exceptions apply to the land in question, restrictions pursuant to paragraphs 18(2)(a) and (b) will not be applicable to pre-construction expenses to deny a deduction as a current expense. Where the exceptions do not apply, such that subsection 18(2) of the Act applies to deny a deduction to a taxpayer in respect of interest and/or property taxes paid by a taxpayer in a taxation year in excess of the amounts referred to in paragraphs 18(2)(e) and (f) above, if the land represents inventory of a business, by virtue of subsection 10(1.1) of the Act, the taxpayer is entitled to add such denied amounts to the cost of the land for the purposes of subsections 10(1) and 10(1.01) of the Act.

Further, section 10 of the Act sets out rules for the valuation of inventory for the purpose of computing a taxpayer's income or loss from a business. Pursuant to subsection 10(1) of the Act, "[f]or the purpose of computing a taxpayer's income for a taxation year from a business that is not an adventure or concern in the nature of trade, property described in an inventory shall be valued at the end of the year at the cost at which the taxpayer acquired the property or its fair market value at the end of the year, whichever is lower, or in a prescribed manner." However, pursuant to subsection 10(1.01) of the Act, "[f]or the purpose of computing a taxpayer's income from a business that is an adventure or concern in the nature of trade, property described in an inventory shall be valued at the cost at which the taxpayer acquired the property."

On the other hand, if the land is capital property of the taxpayer, paragraph 53(1)(h) of the Act provides for an addition to a taxpayer's adjusted cost base of the land for the amount of interest on borrowed money and property taxes for which a deduction is denied under subsection 18(2).

Again, the facts of a particular situation will determine which of the above-noted provisions will apply.

We trust our comments will be of assistance to you.

Yours truly,

R.A. Albert, CA
For Director
Financial Industries Division
Income Tax Rulings Directorate
Policy and Legislation Branch