7 June 1991 Income Tax Severed Letter - Available-for-Use Rules

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.

Dear Sirs:

Re: Draft legislation paragraphs 13(27)(a)&(d) of the Income Tax Act (the "Act")

This is in reply to your letter dated December 21, 1990 wherein you requested our interpretation of the proposed "available for use" rules found in the draft legislation dated July 1990 and released on the 13th of that month. Since you have written the above mentioned letter, the Department of Finance tabled Bill C-18 on May 30, 1991, to include subsection 13(27) to the Act and our response shall pertain to this draft legislation.

You requested that we base our comments under the following hypothetical scenarios:

• 1. A production line contains three pieces of equipment. The line results in the production of a product. All three pieces are in the possession of the taxpayer. One piece is ready to operate while the other two are not. Is the piece which is ready to operate considered to be available for use?
• 2. A production process includes two groups of equipment. The first group produces an intermediate product which feeds the second group of equipment. The second group produces a final product. The intermediate product is not normally purchased from the outside market. The first group of equipment is not capable of producing its product at year-end. The second group, if it had feedstock would be able to produce the product. Is the equipment in the second group considered available for use?
• 3. A piece of equipment is in the test stage. It is capable of producing a product that could be sold on the market. However, the intent is to have it produce a product that is machined to a much closer tolerance. Is this piece of equipment considered available for use?
• 4. A piece of equipment has been tested to the correct tolerance level. At year-end it is being tested for quality control and its ability to operate at full production levels. Is this equipment considered to be available for use?
• 5. A company acquires a computer and various packaged software. While some of the minor software can be used as is, modifications will be required to the main software package before the computer can be used for its planned applications.

Under the first four scenarios described above, it is your view that the equipment is considered capable of producing a commercially saleable product within the meaning of proposed paragraph 13(27)(d) of the Act. Under the fifth scenario you asked if the computer or the software are considered to be available for use?

• 6. Your last opinion request was regarding the application of proposed paragraph 13(27)(a) of the Act. You presented us with the following opinion and example.

Where equipment being tested does not meet the requirements of proposed paragraph 13(27)(d) of the Act, it may still be considered to be available for use since the overall test found in proposed subsection 13(27) of the Act refers to the time that is the earlier of proposed paragraphs 13(27)(a) through (k) of the Act. Proposed paragraph 13(27)(a) of the Act refers to the time that equipment is "... first used for the purpose of earning income ...". It may be argued that "used" could apply to the testing stage. You suggested the purpose of the testing activity is to earn income and that added substance is given to this argument when one considers that the phrase "used to earn income" is also utilized in paragraph 20(1)(c) of the Act relating to the deductibility of interest.

You requested that we consider the following hypothetical situation:

A company borrows money and buys a piece of equipment. It deducts the interest it pays on the loan under subparagraph 20(1)(c) of the Act because it is considered that the borrowed money which it used to purchase the equipment was used to earn income. The equipment was under preliminary testing and was not considered to be available for use pursuant to proposed paragraph 13(27)(d) of the Act.

You argued that since the money is considered to be used to earn income, it would seem that this could only be the case because the property financed, i.e. the equipment, was capable of passing the same test. Accordingly it follows that equipment being tested would meet the purpose test "used for the purpose of earning income". You requested our interpretation of proposed paragraph 13(27)(a) of the Act as it applies to the above set of facts and our comments on the parallelism of the words used in that proposed paragraph and paragraph 20(1)(c) of the Act.

Our Comments

While we are only capable of providing confirmation of the tax effects of proposed situations in the form of advance income tax rulings, we nevertheless are prepared to provide the following general comments for your assistance.

Provided the Act is amended by adding thereto subsection 13(27) substantially as set forth in subsection 9(11) of Bill C-18, An Act to Amend the Income Tax Act ... and certain related Acts, respecting the "available for use" rules tabled by the Minister of Finance, on May 30, 1991, our opinion as to the application of that proposed subsection is stated below.

In order that you better understand our opinion, it is important that we define for the purpose of proposed paragraph 13(27)(d) of the Act what is understood by the use of the words "commercially saleable" therein. The word `commercially' is defined in the 3rd volume of The Oxford English Dictionary, second edition as meaning, "In a commercial manner; from a commercial point of view; as matter of trade." This, in our opinion connotes profit, financial gain or financial return. Therefore, a piece of equipment which is capable of producing a commercially saleable product is in our opinion, equipment which has the capability of performing its task at such a rate and of such quality, that a profit could reasonably be expected to ensue. This would equally be true where the piece of equipment possesses the above described capability but at that particular point in time cannot perform the function for which it is intended. Both the determination of whether a piece of equipment is capable of producing and whether the product it is capable of producing is commercially saleable, are findings of fact which require a thorough understanding of the specific situation being considered. In a situation where the particular piece of equipment is to provide a service, it must be capable of providing either a commercially saleable service or an intermediate service that is used or consumed in providing a commercially saleable service or product.

With regards to equipment in the testing stage, it is our opinion that the testing activity would not qualify equipment under proposed paragraph 13(27)(a) of the Act, to be considered available for use. The words utilized in that particular paragraph "... first used ... for the purpose of earning income," in our opinion means that the equipment must first be used in the function for which it was intended that would contribute to earning income and not merely used for the purpose of bringing the piece of equipment on line. In our view, a more direct relationship must exist between the use and the process of earning income.

The Department does not share your analogy with the use of the words "for the purpose of earning income" found in proposed paragraph 13(27)(a) of the Act. Subparagraph 20(1)(c) of the Act would be the provision of the Act permitting a deduction of the interest expense you described in your example. Under that particular provision, the Act contemplates "property acquired for the purpose of gaining or producing income" which the Department considers to be very different from the words used in proposed paragraph 13(27)(a) of the Act, "first used for the purpose of earning income." In the former case, the only requirement is the acquisition of the property, whereas in the latter case, the requirement imposed by the Act is the actual use of the property in the earning process.

The above comments represent our opinion of the law as it applies generally. As indicated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990, an opinion is not an advance ruling and accordingly, is not binding on Revenue Canada, Taxation.

We trust that our comments will be of assistance.