(1)-(16)

An elaborate CRA example illustrates how lush tax credits and CCA can result in recapture of depreciation, even where there is no disposition.

A non-CCPC Canadian corporation acquires solar equipment for $10,000,000 in 2024 for immediate use in generating electricity as an input in its manufacturing operation in Nova Scotia. In its 2024 federal and provincial returns:

• It accesses the accelerated investment incentive property (“AIIP”) rules (based on satisfying Reg. 1104(4)) to claim CCA of $7,500,000 (i.e., the actual capital cost grossed-up to $15,000,000 and multiplied by the 50% Class 43.2 rate);
• It claims the Nova Scotia Capital Investment Tax Credit (“NS CITC”) of 25% of the $10,000,000 capital cost, or $2,500,000 and receives it by way of credit or refund;
• It claims and receives the Clean Technology Investment Tax Credit (“Clean Tech ITC”) pursuant to s. 127.45, which is calculated as 30% of the capital cost, as reduced by the NS CITC, viewed as government assistance that it can “reasonably be expected to receive” (on December 31, 2024, receipt of the NS CITC is contingent on it receiving, by its filing-due date, an entitlement certificate);
• It claims an Atlantic Investment Tax Credit (“AITC”) pursuant to s. 127(9) of $750,000, being 10% of the capital cost, again reduced to $7,500,000 by the NS CITC “government assistance” – and receives the AITC by way of credit against federal tax payable in the current year or during the carryforward or carryback period.

In 2025, the capital cost of the property will have been reduced (pursuant to s. 13(7.1)(e)) by the two federal tax credits claimed and (pursuant to s. 13(7)(f)) by the NS CITC “assistance” claimed, i.e., to $4,500.000. Pursuant to s. 13(1), if the CCA previously claimed ($7,500,000) exceeds the capital cost ($4,500,000), the difference is recognized as recapture of depreciation (of $3,000,000).

A taxpayer added the cost of property acquired to a particular Schedule II class, and then claimed CCA on the property for numerous years including ones which now are statute-barred. CRA has now determined that such property was not depreciable property.

IT-478R2, para. 14 states:

If the revision to the property's capital cost causes the UCC decreases to exceed the UCC increases as of the end of a year now statute-barred, the recapture of that excess amount under subsection 13(1) will not be added into the taxpayer's income for that year or a subsequent year.

Is this correct? The Directorate responded:

…[T]he meaning of the word "allowed"…includes the amount of CCA claimed by the taxpayer and allowed as a deduction under paragraph 20(1)(a) for a taxation year that is statute-barred (even though such CCA deductions were unwarranted or otherwise made in error and can no longer be revised). …

If the total of all the decreases exceeds the total of all the increases to the UCC of a class as of the end of a taxation year, subsection 13(1) provides that this excess shall be included in computing the taxpayer's income for the year. The recapture of CCA that was included in the taxpayer's income then becomes a positive component in the calculation of the UCC of the particular class under element "B" in a subsequent taxation year. Unlike element "E", element "B" does not include any amount of recapture that should have been previously included in the taxpayer's income in a previous (including statute-barred) taxation year, but was not, in fact, included in income.

…[T]he CRA will not add an amount of recapture that otherwise should have been included in the taxpayer's income for a prior taxation year to a year that is beyond the normal reassessment period… . However,…where element "A" has been revised in the first non-statute-barred taxation year, such that there is an excess of UCC decreases over increases at the end of that year, an income inclusion under subsection 13(1) is necessary in order to resolve the negative UCC balance.

Accordingly…the CRA could (re)assess the particular taxpayer to include the appropriate amount of recapture in the taxpayer's income at the end of the first non-statute-barred taxation year in order to resolve the negative UCC balance. …[O]ur positions on the issues discussed in this letter will be updated…in new Income Tax Folio S3-F4-C1…due to replace IT-478R2 in the near future. …[V]iews expressed in this letter [which] represent a change in position…will apply on a prospective basis to property acquired or transactions entered into after December 31, 2015.

Before finding that there was no attribution of recapture of depreciation by virtue of the exception from the application of s. 74.1(1) contained in s. 74.5(3)(a), CRA stated, in its summary:

[T]he nature of recapture of depreciation is analogous to the nature of the depreciation expense that was claimed in the past. That expense was for a rental property, so the recapture will be income from the property.

A holding corporation earned deemed active business income under s. 129(6) from renting a building to an associated corporation for two years, and thereafter earned property income from renting the property to a non-associated corporation – and then disposed of the property, thereby realizing recapture of depreciation. Respecting a proposal that such recapture be prorated between active business income and property income based on the respective periods of time that the property generated the two types of income, the Directorate stated:

In the context of the situation under review, the position you propose, which is to treat a portion of the recaptured depreciation as income from an active business and another portion as property income, appears reasonable to us although there is no provision in the Act expressly supporting this conclusion.

CRA indicated that recapture of depreciation realized on the sale of a farm should be reported as farming income.

Realtyco, which carried on an active business of operating a rental residential real estate portfolio which was not a specified investment business by virtue of having six or more full-time employees, then disposed of its entire business part-way through a year and realized recapture of depreciation. Before going on to find that the recapture was active business income notwithstanding that the corporation did not have employees in the remainder of its taxation year following the disposition, CCRA stated:

[The CRA] administrative position allows, following the cessation of a business, income from the recapture of depreciation arising from the sale of assets used in the business to be treated as income from a business of the category to which the source was originally related. …

CCRA found that: on the disposition of a Class 10.1 passenger vehicle, the corporation's safe income on hand should be adjusted by reducing it by an amount equal to the excess of the acquisition cost of the vehicle in question over its deemed capital cost; and the amount determined under s. 13(2) did not affect the safe income on hand computation. It stated:

[S]ubsection 13(2) provides that the amount calculated, at the end of a taxation year, under subsection 13(1), as recapture of depreciation, in respect of a passenger vehicle the cost of which exceeds $20,000 or any other amount that may be fixed by regulation, is not included in computing income for the year. In addition, subsection 20(16.1) provides that subsection 20(16) (terminal loss in respect of depreciable property) does not apply to a passenger vehicle of a taxpayer the cost of which to the taxpayer exceeds $20,000 or such other amount as may be prescribed.

For the purposes of computing safe income on hand, we are of the view that an amount determined under subsection 13(2) in respect of a corporation, which is not required to be included in computing the corporation's income, has no impact on computing that corporation's safe income on hand.

Is it correct that, following the repeal of the eligible capital property rules effective January 1, 2017, no replacement property provisions will apply to a voluntary disposition of farm quota occurring after January 1, 2017, or to a disposition of farm quota that occurs prior to January 1, 2017 if the replacement property is not acquired before that date? CRA responded:

In the case of a voluntary disposition, subsections 13(4) and 44(1) will only apply if the former property was immediately before the disposition a former business property as defined in subsection 248(1) of the Act. One of the characteristics of a former business property is that the property is real or immovable property or an interest therein. As ECP, and consequently, property included in new Class 14.1, is generally intangible property, we agree that such property will generally not be former business property.

Regarding the situation where a corporation’s building and equipment were destroyed by fire and it used the insurance proceeds to invest in a partnership carrying on a similar business, CRA indicated that the s. 44(1)(a) rollover potentially could apply, but then indicated that s. 13(4) would not apply since “the Company wants to replace a depreciable property (building and equipment) with a non-depreciable capital property, i.e. its interest in the [partnership].”

In order to expand its operations, a manufacturer acquires vacant land, takes three years to build a new plant, moves its operations there and, eight months later, sells the former property. CRA indicated that there is no requirement that the replacement property be acquired after the former property is disposed of – so that the acquisition of the new property in advance of the disposition of the former property would not prevent it from being a replacement property for ss. 13(4.1) and 44(5) purposes.

Where a taxpayer in the business of operating rest homes sold the rest homes and bought a hotel, the operation of the hotel generally would not be considered to be a similar business.

A corporation that had operated a short-term car rental business will now lease the cars on a long-term basis to a partnership that will handle the short-term leasing to the customers. CCRA indicated that since, on a going-forward basis, the cars would cease to satisfy the condition in 16(e) that they are “not expected to be rented or leased to any person for more than 30 days in any 12 month period,” the cars would be required pursuant to s. 13(5) to be moved to another Class.

Where a taxpayer owns buildings that are used in an active business, subsequently leases one of those buildings and it has a cost greater than $50,000, will it be transferred to a separate class and, if eventually sold, will the proceeds be credited only to that class? CRA responded:

Where a particular building that has a cost in excess of $50,000 and that is used in a taxpayer's active business subsequently becomes a rental property, subsection 13(5)… will apply to the reclassification of the building from its former class in Schedule II…to a separate class, as prescribed by regulation 1101(1ac)…. (The taxation year in which a property becomes a “rental property” is a question of fact.) As such, any proceeds received on a subsequent disposition of that rental property will be credited to the separate class and recapture or a terminal loss will be calculated accordingly.

…[P]rovided a taxpayer uses a property for the purpose of gaining or producing income, both before and subsequent to any reclassification of that property, subsections 13(7) and 45(1)… would not apply at the time the property is reclassified.

On the facts in 15 August 1990 T.I. 900372, would Reg. 1102(14)(d) apply to Company B so that upon the commencement of the rental of the properties by Company B, the buildings would then be transferred into separate classes pursuant to Reg. 1101(1ac)? CRA responded:

[O]n the initial transfer, paragraph 1102(14)(d)… would apply to Company B, and immediately upon Company B commencing to rent the buildings, those buildings would be reclassified in separate prescribed classes in accordance with subsection 1101(1ac)… and subsection 13(5)… .

Corporation ABC use various buildings in the same business and which are part of the same CCA class. A building which no longer is needed in the business is rented pending its sale. Is the property a rental property? CRA stated:

[T]he building which is now used principally by Corportion ABC for the purpose of earning rents constitutes a “rental property”…and must be transferred to a separate class by virtue of sections 1101(1ac)or (1ae) of the Regulations (based on the capital cost of the building in question) and, in this regard, in accordance with the rules in subsection 13(5)… .

Company A uses several buildings in an operating business, then later incorporates a subsidiary, transfers its real estate to the subsidiary on a rollover basis and the subsidiary leases the properties back to Company A. In these circumstances, s. 13(5) would apply to reclassify the properties from one class 3 pool to separate classes upon their commencement for use as rental properties.

"Subsection 13(5.1) of the Act does not require that the leasehold interest must have been included in Class 13 of Schedule II of the Regulations at the time of the acquisition."

Where the taxpayer had a leasehold interest in land and acquired the land, s. 13(5.1)(b) would deem the property to be depreciable property of a prescribed class. However, as there is no class in Schedule II which land came within, no claim for capital cost allowance could be made, although the land would be subject to the recapture and terminal loss provisions of the Act.

The capital cost of a property to a taxpayer for purposes of s. 13(5.1)(b) is the capital cost after taking into account subsection 13(5.2). Accordingly, ss.13(5.1)(b) and 13(5.2)(a) do not conflict.

An individual, after having paid $12,500 in lease expenses during the first 48 months of an automobile lease, exercises the option under the lease to acquire the automobile for $15,000, at a time that its FMV is $20,000, then immediately sells it for $20,000.

CRA agreed that if the individual had been using the vehicle in the course of carrying on a business then, by virtue of s. 13(5.2), the capital cost would be deemed to be $20,000 (i.e., the lesser of the vehicle’s FMV, and the sum of the actual cost of $15,000 and the lease expenses), and the individual would be deemed to realize recapture of depreciation of $5,000 on the sale, rather than a capital gain.

Regarding a lease to “Aco” of a truck tractor (the “Vehicle”) with a term of 48 months and a bargain purchase option at maturity, CRA stated:

[S]ubsection 13(5.2) could potentially apply to Aco if it acquires the Vehicle and the cost or capital cost of the Vehicle is less than its fair market value at that time. Subsection 13(5.2) applies to a taxpayer who, after paying rent for a property, subsequently acquires the property. In this case, subject to certain limitations, the rent is "recaptured" if the property is resold at a gain. This is done by treating the rental payments as depreciation, so that on a disposition of the property the rules for depreciable property apply, requiring the recapture of depreciation to be included in income.

Where the lessee of an automobile acquired the automobile for continued use in its business, would it be included in Class 10.1 (by reason of the addition provided under s. 13(5.2)(a)) or in Class 36? Would s. 13(2) apply so that no recapture of depreciation would occur on the disposition of the automobile, notwithstanding an intent of s. 13(5.2) to generate recapture of depreciation respecting amounts added under s. 13(5.2)(b)? CRA responded:

The deemed cost of the automobile must be taken into account under paragraph 13(5.2)(a) to determine whether the individual cost of the automobile exceeds the amount determined for the purposes of subsection 13(2). If this is the case and the automobile is depreciable property, it will be included in Class 10.1.

[Re Q.2] by reason of subsection 13(2), the proceeds would not include any recapture of depreciation (i.e., the excess calculated by virtue of subsection 13(1)) for an automobile that would be included in Class 10.1, even if that excess occurred, among other things, as a result of paragraph 13(5.2)(b).

Where a taxpayer has a property which would have been in Class 34 but for the revocation of a certificate from the Ministry of Energy, Mines and Resources, and the taxpayer has claimed and been allowed capital cost allowance in the incorrect class, a direction may be made under s. 13(6) to deem the property to have been transferred to the correct class in respect of the first year which is not statute-barred.

The BC Secondary Suite Incentive Program assists qualifying homeowners to create a new secondary suite or accessory dwelling unit (a “Secondary Suite”) on the property of their principal residence (“Property”), by providing a forgivable loan in the amount of 50% of the Secondary Suite’s construction costs, subject to a maximum loan amount. It must be rented at no more than a rent affordability limit for at least five years to a tenant who is not an immediate family member, and the loan amount will be forgiven over five years if all of the program requirements are satisfied.

After indicating that such activity likely would be a source of property income, CRA indicated that the forgivable loan when received would reduce the cost of the property pursuant to s. 13(7.1) or 53(2)(k), so that s. 12(1)(x) would not apply by virtue of the exclusion in s. 12(1)(x)(vi).

Aco will receive a grant (the “Government Assistance”), described under s. 12(1)(x)(iv), from a Crown corporation for the purpose of creating or repairing affordable housing. Aco may use the Government Assistance only for the purposes of the purchase of existing non-affordable housing, converting existing structures to affordable housing units, constructing new affordable housing, related land purchases, and the repair and renewal of existing affordable housing units.

CRA indicated that to the extent that the Government Assistance received by Aco was in respect of the acquisition of depreciable property (or land), s. 13(7.1) (or s. 53(2)(k)) will deem that amount to reduce the capital cost of the depreciable property (or land) – without any inclusion under s. 12(1)(x) pursuant to s.12(1)(x)(vi) and without any election required. In this regard, CRA noted:

[T]he expenditure of construction costs may be considered the acquisition of depreciable property that is a “building or structure”. Therefore, any part of the proceeds of the Government Assistance used by Aco to make capital expenditures (as opposed to current expenses) related to the construction of new affordable housing, or to convert existing buildings into affordable housing, may also reduce the cost of that property under subsection 13(7.1).

A taxpayer receives government assistance to build a manure pit. Does s. 13(7.1) apply automatically and, if it does not apply, is the s. 13(7.4) election available? CRA responded:

In this case, if the government assistance is received or receivable in the same year in which the manure pit becomes depreciable property, subsection 13 (7.1) automatically applies. …

[S]ubsection 13(7.1) should apply and that the cost of the manure pit could be reduced by the government assistance received so that an election under subsection 13(7.4) would not be required and the amount of government assistance received will not be included in the taxpayer's income in the year received (unless the amount of government assistance received exceeds the cost of the pit).

The entitlement to the Quebec investment tax credit does not arise until the very end of the taxation year in which the eligible expenditures were incurred. After referring to the stipulation therein that the reduction under s. 13(7.1)(f) occurs for assistance to which the taxpayer is entitled before the particular time, CRA concluded (TaxInterpretations translation):

[A] taxpayer is entitled to receive the ITC in respect of such property at the time the calculation of the ITC for Quebec manufacturing and processing equipment is to be made, being at the end of the taxpayer’s taxation year. Consequently, the reduction in capital cost of property must occur in the taxation year following that in which the taxpayer incurred eligible expenses respecting the Quebec ITC.

Is a taxpayer "entitled to receive" the amount of the investment tax credit for manufacturing and processing equipment in Québec (the “Credit") for the purposes of s. 13(7.1) if it has not filed the prescribed form for the credit? CRA stated:

[T[he prescribed form is not considered [by the ARQ] as an important condition for obtaining the Credit. Accordingly … if a taxpayer incurred eligible expenses for the purposes of section 1029.8.36.166.43 of the QTA in a taxation year … the taxpayer will be entitled to receive the Credit at the end of that taxation year.

A borrower who receives a number of loans under the Quebec Immigrant Investor Program has a major investment project following the acquisition of capital assets or of laying hen quotas. Should a premium of $170,000 received under the Program, which reduces the overall financing cost of the borrower's project and covers the various costs inherent in the investment project, be applied against the acquisition cost of various of certain eligible capital property pursuant to s. 14(10)?

In a general response CRA indicated that if the premium does not reduce the cost of the eligible capital property, it must be included in the borrower's income under s. 12(1)(x), subject to a s. 12(2.2) election being made to reduce the amount of the expense and the amount of the income inclusion.

Under s. 1135.1 et seq., a corporation may benefit from a non-refundable capital tax credit for a taxation year, equal to 5% of the amount of the qualified investment, but limited to the capital tax payable for the year, with the excess available for carry forward to subsequent taxation years. Regarding the federal treatment of the credit, CRA stated:

The Quebec capital tax credit is an inducement payment and represents government assistance … .. It is not to be included in income under paragraph 12(1)(x) but rather is to be applied against the capital cost of the property that generated the credit under subsection 13(7.1) … .

For the purposes of the investment tax credit, paragraph 127(11.1)(b) requires that the capital cost of the property that generated the credit also be reduced to take into account the government assistance. …

These reductions must be recognized when the capital tax credit is received. Income Tax Technical News No. 29 … [states]:

[A] tax credit or a reduction in the tax calculation is considered to be received at the earliest of:

• when the amount is applied as a reduction of instalment payments to be paid by the taxpayer, if it is credited to his instalment account by the fiscal authorities; or

• when all the conditions for its receipt are met, at the earliest of:

• when it reduces the tax payable for a taxation year, or

• when it is paid, if it allows for or increases a tax refund.

The Directorate indicated that a GST rebate claimed by employee respecting CCA deducted for Year 1 on car, but with the rebate claimed in Year 2, would reduce the UCC of the class pursuant to J of the UCC formula rather than under s. 13(7.1), given that the claim was made after the car’s disposition and the replacement car went into a separate class.

Quebec government assistance to the taxpayer to increase the productive capacity of its facilities took the form of covering a portion of the interest on a term loan that it took out to fund the expansion. CCRA concluded that such assistance did not reduce the capital cost of the acquired property pursuant to s. 13(7.1) and was instead assistance regarding the interest expense. The decision of the Québec Court of Appeal in S.M.R.Q. v. Alex Couture Inc., 2001 DTC 5072 (finding that financing assistance reduced the capital cost of the acquired depreciable property) was not binding upon the Department.

S. "13(7.1) of the Act does not apply in general in respect of business arrangements between a public authority and a taxpayer where the public authority carries on a business and enters into transactions with a taxpayer of the same kind as the transactions that any other person engaged in such a business would have for business reasons."

A government loan which is unconditionally repayable would not constitute government assistance for purposes of s. 13(7.1). However, where a repayment was conditional upon achieving a projected sales level, the loan would not be considered to be unconditionally repayable.

A limited partnership ("LP") with an October 31 fiscal period acquires property eligible for the Quebec investment tax credit for manufacturing and processing equipment ("Quebec ITC") and the Quebec capital tax credit, and each year allocates such credits to its limited partners, who claim such credits for their taxation year ending on December 31.

If the tax credits reduce the undepreciated capital cost (UCC) of the LP’s depreciable property, in which taxation year should the LP make the deduction given that, on October 31, it does not know whether the limited partners will use the credits in question – and how can such information be obtained from numerous limited partners? CRA responded:

[A] taxpayer is entitled to receive the amount of the Quebec capital tax credit that does not exceed the capital tax otherwise payable for the year, at the end of its taxation year … [and] is generally entitled to receive the Quebec ITC at the end of its taxation year. However, a taxpayer is not entitled to receive that portion of one of these credits that is carried forward to a subsequent taxation year.

… [S]ince the taxpayer entitled to receive an amount in respect of these credits is a limited partner of the LP, that amount, for the purposes of subsection 13(7.1), is deemed to have been received by the LP on December 31 of the particular year under subsection 13(7.2). In this case, the assistance reduces the capital cost of the depreciable property that qualifies for it, and thereby the UCC of the classes to which the property belongs, in the LP's taxation year that ends on October 31 of the year following the particular year.

… [A]n LP must make arrangements with its partners to provide [the required] information to the LP … .

A taxpayer receives government assistance to build a manure pit. Does s. 13(7.1) apply automatically and, if it does not apply, is the s. 13(7.4) election available? Before concluding that “subsection 13(7.1) should apply … so that an election under subsection 13(7.4) would not be required,” CRA noted:

In a situation where subsection 13(7.1) does not apply, the election under subsection 13(7.4) can be made in order that the capital cost to the taxpayer of the property is reduced by the amount of government assistance received. The application of subsection 13(7.4) is in respect of the cost of a depreciable property acquired by the taxpayer in the year, in the three taxation years immediately preceding the year or in the taxation year immediately following the year. To be valid, an election must be made no later than on or before the day on or before which the taxpayer is required to file the taxpayer’s return of income for the year, or, where the property is acquired in the taxation year immediately following the year, for that following year. One of the requirements of subsection 13(7.4) is that the amount of government assistance received would be included in the taxpayer's income under paragraph 12(1)(x) but for the application of subsection 13(7.4).

where depreciable equipment used in the Canadian branch of a US corporation is moved to its US head office, s. 13(9) will apply to cause s. 13(7)(a) to deem the equipment to be disposed of and reacquired at FMV.

A partial disposition of a vessel will qualify as a disposition of a vessel for purposes of s. 13(16).