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Capital vs Current Expenditures
From tax expert Gerry Vittoratos
July 10, 2017
The age-old question of taxation: is the expenditure incurred by the taxpayer a capital or a current expenditure? In this instalment, we will see the criteria that must be analyzed in order to determine the type of expense, and analyze certain interesting real-life cases on this topic.
Determination Criteria - Current vs Capital Expenditures
Unfortunately, the Income Tax Act (ITA) does not provide any guidance as far as distinguishing between current and capital expenditures. What we have to base ourselves on is the jurisprudence dealing with this question (see below for examples), and the administrative position of the CRA. No single criterion listed below is more important than any other. All of them are relevant and each should be considered in relation to the other rather than as separate tests. Also, the facts and circumstances of each case have to be considered.
The authoritative document which lists the determination criteria is S3-F4-C1, General Discussion of Capital Cost Allowance.
An expenditure will normally be considered a capital expenditure if it is determined that it has an endurable benefit. For example, the changing of a roof of a building, or the re-bricking of a building are examples of expenditures that would be capital in nature due to their enduring benefit. Any expenditure that is recurring and has a short useful life would be considered a current expenditure, and deductible against income as per ITA 18.
Maintenance or Capital Improvement
Any expenditure brought to a property to bring it to its original condition will be considered a current expenditure. For example, as provided in the CRA folio mentioned above, the cost to repair or replace wood steps with wood steps would typically be a current maintenance expense. Any expense that improves the property beyond its original condition would ordinarily be considered as a capital expenditure. Using the same example above, replacing the wooden stairs with concrete stairs would be considered a capital expenditure. The fact that the market value of the property might increase with the repair is not a consideration for this criterion.
Integral Part or Separate Asset
A very important consideration is whether the expense is made to repair a part of the asset (integral part), or if the expense is incurred to purchase a property that is a separate asset. Any expense deemed an “integral part” of the asset would be considered a current expenditure. An expense deemed as a separate asset would be considered a capital expenditure. For example, a machine bought and installed in a factory would be considered a separate asset, while replacing the rudder of a ship would be considered an integral part of the ship, and a current expenditure. When determining this criterion, the relative value of the expense (see below) should also be considered.
When considering whether an expense is a current or capital expenditure, you may have to consider the expense in relation to the value of the whole property, the previous average maintenance costs, and annual profits. A good example, as provided by the CRA folio mentioned above, is the replacement of a spark plug vs the replacement of an entire engine of a vehicle. In the first case, since the value of the spark plug in relation to the vehicle is small, it would be considered a current expenditure, while the replacement of the engine, a greater value in relation to the vehicle, would be considered a capital expenditure.
Readying a Used Property for Rental or Other Use
If a used property is purchased, and repairs are brought to that property to render it useable, these repairs would be considered as capital in nature. For example, repairs brought to a rental property for use would be considered capital expenditures.
Anticipation of Sale
Repairs made in anticipation of, or as condition of the sale of the property would be considered as capital in nature.
Interesting Jurisprudence on the Determination Criteria
All the criteria mentioned above, for the most part, were determined through jurisprudence over the years. Below is a list of a few of the more interesting ones, with a short summary.
Johns-Manville Canada v. The Queen,  2 S.C.R. 46
In this case, Johns-Manville Canada needed to buy an adjacent land to the mining pit they had in order to prevent landslides in the pit. The company considered the expense a current expenditure since there was no ore in the adjacent land purchased, and no depreciation could be taken since there was no prescribed class within the Regulations for the land. Moreover, no depletion allowance was allowed because the land was not used in the mining operations. The CRA considered these expenses as capital in nature due to the relative value of the expenditure.
The judge ruled in favour of Johns-Manville Canada in this case, ruling that the purchase of the land represented bona fide expenses in the course of its regular day-to-day business operations, which meets the criteria for current expenditures under ITA 18(1)a). Moreover, the fact that there was no mechanism in the ITA to recognize this large expense (see previous paragraph) also played a determining role.
Rona Inc. v. The Queen,  TCC 121
In this case, Rona claimed the expenses incurred for professional fees, paid to lawyers, consultants and accountants, in an effort to expand the business, as current expenditures since these expenses were recurring. The CRA argued that these expenses, paid for consulting in the construction of large-format stores for the franchise, construction of large-format corporate-owned stores and acquisition of competitors, have an enduring benefit in nature.
The judge ruled in favour of the CRA for the majority of the claims, ruling that the frequency of the transactions are not an important factor vs the enduring benefit the consulting provided to Rona Inc. in the expansion of their business.
Pantorama Industries Inc. v. the Queen  CAF 135
In this case, Pantorama contracted a third-party consultant, Snowcap, to find and negotiate leases for them at future store sites (Pantorama is a clothing retailer). Snowcap would charge a fixed cost per month, and another variable cost calculated according to the surface area for new leases or the duration of the extension for extended leases. Pantorama claimed both types of expenses as current due to their recurring nature; CRA refused the variable costs and claimed them as capital. The CRA argued that the variable costs were an enduring benefit to Pantorama. Pantorama argued that the variable cost is not any different than the fixed cost that was accepted as a current expenditure.
Pantorama lost their appeal in the Tax Court of Canada; the judge agreed with the position of the CRA by stating that this case was very similar to Rona Inc. v. the Queen (see above). The judge ruled that the frequency of the expense did not matter, Pantorama got an enduring benefit from the expense, and therefore it is capital in nature. This ruling was overturned in the Federal Court of Appeals. The judge at that level ruled that the Tax Court judge erred in his judgment, due to the fact that the circumstances of the Rona decision were different than Pantorama’s. In Rona’s case, their business expanded by using the consultants; in Pantorama’s case, their business was shrinking and consolidating, therefore it is hard to make the argument of an “enduring benefit”. The judge also surmised that had these services been obtained “in-house” in the form of salaries and travel costs, the CRA would have likely accepted these costs as current expenditures; the fact that Pantorama outsourced these services should not hold any bearing.
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