21 November 1990 Ruling 901323 F - Deductibility of Capital Cost Allowance and Interest Expenses

SUBJECT:  24(1)

We are writing in reply to your memorandum of June 18, 1990 concerning the deductibility of capital cost allowance ("CCA") and interest expenses.

Background

The background of the above mentioned project is as follows:

24(1)

Your concerns

24(1)

Our comments

In general, paragraph 18(1)(a) of the Income Tax Act (the "Act") prohibits the deduction of any expense unless it is incurred for the purpose of gaining or producing income. In this case  24(1)

There is a published position given by the Department at the 1981 Canadian Tax Foundation Round Table Conference (Q23) for CCA deductibility. In that conference, the Department maintains that a partner is entitled to claim CCA in respect of property held outside the partnership provided a fair market value rental is charged to the partnership.  24(1)  To our knowledge, the Department was consistently followed this interpretation for rulings purposes and in assessing.

24(1)

In our view, the reasoning advocated in support of the deductions is contrary to one of the most basic concepts found in the Act, that being the concept of computation of total income by reference to the aggregate of "amounts each of which is ... income ... from a source" (paragraph 3(a) of the Act). Section 4 of the Act then proceeds to give rules as to how income from a source is calculated. Each business and each property is recognized as a possible source of income in paragraph 3(a) and subdivision b of division B of the Act provides further rules, including paragraph 18(1)(a) of the Act, to be used in the computation of income from each of those kinds of sources. The scheme of the Act thereby requires that all deductible expenses be applied against income from one source or another. In this case  24(1)

The partnership is going to carry on a business and therefore each partner will be carrying on a business. This constitutes a source of income to the partner, a business. Subsection 9(1) of the Act establishes the income from the partnership as being its profit and therefore each partner's income from this business source is his share of the profit from the partnership. This is established under generally accepted accounting principles ("GAAP") and it  24(1)  It is then necessary to determine -- there are any specific rules in the Act that would require a departure from the result determined under subsection 9(1) of the Act. The provisions of section 18 of the Act cannot be seen as expanding upon the deductions used in arriving at income under GAAP because they only serve to limit deductions. Although section 20 of the Act might appear at first blush to expand on deductions available, its application is restricted to permitting deductions otherwise disallowed by the application of paragraphs 18(1)(a), (b) or (h) of the Act. Thus it will not permit any deductions not allowed under GAAP (Guaranteed Homes 77 DTC 202 and Metropolitan Properties 85 DTC 5128) The inevitable conclusion is that the expenses or the properties cannot be attributed to the source of income that is from carrying on the business of the partnership and there is no other actual source of income to which these expenses may be related. By the same reasoning, according to Regulation 1102(1)(c) of the Act, the properties do not belong to any class as they are not acquired for the purpose of gaining or producing income. Therefore, no CCA can be generated in the first place.

At present, the Department is appealing a Decision of the Federal Court, Trial Division on a similar issue (Theodore Ronald Posno v H.M.Q. 1989 DTC 5423). In this case, the Department has taken the position that for an expense to be deductible, there must be a source of income.

The Department, as stated in paragraph 13 of the Interpretation Bulletin IT-138R, permits a partner to deduct certain expenses related to a partnership to be deductible even if the expenses are incurred outside the partnership. However, this paragraph is an administrative position and only applies to individuals in a very narrow set of circumstances.

In summary

24(1)   This view is consistent with the published position or the Department, the interpretation applied for rulings purposes and the department's position taken in the aforementioned assessment and court case.

We would also suggest that consideration of the application of GAAR should not be ruled out.  21(1)(b)

We trust that our comments will be of assistance.

Yours truly,

for DirectorBusiness and General DivisionRulings DirectorateLegislative and Intergovernmental Affairs Branch