7 August 1990 Income Tax Severed Letter AC74569 - UCC Class 10 - Separate Businesses

Audit Applications Division             Resource Industries Section
Ken Warren                              John Chan
Director                                952-9019

A. Marchand
Application Opinions Section
                                        7-4569

Subject: 19(1)

We are writing in reply to your memorandum dated December 1, 1989, wherein you requested a technical interpretation of section 1101 and 1204 of the Income Tax Relations (the "Regulations") in relation 24(1)

FACTS

The following facts were provided by the Calgary District Office ("Calgary D.O.") in their memorandum dated August 2, 1989, as amended by our telephone conversation, of June 5, 1990, with Gary Kwan, Large Files Auditor of the Calgary D.O..

24(1)

24(1)

OUR COMMENTS

Separate Business Regulation 1101(1) provides "Where more than one property of a taxpayer is described in the same class in Schedule II (of the Regulations) and inhere

          (a)  one of the properties was acquired for the purpose
          of gaining or producing income from a business, and 

          (b)  one of the properties was acquired for the purpose
          of gaining or producing income from another business or
          from the property, a separate class is hereby prescribed
          for the properties that

          Cc)  were acquired for the purpose of gaining or
          producing income from each business; and

          (d)  would otherwise be included in the class."       
          24(1)

The test as to whether separate businesses exist is found in Scales v. George Thompson 6 Company, Limited (1927), 13 TC 83. Therein, Mr. Justice Rowlatt found it to be a question of fact whether or not different operations constitute one business or two separate businesses.

He stated at page 89

          "I think the real question is, was there any
          inter-connection, any interlacing, any inter-dependence,
          any unity at all embracing those two businesses;". 

Factors that are relevant in making such a determination are provided at paragraph 3 of Interpretation Bulletin IT-2 O6R and include

          (a)  the extent to which the two operations have common 
          factors that may be pertinent,

          (b)  whether the operations are carried on in the same  
          premises, 

          (c)  whether one operation exists primarily to supply the 
          other,  

          (d)  whether the taxpayer's accounting system records
          the transactions of both operations as if they were those
          of one business, or whether separate complete sets of   
          records are maintained throughout the year.

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Regulation 1101

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1984 Advance Income Tax Rulings

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In this regard, reference is made to Powell Rouyn Gold Mines Ltd. v. H.N.R., 59 DTC 401, T.A.B., and Bessemer Trust Company et al. v. H.N.R., 72 DTC 6404, F.C.T.D., in which recapture of CCA was held to be applicable to the .same source of income from which the relevant CCA was deducted in prior years. The Bessemer Trust case further held that the recapture provisions of the Act and the Regulations are fundamentally adjustments to income of previous years and do not create, in the year of disposal of the asset, some new form or source of income.

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Other

Gary Kwan requested our comments with respect to a hypothetical situation described at page 3 of the Calgary D.O. memorandum wherein an unintended benefit, i.e., enhanced resource allowance deduction, was perceived to have accrued to a taxpayer who maintains a single Class 10 pool of assets comprising assets used to earn resource profits and assets which are not used to earn resource profits. Had separate classes been required, disposition of assets which are not used to earn resource profits would result in recapture of CCA. The hypothetical situation assumes that since separate classes are not required, this recapture of CCA, which would otherwise result, would reduce the U.C.C. pertaining to assets which are used to earn resource profits. Since CCA claims on assets used to earn resource profits reduce resource profits under the provisions of Regulation 1204(1), reduction of the U.C.C. of these assets results in reduction of the total CCA claims which would eventually reduce resource profits, thereby achieving the perceived benefit. See Illustration I.

As shown in the attached Illustration Il, it is our view that no benefit would result in the above hypothetical situation because actual recapture of CCA would be included in resource profits only to the extent that it pertains to CCA claims which were deducted in computing resource profits. This is supported by the aforementioned Powell Rouyn and Bessemer Trust cases.

Director Bilingual Services and Resource Industries Division Rulings Directorate

                         ILLUSTRATION I

                            Class 10      Resource    
Non-resource

ASSUMPTIONS:

Year  1 - acquisition cost    200           100             100
Year  3 - proceeds            (79)                          (79)
                              121           100              21
Year  4 - proceeds            (79)
Net  write-offs                42            21              21

U.C.C. Class 10 (Single Business)

                            Single              Allocation

                           Class 10      Resource    Non-resource

Year 1  - additions          200           100          100
        - CCA                (30)          (15)         (15)
                             170            85           85
Year 2  - CCA                (52)          (26)         (26)
                             118            59           59
Year 3  - proceeds           (79)          (20)         (59)
                              39            39           NIL
        - CCA                (12)          (12)          
        - U.C.C. (Note 1)     27            27           NIL
Year 4  - proceeds           (79)          (79)
                             (52)          (52)          NIL

NOTE:

          1.   According to the Calgary District Office, CCA claims
          that would reduce resource profits under Regulation 1204: 
          Cost of additions 100  At end of Year 3  (15+2 6+1 2+27) 
          80  Difference 20  Rate of resource allowance  X  25%   

            Unintended Benefit              5          

                         ILLUSTRATION II

U.C.C. Class 10 (Single Business)

Single Allocation Class 10 Resource Non-resource

Year 1 -additions             200           100             100
        - CCA                 (30)          (15)            (15)
                              170            85              85
Year 2  - CCA                 (52)          (26)            (26)
                              118            59              59
Year 3  - proceeds            (79)                          (79)
                               39            59             (20)
        - CCA (Note 1)        (12)          (12)
                               27            47             (20)
Year 4  - proceeds            (79)          (79)
        - Recapture (Note 2)  (52)          (32)            (20)

NOTES:

1. Although there is a notional resource UCC of $59, the actual CCA claimed in Year 3 is $39 X 30%, ie, $12, which is the amount that reduces resource profits in Year 3.

2. Although there is a notional recapture on the non -resource UCC in Year 3, it is not realized until year 4.

                    ILLUSTRATION II (cont'd)

U.C.C. Class 10 (Separate Businesses)

                             Resource           Non-resource
                             Business            Business

Year  1  - additions          100                     100
         - CCA                (15)                    (15)
                               85                      85
Year  2  - CCA                (26)                    (26)
                               59                      59
Year  3  - proceeds                                   (79)
         - recapture                                  (20)
         - CCA                (18)
                               41
Year  4  - proceeds           (79)
         - recapture          (38)

Effect on resource profits computation

                              Single                  Separate
                             Business                 Business

Year 1  - CCA                  15                       15
Year 2  - CCA                  26                       26
Year 3  - CCA                  12                       18
Year 4  - Recapture           (32)                     (38)
                               21                       21