29 October 2004 Internal T.I. 2004-0097181I7 - Dealer's equipment rental

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.

Principal Issues:

Whether the leased equipment of a dealer in heavy equipment is classified as inventory or depreciable property?

Position:

Probably classified as inventory.

Reasons:

Question of fact and law.

		October 29, 2004

	XXXXXXXXXX  TAX SERVICES OFFICE	HEAQUARTERS
	Technical Services	L. J. Roy, CGA
(613) 957-8968
	Attention: XXXXXXXXXX
		2004-009718

XXXXXXXXXX (hereinafter "ABC")

This is in reply to your email of October 1, 2004 and our telephone conversation (XXXXXXXXXX/Roy). You have requested our comments concerning the additional submission of ABC's representative on the classification of rental equipment as depreciable property in the particular fact situation addressed in our previous memorandum of April 29, 2004 (2003-004833).

In his letter of September 28, 2004, the representative submits that the rental equipment is capital property and constitutes inventory only at the time of sale. It is his view that our position does not recognize the generally accepted concept that there can be a conversion of property. In his view, considering that the rental equipment can only be inventory because the intention of the taxpayer is to ultimately sell the property would negate the very reason for the existence of IT-102R2, because it would ignore the fact that the nature of an asset may be converted.

It is our view that our position regarding ABC is not in conflict with the IT-102R2. As mentioned in paragraph 7 of IT-102R2, the facts of each case will determine whether or not a conversion of property from inventory to capital property or from capital property to inventory has occurred. It is the Agency's general view that a conversion is not considered to have taken place where a property that was purchased primarily for resale is temporarily leased in a business to earn income. In such a case, the intention of the taxpayer is always to sell the property in the near future.

Where a property is subject to a lease, a review of all the relevant facts and the lease agreement is necessary to reach a conclusion. However, generally, it is our position that a property subject to a long-term lease could be considered as capital property. Consequently, in a situation where a taxpayer acquires a property with the intention of selling it but later on decides to permanently use it as a capital property, there will be a conversion of property from inventory to capital property.

The representative suggests that a taxpayer that both sells and leases assets of the same kind would be able to claim capital cost allowance (CCA) on its leased assets regardless of whether or not the three conditions outlined in paragraph 4 of IT-102R2 are met. In our view, the opening sentence of paragraph 4 of IT-102R2 clearly conflicts with that position. If a taxpayer does not meet the three conditions in paragraph 4 of IT-102R2 and if he both sells and leases property of the same kind, then all of the properties must be treated as inventory from the date of acquisition.

Paragraph 6 of IT-102R2 sets out that notwithstanding paragraph 4, a leased property may be a capital property rather than inventory in the circumstances described therein. It is our view that, because the condition described in paragraph 6(b) of IT-102R2 is not satisfied, treating the rental equipment of ABC as depreciable property is not appropriate.

The representative has cited the case of Daybo Rentals Inc v. Her Majesty the Queen, (1994) 2 GTC 1019. In that case, the taxpayer was operating a car rental business and in conjunction with rental operations was involved in selling used cars and the court had to determine if some of the leased automobiles were capital property or inventory under the Excise Tax Act. In our view, this case does not support the taxpayer's arguments. However, Judge Bonner made the following statement:

The concept of a capital asset ordinarily involves lasting qualities and an integration of the asset into the profit making structure of the business. The fact that the Appellant used automobiles to earn rental income does not, standing alone, preclude the classification of them as inventory and indelibly stamp them as capital assets of the business.

In conclusion, we are of the view that the taxpayer does not meet the exception described in paragraph 4 of IT-102R2 and, as such, must treat its leased properties as inventory from the date of acquisition for purposes of the Act.

For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Legislation Access Database (LAD) on the CRA's mainframe computer. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the LAD version or they may request a copy severed using the Privacy Act criteria which does not remove client identity. Requests for this latter version should be made by you to Jackie Page at (819) 994-2898. The severed copy will be sent to you for delivery to the client.

We trust the above comments will be of assistance to you.

Ghislain Martineau
For Director
Financial Industries Division
Income Tax Rulings Directorate