A private company (“SherWeb”), which provided, to paying customers, the use of software developed by it, transferred its software for creditor-proofing reasons a newly-formed sister company (“501”) at a gain (with such software licensed back to it for continued use in its software services business).
The Court found that although the acquired software was depreciable property to 501, it had not been depreciable property to SherWeb because SherWeb, rather than claiming capital cost allowance respecting the software, had treated its software development expenses as deductible SR&ED expenses, so that the software had been excluded from treatment in its hands as depreciable property pursuant to the Quebec equivalent of Reg. 1102(1)(d) (which excludes, from depreciable property, any property that was acquired by expenditures in respect of which the taxpayer was allowed a deduction under s. 37). Accordingly, Taxation Act s. 99 (equivalent to the ½ step-up rule in ITA s. 13(7)(e)) did not apply to reduce the capital cost to 501 of the acquired software.
The Court further stated (at paras. 28, 32, TaxInterpretations translation):
Depreciable property is property in respect of which a depreciation allowance has been allowed, or “would have.” The fact that a deduction, in the abstract, could have been allowed in respect of a property cannot, however, permit that property to be characterized as a purely depreciable property to SherWeb, when the evidence demonstrated that it had lost that character by reason of the various expenditures on programmers' salaries, and the SR&ED credits that were accorded to it year after year. …
One cannot escape the fact that, to SherWeb, the Software has never been treated as a depreciable asset, and so continually until the time "immediately before the transfer" to the respondent.
Regarding an ARQ submission that the Reg. 1102(1)(d) equivalent was intended only to preclude a double deduction (for SR&ED and CCA) and not to avoid the ½ step-up rule, the Court stated (at para. 34):
Regarding the appellant's position that the deduction of salaries over the years as an expense does not preclude the Software being depreciable property, it must be remembered that the salaries were deducted as an expense paid to maintain the profitability of the business activities which were, as such, an expense on income account even though the sums spent on the initial creation of the Software could have qualified as capital costs. It seems to us that the appellant's position does not take into account the undisputed facts found by the judge. In this regard, it must be emphasized that the fact that an expenditure is incurred to produce "a capital asset, in the sense of an enduring benefit" does not necessarily transform an (ordinary) expense into a capital expense.
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