Question

Explain how a “factory” is an industrial building according to laws pertaining to capital allowances. [8 marks]

Answer 1

Capital Allowances can only be claimed on the cost of buildings and not on the cost of land.

A distinction between repairs and improvement must still be made in the case of non-depreciable assets such as land. This is because there is no capital allowance pool for such assets. The cost of repairs to non-depreciable assets are deductible under section 41(1)(b) of the Income Tax Act, which the cost of improvements to such assets are added to the cost base under section 58(5) and recognized as a reduction of gain upon disposal.
Buildings, whether used for business purposes (for example, a factory building, shop, or warehouse) or for producing business rental income, are treated as depreciable assets and are eligible for the capital allowance deduction. However, since land is a non-depreciable asset, where a price is paid for land and a building that price must be apportioned and only the part paid for the building qualifies for the allowance (see section 39(11).

Under the system, eligible assets are classified unto five groups:-

1. Plant, machinery and equipment, including cars, trucks and other vehicles  
     
2. All other tangible depreciable assets except building, and intangible depreciable assets, including goodwill.
3. Industrial, manufacturing and agricultural buildings.
4. Other commercial buildings such as office buildings or retail buildings.
5. Other buildings, such as residential real estate.

In a year in which a capital expenditure is incurred and a depreciable asset is put to use, it is necessary to establish to which of these five groups the asset belongs. This determines the rate at which the asset is depreciated. Assets belonging to Group 1 are depreciated at a 40%, assets in Group 2 & 3 are depreciated at a rate of 10% and 15%, assets in Group 4 at 10%, and assets in Group 5 at 5%.

It would be to the taxpayer’s advantage to try to classify all expenditure under Group 1 so as to qualify for the 40% deduction. It is the tax auditors function to examine purchases of capital items to confirm that the correct classification has been made.