Taxation decision could divide ‘R’ from ‘D’

A recent decision by the Ontario Assessment Review Board to change the way some software companies are classified could mean a significant difference in the amount of municipal property taxes they pay.

Based on a case brought forward by two Waterloo, Ont.-based high-tech vendors, the Ontario Assessment Review Board (OARB) ruled that in certain cases what a developer produces is an “intangible asset” rather than a completed good. That means the firms which can prove they produce those intangible assets could be classified as commercial rather than industrial properties. Commercial properties are subject to a lower tax rate than industrial ones.

The OARB held a three-day hearing in May at the behest of Waterloo Maple Inc. and DSP Factory Ltd./AMI Semiconductor Canada Company, who objected to being put in the industrial class by Municipal Property Assessment Corp. (MPAC). Executives from Waterloo Maple, also known as MapleSoft, insisted that the firm is primarily concerned with research and development, offering “release candidates” of interactive mathematical software.

“The Board finds the issue to be whether the creation of the software is in and of itself the final product or is it ancillary to the production of the CD,” the OARB decision says. “The release candidate is not marketable and requires conversion to another form.  Waterloo Maple itself does not create the tangible product.”

AMI, which makes circuit boards and audio chips, will remain in the industrial class under the OARB decision, but a local industry group cheered the victory for Waterloo Maple. According to Communitech, an association that supports IT companies in the region, property tax savings to qualifying software developers in the Waterloo  Region for 2006 taxation will amount to approximately $1.50 to $1.70 per square foot in tax  savings. “For example, a software development firm occupying 25,000 square feet would save up to $40,000 (on average) every year in municipal taxation,” Communitech said in a posting to its members.

Andy Anstett, MPAC’s manager of legislation and policy support, told the OARB decision is a finding of fact, not a legislative change to the Ontario Assessment Act. One of the OARB’s conclusions, for example, is that the wording of one of the Act’s subsections does not require that research at a company be done in connection with manufacturing or processing in order to be considered commercial.

“What the decision says, in essence, is that a company doing pure research without connection to industrial activity – manufacturing, processing – will be considered commercial property,” Anstett said. “It’s not that easy to interpret. There’s some nuances to this that need to be considered.”

Research that is directly connected to product development would be more likely to be considered to be done in connection with an industrial activity, Anstett added.

“It’s a significant decision,” he acknowledged. “Will it mean a lot of companies fall into the commercial classification? Probably not.”

Although Waterloo Maple might seem like a relatively isolated case, a number of companies are starting to produce intellectual property assets that are turned into products by third parties, said Peter Milligan, an associate counsel with Toronto-based law firm Miller Thompson LLP.

It’s certainly still a very grey area. I think the major thing that’s significant that comes out of the case is the recognition that the development of software is an intangible, not tangible in the normal sense,” he said. “You would have to look at each case individually.”

Milligan noted that the OARD only issued an interim decision and that MPAC could appeal, but Anstett said companies that feel they belong in the commercial category are welcome to contact MPAC about a reassessment.

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