24 September 2001 External T.I. 2001-0099635 - SR&ED-RIGHT TO EXHIBIT ISSUE

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.

Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

Principal Issues: Whether Canadian subsidiary T/P must retain some rights to exploit the results arising from SR&ED to claim SR&ED expenditures

Position: no - the fact that the subsidiary does not have the right to exploit the results of SR&ED that it carries out does not, in and by itself, affect its ability to deduct SR&ED expenditures incurred

Reasons: ITA 37(1)

XXXXXXXXXX 2001-009963
Shaun Harkin, CMA
September 24, 2001

Dear XXXXXXXXXX:

Re: Technical Interpretation Request: Scientific Research and Experimental Development ("SR&ED")

This is in reply to your letter of August 29, 2001 wherein you requested our views as to whether a Canadian taxpayer can deduct SR&ED expenditures under subsection 37(1) of the Income Tax Act (the "Act") when the following conditions exist:

(1) A Canadian corporation ("CANCO") provides to its U.S. parent ("USCO") contract SR&ED services as defined in subsection 248(1) of the Act.

(2) The SR&ED expenditures incurred by CANCO are related to the business of CANCO.

(3) USCO remunerates CANCO on an appropriate cost plus basis with respect to the SR&ED expenditures incurred.

(4) USCO retains all ownership rights arising from the SR&ED activities (CANCO does not retain any rights to exploit the results arising from the SR&ED activities).

(5) USCO does not carry on business through a permanent establishment in Canada and does not attempt to deduct SR&ED expenditures or secure access to Investment Tax Credits relating to the SR&ED activities undertaken by CANCO.

You also ask for our comments on the decision in the Sass Manufacturing Ltd. V. MNR, 88 DTC 1363 case in regards to the "right to exploit" issue and whether we agree with your understanding of subparagraph 37(1)(a)(i) of the Act and of CCRA's response to question two at the 1993 Canadian Tax Federation Revenue Canada Round Table.

Our Comments

In the example you described, the fact that CANCO does not have the right to exploit the results of SR&ED that it carries out would not, in and by itself, affect its ability to deduct the SR&ED expenditures incurred by it under subparagraph 37(1)(a)(i) of the Act. To the extent that a reimbursement made in respect of the SR&ED can be considered to be "non-government assistance", as defined under subsection 127(9) of the Act, the reimbursement would affect a claim made by the Canadian taxpayer for SR&ED. However, where, under a contractual arrangement, USCO reimburses CANCO in respect of SR&ED expenditures incurred by CANCO in Canada and CANCO includes the amount of the reimbursement in computing its income from a business carried on in Canada pursuant to subsection 9(1) of the Act, it is our position that the reimbursement would not be considered to be non-government assistance. Accordingly, the reimbursement would not reduce a claim made by CANCO for SR&ED.

In the situation described, it is not evident whether CANCO acts as agent for USCO. In any given situation, it is a question of fact whether SR&ED carried out by a taxpayer on behalf of another person is performed by the taxpayer as agent for the other person, the determination of which would depend on the terms of the particular arrangement. Consideration of such terms would not be limited to the right to exploit the results of the SR&ED or be reimbursed for the SR&ED expenditure. Where a subsidiary is acting as agent for its parent, the parent would have ownership rights to the SR&ED and would be considered to have incurred the SR&ED expenditure made by the subsidiary. However, if the parent has exclusive ownership rights to the SR&ED that, in and by itself, would not determine that the subsidiary, conducting SR&ED for the parent, is acting as agent for its parent.

The decision in the Tax Court of Canada case, Sass Manufacturing Ltd. V. MNR, 88 DTC 1363, to disallow the SR&ED expenditures deducted was based on the fact that Sass Manufacturing was not performing scientific research. The determining factor in the decision was not the "right to exploit" issue. In the decision to the SR&ED issue, Judge Sarchuk stated in part:

"The evidence falls far short of establishing the existence of any systematic investigation or search carried out in a field of technology by means of experiment or analysis. .... Scientific research must mean the enterprise of explaining and predicting and the gaining knowledge of whatever the subject matter of the hypothesis is. This surely would include repeatable experiments in which the steps, the various changes made and the results are carefully noted. There is no evidence of such an approach in the case at bar, .....The appeal on this issue cannot succeed."

Although, the determining factor in the decision was not based on the "right to exploit" issue, Judge Sarchuk did comment on this issue in his analysis. Our opinion is that this issue was mentioned as further evidence that the appellant was not conducting scientific research. However, it was not the deciding factor. The entire particular arrangement between the appellant and Bruinsma, determined that SR&ED was not performed by the appellant.

It is your understanding that a taxpayer would not be permitted to deduct SR&ED expenditures under subparagraph 37(1)(a)(i) of the Act when the taxpayer has incurred SR&ED expenditures on behalf of a third party and the taxpayer does not have ownership rights pertaining to the expenditure. We disagree with your understanding. When a taxpayer enters into a contract to perform SR&ED for a third party, the SR&ED may be undertaken directly by the taxpayer and be related to a business of the taxpayer. Therefore, the taxpayer could satisfy the requirements of subparagraph 37(1)(a)(i) regardless of the fact that the taxpayer does not have the right to exploit the results of the SR&ED.

Also, you are of the opinion that your understanding is consistent with CCRA's views as expressed in response to question two at the 1993 Canadian Tax Federation Revenue Canada Round Table. We disagree with your understanding. The response to question two at the 1993 Canadian Tax Federation Revenue Canada Round Table states in part:

"... Where a subsidiary is acting as agent for its parent, the parent would have ownership rights to the SR&ED expenditure and would be considered to have incurred the SR&ED expenditure made by the subsidiary...."

Applying this to the example described above, if CANCO is acting as agent for USCO then USCO would have ownership rights to the SR&ED expenditure and USCO would be considered to have incurred the SR&ED expenditure. This does not mean that if USCO has exclusive ownership rights to the SR&ED then this, in and by itself, determines that CANCO is acting as agent for USCO and, therefore, USCO is considered to have incurred the SR&ED expenditure.

The foregoing comments represent our general views with respect to the subject matter. As indicated in paragraph 22 of Information Circular 70-6R4, the above comments do not constitute an income tax ruling and accordingly are not binding on the Canada Customs and Revenue Agency. Our practice is to make this disclaimer in all instances in which we provide an opinion.

We trust the above comments are of assistance.

Yours truly,

Steve Tevlin
for Director
Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate
Policy and Legislation Branch

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