28 February 2002 External T.I. 2002-0109835 - SCIENTIFIC RESEARCH

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 CCRA.

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

Principal Issues:

Whether contributions made by a government to a taxpayer in respect of costs incurred from SR&ED activities for which warrants to purchase shares in the taxpayer may be issued to the government, if the contributions are not repaid, can be considered as "government assistance" under subsection 127(9) or an acquisition of interest in the taxpayer under paragraph 12(1)(x).

Position:

The scenario described appears to support that the contributions would constitute government assistance.

Reasons:

The question of issuing warrants which are only options to acquire shares as well as the repayment of the contributions before any warrants or shares were issued appear to indicate that the government was entering into a commercial transaction with a reasonable expectation of receiving a return of its investment. Evidence to this effect depends on a finding of fact which could be obtained by reviewing the relevant agreement between the parties, the particular records of the government as well as verbal or written representations from the government.

Also, since a warrant is an option to acquire shares rather than having beneficial ownership interest in a taxpayer, holding the option through warrants, in and of itself, would not constitute having acquired an interest in the taxpayer. Accordingly, since the contributions were made in respect of SR&ED, the contributions would constitute "government assistance", as defined in subsection 127(9), for the purposes of reducing SR&ED expenditures, under paragraph 37(1)(d) and qualified expenditures, pursuant to subsections 127(18) to (20).

XXXXXXXXXX Frank Fontaine, FCCA
2001-010983
February 28, 2002

Dear XXXXXXXXXX:

This is in reply to your letter dated November 5, 2001 requesting our technical interpretation in connection with the meaning of the term "government assistance", as defined in subsection 127(9) of the Income Tax Act (the "Act"). Specifically, you request our views on the following situation:

(1) A Canadian controlled private corporation ("Canco") is eligible to earn the high-rate refundable investment tax credits ("ITC") in respect of scientific research and experimental development ("SR&ED") expenditures that would be "qualified expenditures" for the purposes of subsection 127(9) of the Act.

(2) Pursuant to a formal contribution agreement, a Canadian government, municipality or other public authority (the "Government") makes contributions to Canco based on a level of eligible SR&ED costs it incurs on certain approved projects.

(3) Once a specified contribution amount is reached, warrants to purchase common shares will be issued to the Government by Canco. The number of warrants issued will be determined by a formula such that their value will be equal to the specified contribution amount. The warrants are exercisable for a five-year term.

(4) If the specified contribution amount is not reached, the contributions are repayable to the Government based on an agreed percentage of revenue earned by Canco.

You asked:

(a) if the Government acquires an interest in Canco, either in the form of direct equity ownership or through a purchase of warrants, and the Government's contributions can reasonably be considered to be in respect of SR&ED, is Canco required to treat the amount received as government assistance pursuant to subsection 127(9) of the Act, and

(b) provided that the Government's specified contribution amount paid to Canco is considered to be an acquisition of an interest in Canco and is not "government assistance", whether the issuing of warrants to the Government would constitute a repayment of assistance for the purpose of the ITC?

OUR COMMENTS

Written confirmation of the consequences inherent in particular transactions are given by the Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R4 (the "Circular"). Where the particular transactions are completed or partially completed, the enquiry should be addressed to the relevant Tax Services Office. Notwithstanding the foregoing, we are providing the following general comments:

1. The definition of "government assistance" is relevant for the purposes of computing the SR&ED expenditure pool, under paragraph 37(1)(d) and for the ITC, under section 127 of the Act, which are to be calculated by reference to a reduction thereto of an amount of any form of assistance described in that definition. There is no exclusion in the definition of government assistance of an amount that is for "the acquisition.....of an interest in the taxpayer" as provided under paragraph 12(1)(x) of the Act. Accordingly, to the extent that a government is not making an ordinary commercial investment in respect of contributions that it makes to the taxpayer, the government would be providing "assistance" within the definition of "government assistance" in subsection 127(9) of the Act.

2. Whether contributions made by a government to a taxpayer at a particular time would constitute "government assistance" depends on a finding of fact. For such purpose, it would be necessary to determine whether sufficient evidence indicates that the government had reason to believe, at the time, that it was entering into a commercial transaction with a reasonable expectation of receiving a return of its investment. Evidence to this effect could be obtained by reviewing the relevant agreement between the parties, the particular records of the government as well as verbal or written representations from officials of the government.

3. Government contributions made to a taxpayer the amount of which is subject to:

(a) a level of costs incurred by the taxpayer,

(b) the issue of warrants in respect thereof,

(c) the uncertainty as to whether any warrants will be exercised during a particular specified period,

(d) the repayment of such contributions prior to any such warrants having been issued, and

(e) the amount of repayment to be based on revenue earned by the taxpayer,

would not appear to have been made in respect of an ordinary commercial investment by the government in the taxpayer.

Based on this scenario, it would be difficult to ascertain:

(f) the intent of the government to make a commercial investment,

(g) the treatment of repayments, if any, if no income was earned, and

(h) whether all or part of the contributions made by the government may or may never be repaid and, therefore whether any such unpaid amounts would themselves be government assistance in the form of "forgivable loans" made to the taxpayer.

4. It is our view that the words "acquisition of an interest in the taxpayer" as they are used in paragraph 12(1)(x) of the Act means holding the right of ownership of a beneficial interest in the taxpayer. Since a warrant constitutes an option to acquire such a right, it is our opinion that a government or taxpayer would not be considered to have acquired a beneficial ownership interest in another taxpayer by virtue of holding warrants to acquire shares in the other taxpayer.

5. It is also our view that the exercise of an option under a warrant to purchase shares in a taxpayer, in and of itself, would not be sufficient to avoid contributions made to the taxpayer from being considered "government assistance" rather than the acquisition of an interest in a taxpayer. As indicated in paragraph 2 above, it must first be established whether the payor thought it was entering into a commercial transaction. However, on the basis of paragraphs 3 and 4 above and, since the contributions would be assistance in respect of SR&ED activities, they would appear to be "government assistance" for the purposes of subsection 37(1)(d) and section 127 of the Act. Warrants issued in respect of such assistance would not represent a repayment thereof. As a result, the amount of government assistance determined would reduce:

(a) the SR&ED deduction available under subsection 37(1), and

(b) the amount of qualified expenditures incurred by the taxpayer for the purposes of the ITC pursuant to subsections 127(18) to (20) of the Act.

The foregoing comments represent an opinion expressing our general views with respect to the subject matter. As indicated in paragraph 22 of the Circular, the above comments do not constitute an advance income tax ruling and, accordingly, are not binding on Canada Customs and Revenue Agency.

We trust our comments will be of assistance to you.

Yours truly,

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

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