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.
Principal Issues: Whether the Sub is entitled to claim a deduction under subsection 37(1) of the Act and the ITC in respect of the SR&ED expenditures for the development of the project software even though it is being reimbursed by a foreign parent and the parent retains ownership of the world-wide rights to exploit the project software.
Position: Yes.
Reasons: The phrase "entitled to exploit the results" appears in subparagraphs 37(1)(a)(i.1) and 37(1)(a)(ii) of the Act but not in subparagraph 37(1)(a)(i). If the Sub otherwise meets the requirements of subparagraph 37(1)(a)(i) of the Act, the fact that the Sub 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 and claim the related ITC.
2008-027612
XXXXXXXXXX Charles Rafuse
613-247-9237
November 10, 2008Dear XXXXXXXXXX :
Re: XXXXXXXXXX :
This is in reply to letter of April 24, 2008, regarding whether the expenses incurred in the XXXXXXXXXX qualifies for an Investment Tax Credit (ITC) as Scientific Research and Experimental Development (SR&ED).
Our understanding of the facts is as follows:
1. XXXXXXXXXX . (Sub) develops the XXXXXXXXXX software in Canada on behalf of its parent company in XXXXXXXXXX (P).
2. P retains ownership of the worldwide rights to exploit the project software.
3. The Sub pays all the expenses incurred in development of the project software and receives quarterly reimbursements for such expenses plus a profit percentage from P.
4. The development of the project software is within the definition of SR&ED.
5. The technology of the project software is proprietary information but not patentable under either the Canadian or the XXXXXXXXXX law.
6. P does not carry on business in Canada.
7. The Sub is in the business of sales, license and development of certain software used in the Canadian XXXXXXXXXX industry.
8. In developing the project software, the Sub also develops software for its own business.
9. The project software is not currently at the marketable stage.
Although P retains the worldwide rights to exploit the project software, it is anticipated that P will allow the Sub to market the project software in Canada. Your question concerns whether the Sub is entitled to claim a deduction under subsection 37(1) of the Act and the ITC in respect of the SR&ED expenditures for the development of the project software even though it is being reimbursed by P and P retains ownership of the world-wide rights to exploit the project software.
Our Comments
Written confirmation of the tax implications inherent in particular transactions is given by this 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 70-6R5, Advance Income Tax Rulings, dated May 17, 2002. As discussed in the circular, there are situations where the CRA will not rule. One such situation is when a matter on which a ruling determination is requested is primarily one of fact and the circumstances are such that all the pertinent facts cannot be established. Where the particular transactions are completed, the inquiry should be addressed to the relevant Tax Services Office. However, we are prepared to offer the following general comments.
The tax treatment of SR&ED expenditures (i.e., as an income deduction, as eligible for the ITC and for the ITC refund) is discussed in detail in Interpretation Bulletin IT-151R5 (Cons), Scientific Research and Experimental Development Expenditures, which is available on the CRA website at www.cra-arc.gc.ca.
In order that a SR&ED expenditure is eligible for the ITC, the expenditure must be a "qualified expenditure" as defined in subsection 127(9) of the Act. A qualified expenditure includes, among other things, an expenditure described under paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Act and excludes, among other things, a "prescribed expenditure"" as that term is defined under section 2902 of the Income Tax Regulations (the "Regulations") and an amount that would be a qualified expenditure to the extent of any reduction in respect of the amount that is required under any of subsections 127(18) to (20).
The phrase "entitled to exploit the results" appears in subparagraphs 37(1)(a)(i.1) and 37(1)(a)(ii) of the Act but not in subparagraph 37(1)(a)(i). In the example you described, if the Sub otherwise meets the requirements of subparagraph 37(1)(a)(i) of the Act, the fact that the Sub 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 and claim the related ITC.
To the extent that a reimbursement made in respect of the SR&ED can be considered to be "non-government assistance" or a "contract payment", as defined under subsection 127(9) of the Act, such reimbursement would affect the ITC claim made by the Canadian taxpayer for the SR&ED because it would reduce the amount of qualified expenditures otherwise computed, pursuant to subsection 127(18) of the Act.
However, where, under a contractual arrangement, a non-resident does not carry on any business in Canada and reimburses a Canadian taxpayer in respect of SR&ED expenditures incurred in Canada and the Canadian taxpayer includes the amount of the reimbursement in computing the taxpayer's 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 or a contract payment for the purposes of paragraph 127(18) of the Act. Accordingly, the reimbursement would not reduce a qualified expenditure incurred by the taxpayer for ITC purposes pursuant to paragraph 127(18) of the Act.
Also, by virtue that the reimbursement would not be deductible by the non-resident person in computing Part I tax under subparagraphs 37(1)(a)(i) and (i.1), the amount would not be a contract payment that would reduce, pursuant to subsection 127(18), the qualified expenditure otherwise incurred by the resident taxpayer. It would be a question of fact whether, in any particular case, an expenditure on SR&ED would be a qualified 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 expenditures made by the subsidiary and be entitled to any related tax benefit. In the situation you described, it is not evident from the facts presented whether the Sub acts as agent for P.
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 expenditures. However, the fact that the parent has exclusive ownership rights to the SR&ED would not, in and by itself, determine that the subsidiary, conducting SR&ED for the parent, is acting as agent for its parent.
Applying this to the situation you described, if the Sub is acting as agent for P then P would have ownership rights to the SR&ED expenditures and P would be considered to have incurred the SR&ED expenditures. However, the fact that P has exclusive ownership rights to the SR&ED, in and by itself, is not sufficient to conclude that the Sub is acting as agent for P and that, therefore, P is considered to have incurred the SR&ED expenditures.
We trust this information is helpful.
Yours truly,
S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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