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 amount deemed by subsection 37(1.4) of the Income Tax Act should be taken into consideration in calculating the prescribed proxy amount under subsection 2900(4) of the Income Tax Regulations.
Position: Yes.
Reasons: Application of subsection 37(1.4) of the Income Tax Act and subsection 2900(4) of the Income Tax Regulations.
February 18, 2010
Policy Development Division HEADQUARTERS
SR&ED Directorate André Gallant
Mrs. Hélène Marquis, A. Director (613) 957-8961
Attention: Mr. Michel Lefebvre
2009-032583
Scientific Research and Experimental Development ("SR&ED")
This is in response to your letter of June 5, 2009, and is further to our telephone conversations with Mr. Chris Boucouvalas from your office (Gallant/Boucouvalas and Parnanzone/Boucouvalas), regarding the application of subsections 37(1.4) and (1.5) of the Income Tax Act (Canada)(the "Act"), dealing with certain SR&ED expenditures outside Canada, with respect to the "proxy method".
Our understanding of the matters at issue follows.
Subsections 37(1.4) of the Act deems the amount of an expenditure determined under subsection 37(1.5) as having been made for SR&ED carried on in Canada. The amount determined under subsection 37(1.5) is the lesser of two amounts. The first amount is the amount of salary and wages paid by a taxpayer to an employee resident in Canada in respect of SR&ED that is carried on outside Canada, directly undertaken by the taxpayer, related to a business of the taxpayer, and solely in support of SR&ED carried on in Canada by the taxpayer. The second amount is 10% of the salaries and wages paid to employees in respect of SR&ED carried on in Canada.
When a taxpayer elects under clause 37(8)(a)(ii)(B) of the Act to use the proxy method of calculating the SR&ED expenditures for a tax year, a prescribed proxy amount ("PPA") for purposes of the investment tax credit is calculated under subsection 2900(4) of the Income Tax Regulations (Canada) (the "Regulations"). The PPA is a notional amount representing the SR&ED overhead expenditures, and is generally used to replace the tracking of overhead expenditures described in subsections 2900(2) and (3) of the Regulations that are used under the "traditional method" of calculating the SR&ED expenditures.
Subject to an overall cap, the PPA for a tax year is generally 65% of the total salary or wages of the employees directly engaged in SR&ED in Canada (the "salary base"). Under one interpretation, because of the deeming provision in subsection 37(1.4) of the Act, the salary base would include the salary or wages referred to in subsection 37(1.5) of the Act to the extent they are paid to employees directly engaged in SR&ED. Therefore, the PPA will be calculated on these salary or wages. This, you say, is reflected on the latest published version of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim (2008).
An alternative interpretation of subsections 37(1.4) and (1.5), discussed with Mr. Boucouvalas, is that no portion of the amount deemed by subsection 37(1.4) to be made in respect of SR&ED in Canada would be reflected in the salary base for purposes of calculating the PPA. This is because subsection 37(1.4) does not specifically refer to an expenditure for salary or wages, but simply refers to a generic expenditure. The amount determined under subsection 37(1.4) would therefore not be relevant for PPA purposes. This alternative interpretation is based on the argument that the deemed amount in subsection 37(1.4) is not explicitly a "salary or wages expenditure", but is an "expenditure for a taxation year determined under subsection (1.5)".
In fact, subsection 37(1.5) provides that the amount of the taxpayer's expenditure for a taxation year is the lesser of two other amounts. The first of these two amounts deals with certain salaries or wages paid to the taxpayer's Canadian resident employees in respect of SR&ED carried on outside Canada (the paragraph 37(1.5)(a) amount). The second amount is 10% of the total of all expenditures in respect of salaries or wages paid to employees in respect of SR&ED carried on in Canada (the paragraph 37(1.5)(b) amount). Under the alternative interpretation, the fact that the two amounts both refer to salary or wages should have no impact on the meaning of the word "expenditure" that is deemed to be made in respect of SR&ED carried on in Canada, pursuant to subsection 37(1.4). Again, since the subsection 37(1.4) deemed expenditure would not necessarily be salary or wages expenditure, no part of the subsection 37(1.4) amount would be included in the PPA calculation under this alternative interpretation.
You are asking whether the amount deemed by subsection 37(1.4) should be used in the PPA calculation.
We are of the view that the amount deemed by subsection 37(1.4) of the Act should be taken into consideration in calculating the PPA in subsection 2900(4) of the Regulations based on a textual, contextual and purposive analysis of subsection 37(1.4).
The word "expenditure" in subsection 37(1.4) must be read together with subsection 37(1.5) as a whole, especially because subsection (1.4) specifically refers to an amount determined under subsection (1.5). In fact, it is not any general expenditure under subsection 37(1.4) that is deemed to be made in respect of SR&ED carried on in Canada, but an "expenditure ... determined under subsection (1.5)".
Subsection 37(1.5) only deals with salary or wages, and more specifically with salary or wages in respect of SR&ED carried on outside Canada. While paragraph 37(1.5)(b) deals with salary or wages in respect of SR&ED carried on in Canada, this paragraph only serves as a cap to the amount in paragraph 37(1.5)(a). Paragraph 37(1.5)(a), for its part, only deals with salary or wages in respect of SR&ED carried on outside Canada. This view appears to be consistent with the comments made by the Department of Finance in the following extract from the 2008 Budget Plan, Annex 4:
"Permissible salary or wages incurred by a taxpayer in a taxation year will be limited to 10 per cent of the total salary and wages directly attributable to SR&ED carried on in Canada by the taxpayer during the year..."
The view that the expenditure in subsection 37(1.4) was only meant to cover salary or wages expenditures is also confirmed by the reference to subsection 37(1.4) in subsection 37(2). Pursuant to subsection 37(2), a taxpayer may deduct in computing income certain expenditures of a current nature on SR&ED carried on outside Canada, "except to the extent that subsection (1.4) deems the expenditures to have been made in Canada". If the "expenditure" in subsection 37(1.4) was only meant to be a general kind of expenditure, without specifying that it would be outside Canada, the reference to subsection (1.4) in subsection 37(2) would be meaningless.
It would appear that subsection 37(1.4) was intended to cover salary or wages expenditures as the following extract from the 2008 Budget Plan, Annex 4, illustrates:
"Currently, expenditures incurred on SR&ED carried on outside Canada do not qualify for the SR&ED ITC. Budget 2008 proposes to recognize, for the purpose of the SR&ED ITC, certain salary or wages incurred by a taxpayer in respect of SR&ED carried on outside Canada.
Specifically, the SR&ED ITC will be available to a taxpayer for permissible salary or wages incurred by the taxpayer in respect of Canadian-resident employees carrying on SR&ED activities outside Canada. The activities outside Canada must be directly undertaken by the taxpayer and must be done solely in support of SR&ED carried on by the taxpayer in Canada."
The foregoing interpretation is consistent with the CRA published position regarding the nature of the subsection 37(1.4) amount: form T661 currently permits the addition of part or all of the subsection 37(1.4) amount in the PPA calculation, as you noted in your letter. At line 810 on page 6 of T661, the computation of the salary base for PPA purposes includes the salary or wages of employees directly engaged in the SR&ED for work performed in Canada (line 300) and for work performed outside Canada (line 307). The comments for line 810 in T4088, Guide to Form T661 - Scientific Research and Experimental Development (SR&ED) Expenditures Claim), confirm that the amounts from both lines (300 and 307) are to be taken into account in calculating the PPA.
Subsection 37(1.4) only deals with the amount of salary or wages referred to in subsection 37(1.5). To the extent that an expenditure amount is not described in subsection 37(1.5), it is not affected by the deeming provision of subsection 37(1.4).
We trust that these comments will be of assistance.
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the CRA's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should your client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. You should make requests for this latter version to Mrs. Jackie Page at (819) 994-2898. A copy will be sent to you for delivery to the client.
Yours truly,
S. Parnanzone
For Director
Business and Partnerships Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
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