21 June 2013 Internal T.I. 2012-0459731I7 - Government Assistance

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 amounts received under the SADI program are considered government assistance?

Position: Yes

Reasons: The contributions do not appear to have ordinary commercial terms.

June 21, 2013

Elizabeth Koopman HEADQUARTERS
Director Income Tax Rulings
Technical Guidance Division Directorate
SR&ED Directorate Sandro D'Angelo
16th Floor, 344 Slater Street, Ottawa (613) 952-5803

ATTN: Elsa D'Adderio 2012-045973

Meaning of Government Assistance

This is in reply to your memorandum of August 22, 2012, wherein you requested our views on whether certain amounts received (or to be received) by XXXXXXXXXX pursuant to the Strategic Aerospace and Defence Initiative ("SADI") program represent "government assistance" as that term is defined in subsection 127(9) of the Income Tax Act (the "Act").

Facts

Our understanding of the key facts is briefly summarized as follows: (footnote 1)

• SADI program was launched in April 2007 and supports private sector industrial research and pre-competitive development in Canada's aerospace, defence, security and space industries by way of "repayable investments" and has three key objectives:

1) to encourage strategic research and development that will result in innovation and excellence in new products and services;

2) to enhance competitiveness of Canadian aerospace and defence companies; and

3) to foster collaboration among research institutes, universities, colleges and the private sector.

• The SADI program is administered on behalf of the Minister of Industry Canada by Industrial Technologies Office ("ITO"), which is a special agency of Industry Canada.
• In accordance with the above, XXXXXXXXXX entered into an agreement (the "Agreement") with the Minister of Industry Canada, as represented by ITO, on XXXXXXXXXX, pursuant to which ITO would make a "repayable investment" in XXXXXXXXXX in the form of amounts described in the Agreement as contributions (the "ITO Contributions"). (footnote 2)
• The ITO Contributions are described as financial assistance in the Agreement. The ITO Contributions are intended to assist the funding of XXXXXXXXXX's research and development activities relating to XXXXXXXXXX. XXXXXXXXXX's research and development activities in respect of XXXXXXXXXX are intended to qualify as "scientific research and experimental development" ("SR&ED") as that term is defined in subsection 248(1) of the Act.
• Pursuant to the Agreement, the ITO Contributions are to be disbursed to XXXXXXXXXX over a period of time and are based on a percentage (i.e., XXXXXXXXXX%) of the total eligible costs incurred each year by XXXXXXXXXX. The total maximum amount of ITO Contributions that XXXXXXXXXX can receive under this Agreement is $XXXXXXXXXX. (footnote 3) The ITO Contributions have been, or are expected to be received by XXXXXXXXXX as follows:

XXXXXXXXXX

• The Agreement provides that the ITO Contributions must be repaid by XXXXXXXXXX. As set out in paragraph XXXXXXXXXX of Schedule XXXXXXXXXX of the Agreement, the first repayment to be made by XXXXXXXXXX is due by XXXXXXXXXX (approximately XXXXXXXXXX years following XXXXXXXXXX's receipt of the first ITO Contribution) and the last repayment is due by XXXXXXXXXX (XXXXXXXXXX years following XXXXXXXXXX's receipt of the last ITO Contribution). (footnote 4) Assuming the maximum amount of ITO Contributions are received by XXXXXXXXXX, the first XXXXXXXXXX annual repayment amounts are expected to be $XXXXXXXXXX; the second XXXXXXXXXX annual repayment amounts are expected to be $XXXXXXXXXX and the last XXXXXXXXXX repayment amounts are expected to be $XXXXXXXXXX. The maximum amount to be repaid by XXXXXXXXXX is equal to XXXXXXXXXX times the ITO Contributions or $XXXXXXXXXX (assuming XXXXXXXXXX receives the entire $XXXXXXXXXX). Each repayment amount is comprised of a portion representing the repayment of the ITO Contributions received and a portion representing an additional XXXXXXXXXX% of such amount.
• It is also our understanding that the repayment of the ITO Contributions by XXXXXXXXXX under the Agreement is unconditional and that none of the ITO Contributions received by XXXXXXXXXX are intended to be, or expected to be forgiven or otherwise remain unpaid at the end of the repayment period.

SR&ED Directorate's Views

As set out in your memorandum, it is your view that the terms of the Agreement do not establish an ordinary business relationship between XXXXXXXXXX and the Minister of Industry Canada as the Agreement is not for the purpose of advancing any business of the payer. As such, it is your view that the amount of ITO Contributions received by XXXXXXXXXX under the Agreement is government assistance. However, due to the fact that XXXXXXXXXX is expected to repay the ITO Contributions plus an additional XXXXXXXXXX% of such contributions you are concerned that it might be argued that the ITO Contributions should not be considered as government assistance on the basis that the arrangement is akin to a repayable loan made on commercial terms. Notwithstanding this concern, you have also referred to various Rulings documents and case law which supports your understanding that the definition of government assistance is sufficiently broad such that it could include any form of assistance made by an agency of the Federal government whether repayable or otherwise.

Our Comments

The definition of the term "government assistance" in subsection 127(9) of the Act is as follows:

"government assistance" means assistance from a government, municipality or other public authority whether as a grant, subsidy, forgivable loan, deduction from tax, investment allowance or as any other form of assistance other than as a deduction under subsection (5) or (6). (emphasis added)

Paragraph 37(1)(d) of the Act reduces a taxpayer's deductible expenditures for SR&ED activities by the amount of any government assistance or non-government assistance that, at the taxpayer's filing-due date for the year, the taxpayer has received, is entitled to receive or can reasonably be expected to receive for his taxation year. Paragraph 37(1)(c) of the Act states that all repayments of such assistance shall increase the deductible expenditures for SR&ED activities in the year of repayment if such assistance previously reduced the amount. Further, for the purposes of determining the amount of a taxpayer's deductible SR&ED "qualified expenditures" as an "investment tax credit" ("ITC") under the rules in section 127 of the Act, subsection 127(18) of the Act reduces the amount of such qualifying expenditures by any amount of government assistance, non-government assistance or contract payment that can reasonably be considered to be in respect of such SR&ED activities (whether or not related to the qualifying expenditures) that the taxpayer has received, is entitled to receive or can reasonably be expected to receive on or before the filing due date for the taxation year. If such assistance is eventually repaid, paragraphs (e.1) and (e.2) of the definition of ITC in subsection 127(9) of the Act, as the case may be, allow the taxpayer to include, in calculating its ITC, the specified percentage of that part of a repayment made if the assistance was previously used to reduce the qualifying expenditure.

The facts in the present situation appear to be similar to the fact situation considered in Rulings document 2007-0224191E5. In that Rulings document, we considered whether amounts received from Technology Partnerships Canada ("TPC"), which was another agency of Industry Canada, were government assistance. In that situation, the particular contributions received by the taxpayer from TPC also had to be repaid in full including an additional XXXXXXXXXX% of the total contributions received. In our response, wherein we confirmed the amounts received by the taxpayer from TPC were considered to be government assistance, we indicated the following:

To the extent that a government is not making an ordinary commercial investment in respect of contributions that it makes to a taxpayer, the government would be providing "assistance" within this definition of government assistance. TPC is a special agency of Industry Canada whose business is not investment for profit and is, accordingly, unlike that of a normal commercial investor. In our view the definition of government assistance is broad enough to include contributions received from TPC.

XXXXXXXXXX.

In Rulings document 2011-0405061I7, we also considered a somewhat similar situation involving partially repayable contributions made to a taxpayer under another program administered by another agency of Industry Canada. In that situation, it was concluded that the entire amount of the contributions received by the taxpayer was government assistance that was required to be included in the taxpayer's income under paragraph 12(1)(x) of the Act. This was the case, notwithstanding the fact that the taxpayer had taken the position that only XXXXXXXXXX (i.e., $XXXXXXXXXX of the total $XXXXXXXXXX received) was government assistance because the remaining $XXXXXXXXXX was, in essence, a loan that had to be repaid (i.e., it was not a forgivable loan). (footnote 5)

XXXXXXXXXX.

In CCLC, the taxpayer incurred expenses relating to SR&ED and received financial support from the province of Alberta. In exchange for this financial support, the province of Alberta received a fifty percent undivided interest in the project. Once the project was completed, the province of Alberta was entitled to be repaid out of the gross revenue produced from the project. The repayment included the entire investment plus a return on that investment and the province of Alberta would be required to give up its fifty percent undivided interest in the project technology. If the project was not completed, the province of Alberta would hold onto its fifty percent of the undivided interest. The FCA found that the agreement between the parties did not establish an ordinary business arrangement and stated:

We find it impossible to characterize this as an ordinary business arrangement. Whatever public policy merits the agreement may have had from the standpoint of Alberta, it does not amount to an arrangement that a business would enter into to advance its business interest. A business which invested money in ventures on the basis that it could not receive any net profit if the venture succeeded, and would gain an equity interest only if the venture proved uncommercial, would not long survive.

Somewhat similarly, in a recent Tax Court of Canada ("TCC") case, Immunovaccine Technologies Inc. v The Queen, 2013 TCC 103 ("Immunovaccine"), a taxpayer received a repayable contribution from the Atlantic Canada Opportunities Agency ("ACOA") in respect of a scientific research project conducted by the taxpayer. The particular agreement required that the contribution made by ACOA had to be fully repaid based on a percentage of the taxpayer's gross revenue generated by its operations. The taxpayer had argued that the total amount of the contribution was essentially an ordinary loan advanced to it on reasonable terms and for the business purposes of ACOA even though ACOA was not entitled to any further return on its investment (i.e., interest). (footnote 6) The TCC, in finding that the agreement between the parties did not establish an ordinary business arrangement, stated the following at [46]:

In fact, the real test, as suggested by the Federal Court of Appeal in CCLC Technologies, supra, referring to Consumers' Gas, supra, is whether the contribution made by ACOA was made "in exactly the same way for exactly the same reasons as payments made by private business, that is, for the purpose of advancing the interests of the payor". (emphasis added)

In comparison to CCLC and Immunovaccine, it might be argued that the Agreement in our present situation constitutes an ordinary business arrangement as ITO is expected to receive some form of return on its contributions regardless of XXXXXXXXXX's profitability relating to XXXXXXXXXX (i.e., it will receive XXXXXXXXXX times the amount of the ITO Contributions). The main differences between the facts in our present situation and those in Rulings document 2011-0405061I7 and in Immunovaccine are as follows:

(i) all the ITO Contributions are required to be repaid (i.e., there appears to be no forgivable portion);

(ii) the repayment amount provides ITO with a "return on its investment" since for every $1 dollar received an additional $XXXXXXXXXX must be repaid: and

(iii) XXXXXXXXXX.

We have not been provided with XXXXXXXXXX's reasons as to why the ITO Contributions should not be considered as government assistance. To the extent that XXXXXXXXXX relies on the same arguments as those advanced by the taxpayers in Rulings Documents 2011-0405061I7 and 2007-0224191E5, we do not expect our position to change. XXXXXXXXXX.

Generally, it is our understanding that the Department of Finance still considers repayable contributions to be government assistance, XXXXXXXXXX. In our view, this is consistent with the position that the CRA has taken in numerous Rulings documents. (footnote 7)

Conclusion

Based on the above, it is our opinion that the better view is that the ITO Contributions received by XXXXXXXXXX are government assistance and should be treated accordingly for income tax purposes.

We trust our comments will be of assistance.

Yours truly

Michael Cooke, C.P.A., C.A.
Manager
Business Income and Capital Transactions Section
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch

FOOTNOTES

Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:

1 This information was obtained from your memorandum and from information obtained from Industry Canada's website.

2 XXXXXXXXXX.

3 All dollar amounts are Canadian.

4 Interest is to be charged if a payment is late.

5 We also indicated that based on the terms and conditions of the particular agreement between the parties the entire amount did not legally appear to be a loan or represent borrowed money. In any event, since only XXXXXXXXXX of the total contributions had to be repaid over a term of XXXXXXXXXX years (without any interest), we concluded that such an arrangement could not reasonably be considered as a normal commercial arrangement.

6 The TCC noted at [49] and [50] that ACOA's purpose for making the contribution was essentially to support and promote opportunity for economic development of Atlantic Canada and not in order to advance its own business interests.

7 Refer to Rulings documents 2011-0405061I7, 2007-0224191E5, XXXXXXXXXX, 2005-0141131C6, 2002-0109835.