9 July 1987 Income Tax Severed Letter 5-3035 - [Scientific Research and Experimental Development Regulation 2902]

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.

R.H. Joyce (613) 957-2098

JUL 9 1987

Dear Sirs:

Re: Scientific Research and Experimental Development Regulation 2902

This is in reply to your letter of February 27, 1987 wherein you requested the Department's view on section 2902 of the Income Tax Regulations ("the Regulations") as it relates to certain taxpayers carrying on scientific research and experimental development ("SR & ED").

Of particular interest to you is the Department's position concerning the exception contained in paragraph 2902(a) of the Regulations wherein a taxpayer will not be considered to have incurred prescribed expenditures for investment tax credit purposes if he derives all or substantially of his revenue from the prosecution of SR & ED.

You have requested that we provide our comments as to whether the taxpayer, in the situations described below, would be considered to derive all or substantially all of his revenue from the prosecution of or sale of rights in or arising out of SR & ED. In each case it is assumed that the activities themselves qualify as SR & ED as defined in subsection 2900(1) of the Regulations, that the taxpayer retains ownership of the technology, and that the taxpayer has no other sources of revenue other than those described.

(1) The taxpayer researches and develops projects up to the creation of a successful prototype. The manufacturing, marketing and distribution rights to particular applications of the technology and/or to particular geographic regions are then sold to one or more third parties, in exchange for a royalty based on sales.

(2) Same as case 1, except all manufacturing, marketing and distribution rights are sold to a corporation related to the taxpayer.

(3) The taxpayer develops computer software which is licensed on an exclusive basis to an arm's-length computer hardware manufacturer/distributor. The taxpayer receives a royalty for each license of the software by the distributor to end users.

(4) Same as case 3, except the exclusive license is granted to a corporation related to the taxpayer, which markets the software and pays a royalty to the taxpayer.

(5) The taxpayer develops computer software, which it then licenses on a non-exclusive basis to end users.

In determining whether a taxpayer derives all or substantially all of his revenue from the prosecution of or sale of rights in or arising out of SR & ED within the meaning of paragraph 2902(a) of the Regulations, it is the Department's practice to look to the manner in which the taxpayer derives his income or intends to derive his income. If the taxpayer intends to manufacture, process, and sell a product, or plans to actively exploit any technology developed, the taxpayer could not be considered to derive all or substantially all of his revenue from the prosecution of or sale of rights in or arising out of SR & ED.

It is our opinion that income from the sale of the marketing and distribution rights referred to in examples 1 and 2 above would normally be considered to be income from the sale of rights arising out of SR & ED as contemplated in paragraph 2902(a) of the Regulations. Should the taxpayer derive his revenue in the manner described in examples 3 and 4 above, it is our view that the income would generally be considered to have been derived from the prosecution of SR & ED.

In example 5, it is our opinion that the granting of non- exclusive licenses to end users by the taxpayer could constitute active exploitation of the technology developed, especially if the computer software was manufactured by the taxpayer. Accordingly, this revenue would not be considered to have been derived from the prosecution of or sale of rights in or arising out of SR & ED.

We trust the above comments will be of assistance.

Yours truly,

Original Signed by Original signé par

T. HARRIS

for Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch