18 November 1987 Income Tax Severed Letter 7-1900 - [Preliminary draft of IT-151R3]

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.

Date Nov 18 1987

TO        W.B. Blanche
          Acting Director
          Publications Division
          Legislative Affairs Directorate

ATTENTION J. Grisé

FROM      Small Business and
            General Division B. Fields
          Tel: (613) 957-2096

RE        Preliminary draft of  IT-151R3

As requested, we have reviewed the preliminary draft of IT- 151R3. Since the proposed revisions are still at the preliminary stages, we have tried to restrict our comments to technical issues.

Our comments and observations are as follows:

1. You may wish to expand the reference section to include references to paragraphs 12(1)(v) and 149(1)(j) of the Income Tax Act (the "Act").

2. The summary paragraph could also refer to R & D outside Canada which may be deductible under subsection 37(2) of the Act.

3. Paragraph 1, sentence 2 should also reflect that in order to deduct R & D expenditures in future periods the legislation requires that the taxpayer continue to carry on the business to which the prior expenditures relate (see working paper A attached).

4. In order to consolidate the commentary in respect of capital expenditures, perhaps the comments in paragraph 1 in respect of capital expenditures could be included in paragraph 12.

5. We have had numerous inquiries related to the meaning of the terms "expenditure made", "directly undertaken" and "related to the business". Perhaps the revised bulletin could elaborate on these requirements under separate headings. Previous comments regarding our interpretation of these terms can be found in the attached working papers B, C, D, E, F, G and H.

6. The first sentence of paragraph 2 should reflect that the deduction is allowed by virtue of paragraph 20(1)(t) and subsection 37(1) of the Act.

7. The last sentence of paragraph 2 may no longer be relevant.

8. Although a memorandum in our research files (working papers I and J) supports the interpretation given in paragraph 3, it is not apparent that subsections 11(1) and (2) and paragraph 20(1)(t) were given adequate consideration at the time the interpretation was given. In our view the interaction of section 37, subsections 11(1) and (2) and paragraph 20(1)(t) would require that the expenditures are deductible on a fiscal year basis only. Thus, based on our view, given the circumstances described in paragraph 3, the proprietor would not be entitled to deduct the expenditures incurred in the period between the end of his fiscal period and the end of the calendar year until the end of the subsequent fiscal period.

9. In paragraph 4, the reference to paragraph 37(1)(a) should be changed to 20(1)(t) and 37(1)(a). Regarding R & D work outside Canada, their ineligibility is due to the fact that they were not for R & D in Canada, not that they are not R & D expenditures.

10. The comments in paragraph 5 regarding subsection 18(9) should be expanded to reflect that subsection 18(9) could also apply to payments under subparagraphs 37(1)(a)(ii) to (v) where the payments are for services rendered after year-end. Note that paragraph 18(9)(d) specifically excludes payments under 37(1)(a)(vi) from subsection 18(9).

11. The last sentence of paragraph 6 does not appear to be necessary since an entity that does not itself engage in R & D would not be granted approved status. You may also wish to include a note indicating that payments to these organizations will qualify only if the R & D is related to the business or class of business, as the case may be, of the contributor. You may also wish to include a cross-reference to paragraph 23.

12. Regarding paragraph 7, you may wish to expand the comments to reflect the views expressed in working papers K and L. You may also wish to expand the comments in paragraph 7 to include a reference to Regulation 2900(4) (see working papers M, N and 0).

13. Paragraph 9 should also establish that although interest may qualify as an expenditure in respect of R & D for the purposes of section 37, such expenditures will be prescribed expenditures by virtue of Regulation 2902(a)(i)(C) unless the taxpayer satisfies the revenue test established therein. Consequently, such expenditures will not qualify for the investment tax credit.

14. Regarding paragraph 11, it would seem prudent to note that the amounts received in respect of the contract will likely be "contract payments", as defined in subsection 127(9), for the purpose of the investment tax credit, which would reduce the amount of the performers investment tax credit. A cross-reference to the comments you may wish to add as a consequence of our recommendation in paragraph 24 below would also seem appropriate.

15. Rather than referring to the "whole amount of expenditures" in the first sentence of paragraph 12 it may be more appropriate to refer to the "lesser of" calculation provided by subparagraphs 37(1)(b)(i) and (ii). A reference to subsection 13(7.1) could also be included in your discussion of subparagraph 37(1)(a)(ii) in order to reflect that various forms of assistance will also reduce a taxpayers expenditure pool by virtue of the interaction of subsection 13(7.1) and subparagraph 37(1)(b)(ii). (See working papers P and Q).

16. You may wish to cross-reference the comments in paragraph 15 to the Department's position on "carve- outs" in article 7.9 of IC 86-4R.

17. The reference to the term "grants" in paragraph 16 should be changed to "assistance" in order to reflect the variety of mechanisms available (i.e. forgivable loans, tax credits, etc) to subsidize an R & D project.

18. Similarity, the word "grant" in the heading and body of paragraph 17 should be changed to the word "assistance".

19. The comments in paragraph 16 regarding subsection 37(6) could be expanded to reflect that subsection 37(6) deems amounts claimed under 37(1)(b) and 20(1)(t) to be amounts allowed as CCA which will reduce the amount at 37(1)(b)(ii) in future years.

20. The portion of paragraph 17 that indicates "specific Acts under which grants are made may themselves describe the grant's tax treatment" should be expanded to clarify that pursuant to paragraph 81(1)(a) the treatment described in the specific act will override the requirements of the Income Tax Act. You may also wish to distinguish the tax consequences of the receipt of assistance from a provincial government from the tax consequence of the receipt of federal government assistance.

21. In order to clarify that amounts included in income by virtue of paragraph 12(1)(v) increase the pool, the reference to "such amount" in the second last sentence of paragraph 17 could be changed to either "amounts included in income pursuant to paragraph 12(1)(v)" or "such excess".

22. Since the tax treatment for the various forms of assistance described in paragraphs 18, 19, and 20 do not differ from the general tax treatment described in paragraph 17, it does not appear necessary to discuss these three programs independently, i.e. it may be more appropriate to describe these as examples of payments under an Appropriation Act.

23. In addition to noting that ITC's may be deducted from tax otherwise payable, the first sentence of paragraph 21 could include a reference to those ITC's that are refundable pursuant to section 127.1. The second sentence of paragraph 21 should refer to the ITC "claimed" and reflect that the ITC claimed reduces the amount of the "available tax deduction".

24. In view of the fact that the legislation in respect of ITC's earned on R & D expenditures has changed significantly since the issue of IT-151R2 and in view of the fact that these changes are not adequately explained in the latest revision of IT-331R , it would seem appropriate to expand paragraph 21 in order to comment on the various entitlements and requirements in respect of ITC's on qualified expenditures.

Comments in respect of the following items would appear to be in order:

a) the definition of qualified expenditures - again, it may be helpful to refer to the difference between 37(1)(b)(i) and (ii);

b) Regulation 2902 (See working papers R, S, T, U, V, and W);

c) the deeming provisions of paragraph 127(11.1)(c);

d) the definitions of government assistance, non-government assistance and contract payments and Regulation 4606;

e) the different grandfathering provisions in respect of the coming into force of 127(11.1)(c) and the definition of the term "contract payment";

f) paragraph 12(1)(x) and Regulations 7300 and 6702;

g) the specified percentage in respect of R & D carried out by individuals, CCPC's and others and that a CCPC which is a member of a partnership is not entitled to the 35% rate of ITC in respect of the qualified expenditures made by the partnership;

h) the refundability of ITC's in respect of qualified expenditures and the enhanced refundability in respect of current expenditures on R & D;

i) the impact of ITC's claimed in respect of R & D expenditures on the pool i.e. paragraph 37(1)(e) in respect of current expenditures and subparagraph 37(1)(b)(ii) and subsection 13(7.1) in respect of capital expenditures;

j) the deeming provisions of subsections 127(12) and 127(12.1) in respect of ITC's allocated from trust's or partnerships;

k) change in control rules; and

l) the impact of repayments of government assistance.

25. The comments in paragraph 22 regarding subsection 37(4) could be expanded to reflect the response to question 6 in working paper X attached.

26. The comments in paragraph 23 should be expanded to indicate that although the Department considers that all Canadian universities and affiliated colleges are approved for purposes of subparagraph 37(1)(a)(iii) it is the Department's expectation that contributions to entities that have been approved for purposes of 37(1)(a)(iii) will be expended within a reasonable time frame, generally two years from the date of receipt of the contribution. Alternatively, we may want to reconsider whether the blanket approval granted to universities should be dropped and whether each university should be advised to seek approval. Regarding the portion of paragraph 23 that suggests that a potential contributor could determine a recipients approved status by contacting District Office officials, we should note that we consider a taxpayer's approved status to be confidential information which could only be provided with the authorization of the entity in question.

27. Regarding the description of the transitional provisions in paragraph 24, the word "and" at the end of paragraph (a) should be changed to the word "or". Also, the portion of paragraph (b) relating to projects should be expanded to mirror the requirements of subparagraph 11(b)(ii) of Chapter 1 of the statutes of Canada 1983- 84.

28. Since IT-151R3 will be relevant from its date of issue it may not be necessary to include the comments in respect of years prior to 1984 in paragraph 28.

29. The commentary on pending legislation in paragraph 30 should be expanded to reflect the proposals contained in the June 18, 1987, Notice of Ways and Means Motion to Amend the Income Tax Act, in respect of buildings used for R & D.

30. You may also wish to consider the various corrections of typographical errors and minor word changes that have been made on the enclosed photocopy of your preliminary draft.

We hope our comments will be of assistance.

B.W. Dath

B.W. Dath Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch