13 December 1989 Ruling 74191 F - SR & ED Investment Tax Credit

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.

SUBJECT:  Scientific Research and Experimental Development ("SR & ED") Corporations

This is in reply to your memorandum of July 26, 1989, concerning the statements made in our memorandum of April 28, 1989.  In your memorandum you have requested the following:

21(1)(b)

Our Comments

Our comments assume that the corporation involved is a sole purpose SR & ED Company defined as a corporation that derives all or substantially all of its revenue from the prosecution of SR &  ED, that the expenditures were made in and after 1973 and the expenditures are of a current nature.  Given these assumptions, the definition of "investment tax credit" in subsection 127(9) of the Income Tax Act (the "Act") states that a taxpayer's investment tax credit will be a specified percentage of the taxpayer's "qualified expenditures" made in the year.  In order to meet the requirements of a "qualified expenditure" in subsection 127(9) of the Act, the expenditure must be an expenditure as described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Act and not be a "prescribed expenditure" as defined in section 2902 of the Regulations to the Act (the "Regulations").  If a corporation derives all or substantially all of its revenue from the prosecution of SR & ED, its expenditures are excluded from the definition of "prescribed expenditures" in section 2902 of the regulations.  However, each expenditure must still satisfy the requirements of paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Act.  As the expenditures are not capital expenditures subparagraph 37(1)(b)(i) of the Act is not applicable.  Paragraph 37(1)(a) which is applicable requires that each expenditure be made on "scientific research and experimental development".  Thus even a corporation which receives all or substantially all of its revere from the prosecution of SR & ED will only receive investment tax credits on its expenditures made on SR & ED.

The definitions of SR & ED and expenditures on SR & ED are contained in paragraph 37(7)(b) and 37(7)(c) of the Act.  Paragraph 37(7)(b) of the Act states that SR & ED has the meaning given in section 2900 of the Regulations and clauses 37(7)(c)(ii)(A) & (B) of the Act state that for expenditures of a current nature made in Canada, an expenditure on SR & ED is an expenditure, incurred for and all or substantially all attributable or directly attributable, as determined by relation (subsections 2900(2) & (3) of the Regulations), to the prosecution, or to the provision of premises, facilities or equipment for the prosecution of SR & ED.  Thus for a sole purpose SR & ED company to receive investment tax credits, an expenditure must still meet the requirements of being an expenditure incurred for and all or substantially all attributable to SR & ED as defined in subsection 2900(1) or directly attributable to SR & ED as provided for in subsections 2900(2) & (3) of the Regulations.

Based on the above analysis of the law which applies to sole purpose SR & ED companies, we offer the following comments:

1)     In order for costs associated with the bidding process to be eligible for ITC's they must satisfy the requirements of either 37(7)(c)(ii)(A) of the Act as being expenditures incurred for and all or substantially all attributable to SR & ED as defined in subsection 2900(1) of the Regulations or subsections 2900(2) or (3) of the Regulations as being directly attributable to the prosecution of SR & ED.  Our comments related to these subsections are as follow:

a)     Subsection 2900(1):

     In our opinion, the fact that the overall purpose of a company or program is SR & ED (as defined in subsection 2900(1) of the Regulations) does not ensure that every expenditure of the company will qualify as SR & ED, if this were the case, sole purpose SR & ED companies could have been excluded from the requirements in subparagraph 37(7)(c)(ii) of the Act.  As such, each expenditure must be looked at on its own merits and we must consider the bidding costs themselves in relation to the company's overall SR & ED activities when considering whether bidding costs are eligible for ITC's.  Generally, bidding activities will not be all or substantially all attributable to SR & ED as defined in subsection 2900(1) of the Regulations as SR & ED would have to be carried out in order for an expenditure to be attributable to it.  In addition, they could not be considered to be all or substantially all attributable to support activities such as engineering or design, operations research, mathematical analysis, computer programming or psychological research.  The bidding costs may or may not eventually lead to the taxpayer receiving an SR & ED contract and SR & ED subsequently occurring.  The bidding costs appear more likely to be substantially all attributable to increasing the company's business.

b)     Subsection 2900(2):

     A review of this subsection indicates that paragraph (c) would include the bidding costs as directly attributable to SR & ED if they relate directly to the prosecution of SR & ED and would not have been incurred if such prosecution had not occurred.  Bidding costs may relate to successful and unsuccessful bids with the following results:

1)     Where a bid is unsuccessful the company will not carry out the prosecution of SR & ED against which the bid is directly related and as such the first test in paragraph (c) will not be met. The second test in the paragraph will not be met either as the unsuccessful bidding costs were made even though prosecution of SR & ED had not occurred.

2)     Where the company is successful in its bid and SR & ED occurs the second test has still not been met as the costs would have been incurred even if the bid were unsuccessful and such SR & ED had not occurred. 

     From the above, it appears that generally bidding costs, whether successful or unsuccessful, do not satisfy the requirements in paragraph (c) and would not be considered directly attributable to the prosecution of SR & ED.  In our view, bidding costs are attributable to the creation of business for a particular company, as opposed to SR & ED.

c)     Subsection 2900(3):

     This subsection would not apply to bidding costs as they do not relate to the provision of premises, facilities or equipment.

2)     In our opinion, there is no support, in law, for a position that all current expenditures attributable to the business of the prosecution of SR & ED of a sole purpose SR & ED company would be considered to be directly related to the actual prosecution of SR & ED.  Each expenditure must be considered on its own merits for purposes of Section 2900 or the Regulations.  Examples of some expenditures which would not qualify under clause 37(7)(c)(ii)(A) of the Act are:

a)     Expenditures not related to a sole purpose SR & ED company's SR & ED activities.  As a company need only derive 90% of its revenue from the prosecution of SR & ED or the sale of rights in or arising out of SR & ED carried on by it in order to qualify as a sole purpose SR & ED company, many expenditures may relate to its other activities and as such not qualify.  For example, a company which carries on two businesses, one being SR & ED and the other the marketing of widgets, would find that none of its expenditures related only to the widget business would qualify.  In addition, it may find that although 90% of its revenue is derived from SR & ED, less than 90% of its expenditures relate to SR & ED.  As such a common or shared expenditure of the two businesses such as for personnel services, management, or accounting, etc. may not meet the all or substantially all attributable test as it is not 90% or more attributable to SR & ED.

b)     In a sole purpose SR & ED company selling the results of its SR & ED expenditures related to marketing activities would not qualify under clause (A).

c)     The training of staff to carry out SR & ED activities would likely qualify however, the training of staff to carry out management, marketing or other functions may not be considered to be substantially all attributable to SR & ED.

     It should be noted that capital expenditures are restricted by other provisions in the Act.

3)     In our view, the criteria to be used to differentiate an expenditure than qualifies for SR & ED purposes from one that does not for sole purpose SR & ED corporations are the same criteria as those used for any other taxpayer.

     21(1)(b) In our opinion, where paragraph 2900(2)(c) being considered, a taxpayer will meet the requirements of the paragraph where he can show that SR & ED was actually carried out which related directly to the expenditure and that the expenditure would not have occurred if the research had not occurred.  Bidding, advertising, entertainment, and many other expenditures will generally not meet the above criteria as they do not directly relate to specific SR & ED activities and would be incurred whether or not SR & ED occurred.

4)     Subparagraph 2902(a)(i) of the Regulations serves to restrict the eligibility for the ITC of a general administration or management expenditure which might otherwise qualify as a SR & ED expenditure as described in paragraph 37(1)(a), where the expenditure is incurred by a taxpayer who does not derive all or substantially all of his revenue from the prosecution of SR & ED or the sale of rights in or arising out of SR & ED carried on by him.  The subparagraph should not be interpreted to mean that a sole purpose SR & ED company can receive ITC's on all of its general administration expenses; it simply means that it is entitled to ITC's on its general administration expenses that meet the other requirements of the Act related to SR & ED expenditures.

We trust our comments will be of assistance.

B.W. DathDirectorSmall Business and General DivisionSpecialty Rulings DirectorateLegislative and IntergovernmentalAffairs Branch