3 August 1990 Ruling 901703 F - Research Project

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.

Dear Sir:

Re:  Research Project

This letter is further to our letter of July 23, 1990 and concerns the questions which were outstanding at that time.  Your questions and our responses are stated below.

1.     You want to know the tax consequences for both the entity and its scientific beneficiaries with regard to the establishment of such an entity were the occasion to arise.  This would include the preliminary step (founding meetings, travel expenses, incorporation fees) as well as those that follow, and those that took place in 1988-89.

Our Response

The tax consequences which will arise will depend on the type of entity you choose.  For instance, you could create a corporation (a "Non-profit Research Corporation") constituted exclusively for the purpose of carrying on or promoting scientific research and experimental development ("Research").  Such a corporation would be exempt from income tax provided it meets the criteria stated in paragraph 149(1)(j) of the Income Tax Act (the "Act"). However, you may find such criteria, which are as follows, to be overly restrictive:

-     no part of the corporation's income may be payable to or otherwise available for the benefit of any member or shareholder;

-     the corporation cannot acquire control of any other corporation;

-     the corporation cannot carry on business; and

-     the corporation must expend 90% of its income on Research.

It would also be possible to create a trust (a "Non-profit Trust").  Provided the trust was organized and operated exclusively for social welfare or any other purpose except profit, and no part of its income was payable to or otherwise available for the benefit of any member, it would not be subject to tax.

A third alternative would be the creation of a taxable corporation.  A taxable corporation would not be subject to income tax unless its income exceeded its expenses in any year. Thus, it might be possible to arrange that the payments to be received by the corporation in a year to do research would not exceed the expenses.  However, even if there were excess income in a year, it may be possible to incur a loss in a subsequent year and have that loss applied back to decrease the excess income.  Thus the tax may only be a short-term timing issue, since it is feasible to operate with a taxable corporation and yet not incur taxes in the long term.

A problem with the use of a Non-profit Research Corporation or a Non-profit Trust is that these entities are intended to benefit the public in that the results of their research must vest in the public domain or with a sector of the public, and there can be no significant direct or indirect benefit to the parties funding such entities.

24(1)  it would not be appropriate to attempt to fund the Research through a non-profit entity.  This would apparently leave you with the option of using a taxable corporation.

One advantage of using a corporation as the intermediary entity is that corporate law provides that expenses may be incurred by you on behalf of the corporation prior to incorporation, as discussed in our Interpretation Bulletins IT-454 and IT-364. Although such expenses would not be deductible by you in calculating your taxable income, you could be reimbursed by the corporation upon its incorporation.  Such reimbursement would not be taxable in your hands, and the expenses could be deductible to the corporation in calculating its taxable income, depending on what the original expenditures were incurred for.  For further discussion on the start-up costs, please refer to question 2.

The tax consequences to the scientific beneficiaries are discussed under question 5 below.

2.     In particular, you want to, know if the agent (representative) could be exempt from income tax, and if not, to what extent he would be tamed when acting strictly on the project.

Our Response

It seems that your concern  24(1)

24(1)  In order for expenditures to be deductible, it is a general prerequisite that such  expenditures be laid out to earn or produce income.  24(1)  The consequences of such reimbursement are described under question 1.

24(1) 

3.     Likewise, you want to know the tax consequences brought about by the group (research and financial backers) passing the results of its research on to a commercial company for exploitation.

Our Response

Since a Non-profit Research corporation cannot carry on business and a Non-profit Trust must not have a profit motive, and also since neither type of entity may make any part of its income available to a member or a shareholder, the financial exploitation of the research results would have to be undertaken by a separate taxable entity.  However, any attempt to transfer rights from a non-profit entity to a taxable entity could jeopardize the non-profit status of the purported non-profit entity.  Thus when using a non-profit entity, it is apparently not possible, to have the researchers share in any profits from products developed as a result of the research of course, is a taxable corporation were used as the entity, it would not be necessary to transfer the research results to a separate corporation for exploitation, although such could be done.

Before the tax consequences can be determinated with certainty, there are non-tax matters which you need to resolve, such as the legal ownership of rights to research results and the manner in which these rights may be transferred for marketing purposes.

4.     Were the occasion to arise, you would like to know the tax consequences for the group (to be defined within the eventual commercial corporation) and for its participants - financial backers and scientists alike - were the aforementioned to receive monetary participation in the commercial company which could ensue from the project.

Our Response

In addition to our response to questions 3 and 5, please note that royalties paid to the researchers would constitute income in their hands.

5.     Royalties to be paid to the researchers would be part of the commercial corporation's responsibilities.

Our Response

Provided a taxable entity were used to fund the Research, royalties could be paid to the researchers from the commercial corporation. Such royalties would constitute income in the hands of the researchers, and would be a deductible expense to the entity.

......

Although you have not raised this issue, you may have thoughts or concerns regarding the tax consequences to the financial backers. Section 37 of the Act provides that payments to research institutes, etc. or to any corporation resident in Canada, to do Research may qualify as a deduction in calculating the payor's income from a business carried on in Canada, provided that the Research relates to such business.  Such qualifying payments are also eligible for investment tax credits pursuant to section 127 of the Act.  Obviously, if a person  24(1)  is not carrying on business in Canada, it will not be able to make a deduction under section 37.

Alternatively, if a financial backer were to contribute to a taxable corporation by purchasing shares of the corporation, his contributions would add to the cost of those shares and this cost would be relevant in calculating his gain or loss on a subsequent disposition of those shares.

I would be pleased to consider your proposal in more detail when you have determined your course of action.

Yours truly,

R.J.L. ReadActing Assistant Deputy MinisterLegislative and IntergovernmentalAffairs Branch