26 April 1991 Ministerial Correspondence 910254 F - Deductibility of SR&ED Carried on Outside of Canada

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.

We are writing in response to your memorandum of January 16, 1991 and the meeting of March 7, 1991 with you, your group head and representatives from 24(1) in regard to the deductibility of payments of scientific research and experimental development ("SR & ED") carried on outside of Canada.  Our understanding of the facts submitted by  24(1) representatives is as follows:

Facts

24(1)

Position Taken By The Taxpayer

Due to the above involvements

24(1)

The requirement of "related to the business" is not important as whatever a corporation does constitutes its business.

(24(1)

Position Taken By D.0.

"On behalf of"  implies that a taxpayer must enjoy 100% of the benefit from the results of the SR ED.

24(1)

Our Comments

Section 37(2) of the Act sets out the requirements for the SR & ED deduction.   The main issues in this case are "related to the business" and "directly undertaken by or on behalf of".

A.      Related to the Business

We acknowledge tat at the meeting we were under a misapprehension regarding the "related to the business" issue applicable to transactions incurred prior to December 17,1987.  However, this issue does need to be examined notwithstanding that it was not the major focus of the discussions at the meeting.

Paragraph 5 of the Interpretation Bulletin IT-I51R3 states that for the SR & ED to be related to a business carried on by a taxpayer, it is necessary to have some interconnection or link between the taxpayer's business and the SR & ED expenditure.  This requirement will generally be satisfied when the results of the SR & ED have a direct and beneficial application in the business that is carried on by the taxpayer in the year.  In addition, paragraph 37(7)(d) provides that references to SR & ED relating to a business include any SR & ED that may lead or facilitate an extension of that business.  There was a guideline issued in 1982 to determine whether a non-performing funder of SR & ED carries on a research business to which the SR & ED could be automatically related. The following is a brief summary of the guideline:

•     The funder must be a principal in the new business to be carried on in the year. It must be legally possible for a funder to carry on such a business as a principal.

•     The funder must have rights to commercially exploit any resulting products and/or processes.  However, a funder may license the right to use to another party in exchange for a share of gross or net revenue for an unlimited term or a term approximating the expected useful life of the resulting product or process.

•     The proportionate share of revenue to the funder must represent a reasonable expectation of profit.

•     The funder must not be guaranteed a return of his principal and/or revenue

24(1)

However, this guideline was subsequently cancelled by the Department in April 1987 and the determination of whether a taxpayer carried on a business would be based on the facts of each case.

24(1)

B.      Directly undertaken by or on behalf of

Although at one time the Department did insist that a principal-agency relationship must exist, since 1986 the position has been that the existence of some direction or control or some other form of involvement in the performer's activities coupled with the acquisition of certain rights to the research performed would be sufficient to say that the research was performed on the funder's behalf.  With tax reform in 1987, the requirement of "entitled to exploit" was added in paragraph 37(2)(b) of the Act and elsewhere but not in paragraph 37(2)(a).  However the Department has taken the position that the phrase "directly undertaken by or on behalf of" implies that the taxpayer would have entitlement to exploit the results of the SR & ED.  If the taxpayer is not entitled to exploit the result of SR & ED, no deduction will be allowed.

In our opinion, the "entitled to exploit the result of SR & ED" requirement will be fulfilled where the taxpayer receives the right to use patents that result from the SR & ED on an exclusive or non-exclusive basis regardless of any reasonable territorial restrictions.  In addition, the right to use the results of a SR & ED in circumstances where the funding taxpayer is charged a royalty, license fee or some other amount would also constitute an entitlement to exploit the results of the SR & ED.

24(1)

We trust the above comments will be of assistance, however, if you need further clarification , please do not hesitate to contact us.

for DirectorBusiness and General DivisionRulings DirectorateLegislative and IntergovernmentalAffairs Branch