19 March 1993 Income Tax Severed Letter 9225325 - SR & ED

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.

Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department. Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.

                                           922532
XXXXXXXXXX                                 F.B. Fontaine
                                           (613) 957-4364

Attention: XXXXXXXXXX

March 19, 1993

Dear Sirs:

Re: Scientific Research & Experimental Development (SR & ED)

This is in reply to your letter of August 21, 1992 wherein you requested the meaning of the phrase "directly undertaken by or on behalf of the taxpayer", as it is used in subparagraph 37(1)(a)(i) of the Income tax Act (the "Act"). We regret the delay in responding to your letter.

You have described various situations in which a Canadian corporation ("CANCo") performs SR & ED in Canada that is funded by a related non-resident corporation ("NRCo") and have requested our views as to whether CANCo would, in those situations, be entitled to the investment tax credit ("ITC") on SR & ED expenditures incurred by it in Canada.

Based on the Department's comments in paragraph 21 of Information Circular 70-6R2 (the "Circular"), we are unable to provide confirmation of the income tax effects of the particular situations. However, we are prepared to offer the following general comments:

The phrase described in the first paragraph above, in our opinion, would represent a situation where (i) the SR & ED is carried out by the taxpayer or (ii) where the SR & ED is contracted out by the taxpayer who maintains ownership rights to the SR & ED. Whether SR & ED is carried out on behalf of a taxpayer is a question of fact and would depend on the terms of the particular arrangement.

In order that an expenditure be eligible for the ITC, the expenditure must be a "qualified expenditure" as defined in subsection 127(9) of the Act. That is, among other things, the expenditure must be an expenditure described under paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Act and must not be a "prescribed expenditure" as defined under section 2902 of the Income tax Regulations.

Both subparagraphs 37(1)(a)(i) and 37(1)(b)(i) require that SR & ED undertaken by a taxpayer must be "related to a business of the taxpayer". Whether an expenditure on SR & ED incurred by CANCo under an arrangement with NRCo is related to CANCo's business is a question of fact. Paragraph 37(7)(d) of the Act provides an inclusive definition of the term "SR & ED related to a business". It is our view that for 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 expenditures. This requirement will generally be satisfied when the results of the SR & ED, if successful, have a direct and beneficial application in the business that is carried on by the taxpayer in the year.

For the purposes of calculating a taxpayer's ITC, paragraph 127(11.1)(c) specifies that a qualified expenditure must be reduced by certain amounts, including a "non-government assistance" payment and a "contract payment", as defined under subsection 127(9), in respect of the qualified expenditure that the taxpayer has received, is entitled to receive or can reasonably be expected to receive. The amount of a reimbursement, among other things, received by a taxpayer in respect of the cost of property or in respect of other expenditure, if included in income under paragraph 12(1)(x) of the Act may be considered a non-government assistance payment. A contract payment would include an amount payable by a non-resident person if that person is entitled to deduct that amount in computing Part I tax.

Where, under a contractual arrangement, NRCo does not carry on any business in Canada and reimburses CANCo in respect of SR & ED expenditures incurred by CANCo in Canada and CANCo includes the amount of the reimbursement in computing its income from a business carried on in Canada pursuant to subsection 9(1) of the Act, it is our position that the reimbursement would not be considered to be a non-government assistance or a contract payment for the purposes of paragraph 127(11.1)(c) of the Act. This position would also apply in respect of an amount that CANCo received or would be entitled to receive under a "fixed-fee" or similar contractual arrangement. Such an amount, in our opinion, normally would not constitute a reimbursement. Accordingly, the reimbursement would not reduce a qualified expenditure incurred by CANCo for ITC purposes pursuant to paragraph 127(11.1)(c). It is our view that this conclusion would not be affected whether (i) NRCo owns all the rights arising under the contract and grants CANCo a right or license to exploit or use the results of the SR & ED, or (ii) NRCo reimburses CANCo for a portion or all of the SR & ED. However, it would be a question of fact whether in any particular case an expenditure on SR & ED would be a qualified expenditure.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 21 of the Circular, this opinion is not a ruling and, accordingly, is not binding on Revenue Canada, Taxation.

We hope our comments will be of assistance to you.

Yours truly, for Director Manufacturing Industries, Partnerships and Trusts Division Rulings Directorate Legislative and Intergovernmental Affairs Branch