25 February 1993 Income Tax Severed Letter 9232315 - R & D Meaning of "Carried on"

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.

                                           923231
XXXXXXXXXX                                 Marc Vanasse
                                           (613) 957-8953

Attention: XXXXXXXXXX

February 25, 1993

Dear Sirs:

Re: Technical Interpretation

This is in reply to your letter dated October 26, 1992, wherein you request a technical interpretation on the application of subsections 37(1), 85(1.1), 127(9), section 127.1 and paragraph 37(7)(e) of the Income Tax Act (the "Act"). We apologize for the delay in responding to your request.

The particular circumstances outlined in your letter appear to be contemplated transactions involving specific taxpayers. As mentioned in paragraph 21 of Information Circular 70-6R2, dated September 28, 1990, it is not the practice of this Department to issue opinions with respect to proposed transactions other than in the form of advance income tax rulings. This Directorate is therefore not in a position to give a definitive response to your inquiry. However, we are prepared to offer you the following general comments which may be of some assistance.

Eligible property, as defined in subsection 85(1.1) of the Act, includes namely an eligible capital property, a capital property (other than real property owned by a non-resident) and an inventory (other than real property). Certain licences and patents issued for a limited period in respect of property (other than inventory) constitute depreciable property included in Class 14 of Schedule II of the Income Tax Regulations (the "Regulations"). Patents and licences issued for an unlimited period of time or excluded from Class 14 by virtue of paragraphs (a) to (d) thereof and know-how are generally considered eligible capital property within the meaning of paragraph 54(d) of the Act. Therefore, licences, patents and know-how will generally constitute eligible property under subsection 85(1.1) of the Act, whether they constitute Class 14 property, eligible capital property or inventory (other than real property).

The question of whether a taxpayer (referred to in your letter as "a sole purpose scientific research and experimental development company") derives all or substantially all of his revenue from the prosecution of scientific research and experimental development (SR & ED) carried on by him is a question of fact that can only be determined after a careful review of all the facts and surrounding circumstances, which is normally done by our District Taxation Offices in the course of tax audits. A taxpayer who contracts with another person in order that this person performs SR & ED on his behalf and who pursues no activities, other than (1) retaining the rights pertaining to any results from the SR & ED performed and (2) commercializing these rights or results, cannot be said to derive substantially all of his revenue from the prosecution of SR & ED carried out by him, within the meaning of paragraph 2902(a) of the Regulations. Furthermore, revenue derived from the commercial exploitation of products or processes developed by using the know-how, including, for example, the sale of computer software, does not constitute revenue from the prosecution of SR & ED, within the meaning of paragraph 2902(a) of the Regulations, but rather it constitutes the sale of finished products. It is our view that revenue arising from the prosecution of SR & ED generally envisages the provision of scientific research for a fee or a sale of the know-how developed, i.e. the rights.

Whether paragraph 37(7)(e) of the Act would apply in a particular case would depend on whether or not the taxpayer can be said to derive all or substantially all of his revenue from the prosecution of SR & ED.

With respect to the availability of a refundable investment tax credit, subsection 127(10.1) of the Act provides that a Canadian-controlled private corporation and all associated corporations whose aggregate taxable income do not exceed the business limit of $200,000 in the immediately preceding taxation year, are entitled to a 35% investment tax credit in respect to the first $2,000,000, in the aggregate, of qualified expenditures in each taxation year.

The status of a small business corporation, within the meaning of subsection 248(1) of the Act, has to be determined at a specific "particular time". We are not in a position to comment as to the status of a corporation to be created in the future.

On the dissolution of a small business corporation, shareholders of the corporation, dealing at arm's length with the corporation, who suffer a capital loss, may, subject to the provisions of subsection 39(9) of the Act, claim an allowable business investment loss.

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