6 April 1994 External T.I. 9331715 - SAFE INCOME AND SRED EXPENDITURES

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.

Principal Issues:

Effects of scientific research and exp dev on safe income on hand

Position TAKEN:

CURRENT SRED Expenses deducted in the computation of Safe Income on Hand in the year that it is paid out or incurred whereas capital SRED Expenses are deducted in the computation of Safe Income on Hand in the year that the amount is claimed as a deduction in the computation of the corporation's taxable income.

Reasons FOR POSITION TAKEN:

Position consistent with papers presented by J. Robertson in 1981 and M. Hiltz in 1991.

			933171

XXXXXXXXXX M.P. Sarazin

Attention: XXXXXXXXXX

April 6, 1994

Dear Sirs:

Re: Income earned or realized after 1971 ("Safe Income")
Scientific Research and Experimental Development Expenditures

This is in reply to your letter dated October 29, 1993 wherein you requested our comments regarding the effects that undeducted scientific research and experimental development expenditures ("SRED Expenses") have on the calculation of a corporation's Safe Income and safe income on hand ("Safe Income on Hand"). Unless otherwise stated, all statutory references are to the Income Tax Act S.C. 1970-71-72, c.63, as amended, consolidated to June 10, 1993 (the "Act").

A taxpayer who carries on business in Canada may deduct current and capital expenditures that are made in Canada for scientific research and experimental development carried on in Canada in the year the expenditure is made or he may carry forward these expenditures to any future year as long as the business to which they relate continues to be carried on in that year. Both current and capital SRED Expenses are added to a pool (the "Pool") and the taxpayer is entitled to deduct any amount that does not exceed the balance in the Pool at the end of the year in computing its income for income tax purposes for that particular year. In addition, there is no segregation between the current and capital SRED Expenses within the Pool.

Based upon your enquiries and research, you believe that current and capital SRED Expenses incurred by a corporation only reduce its Safe Income in the year that such SRED Expenses are claimed as a deduction by the corporation. However, while current SRED Expenses would reduce the corporation's Safe Income on Hand in the year that such expenditures are incurred regardless of when such expenditures are claimed as a deduction by the corporation, capital SRED Expenses would reduce Safe Income on Hand in the year in which they are deducted for tax purposes by the corporation.

You are of the view that the current SRED Expenses should be treated in the same manner as the capital SRED Expenses for purposes of the calculation of a corporation's Safe Income on Hand. Since the current SRED Expenses are treated in the same manner as the capital SRED Expenses for the purposes of computing the corporation's income under the Act and for the purposes of computing its Safe Income then the current and capital SRED Expenses should also be treated in the same manner for the purposes of the calculation of computing the corporation's Safe Income on Hand. In addition, such treatment of the current SRED Expenses is inconsistent with the treatment of other expenditures that are pooled for purposes of determining the amount that may be deducted in the calculation of the corporation's income (e.g. capital cost allowance).

Our Comments

In order to contribute to a gain on a share, we are of the view that income earned or realized by a corporation must be on hand. Consequently, Safe Income on Hand with respect to a share of a corporation refers to the portion of the income earned or realized by the corporation during the relevant period of time that could reasonably be considered to contribute to the capital gain that would be realized on a disposition at fair market value of the share at that time.

Generally, a corporation's annual Safe Income consists of its net income for tax purposes as adjusted by paragraph 55(5)(b), (c) or (d), as the case may be. Certain deductions in computing taxable income (e.g. charitable donations), income taxes, dividends and other expenses which are either non-deductible or which have not been deducted for income tax purposes are then deducted in computing a corporation's Safe Income on Hand. Consequently, we agree with your understanding that the SRED Expenses will only reduce the Safe Income of a corporation in the year that the amounts in the Pool are deducted in the determination of the particular corporation's net income for tax purposes. However, it is essential for the purposes of subsection 55(2) of the Act to determine whether a gain inherent in the shares of the corporation would be attributable to Safe Income on Hand and/or attributable to something else, e.g. an unrealized gain in respect of property of the corporation.

Even though the current SRED Expenses may not have been claimed as a deduction in computing a corporation's net income for tax purposes, it is our view that the current SRED Expenses represent amounts that have been paid out by the corporation in the course of its operations and these amounts would not be available for distribution to the corporation's shareholders. Therefore, the current SRED Expenses would have to be deducted in computing the corporation's Safe Income on Hand because they would not contribute to the gain inherent in the corporation's shares. However, the subsequent deduction of the current SRED Expenses will not result in a second reduction of the corporation's Safe Income on Hand.

Since capital SRED Expenses generally relate to the acquisition of property by a taxpayer, we are of the view that a corporation's Safe Income on Hand will not be reduced by the amount of its capital SRED Expenses until the year that such amounts are claimed as a deduction in computing the corporation's net income for tax purposes.

The treatment of current and capital SRED Expenses in the calculation of a corporation's Safe Income on Hand, as described above, is consistent with the following comments from a paper presented by Mr. J.R. Robertson at the 33rd Tax Conference of the Canadian Tax Foundation held in 1981 and found at page 90 of the 1981 Conference Report:

"A deduction for any expense incurred or disbursement made in the period that was not allowed or not claimed as a deduction in computing income will reduce safe income. However, there will be no deduction for an expense incurred or disbursement made in respect of the acquisition of property, an eligible capital expenditure, or a repayment on account of the principal amount of a loan."

As stated in paragraph 21 of Information Circular 70-6R2 dated September 28, 1990, the opinions expressed in this letter are not rulings and are consequently not binding on the Department.

Yours truly,

for Director
Reorganizations and Foreign Division
Rulings Directorate
Legislative and Intergovernmental
Affairs Branch