25 August 1994 External T.I. 9417185 - 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.

		941718
XXXXXXXXXX	F.B. Fontaine

Attention: XXXXXXXXXX

August 25, 1994

Dear Sirs:

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

This is in reply to your letter dated June 21, 1994 wherein you outlined a situation in which a Canadian corporation ("Canco") performs SR&ED in Canada that is funded by Canco's non-resident parent corporation ("USco"). Pursuant to an agreement, USco will have beneficial ownership of any intellectual property arising from the SR&ED and Canco will acquire rights to utilize such intellectual property in its business in consideration of payment of a royalty to USco. You have requested us to confirm the tax implications to Canco of performing the SR&ED on behalf of USco as they relate in particular to the deductibility of expenditures by Canco under section 37 of the Income Tax Act (the "Act") and the availability of the investment tax credit ("ITC") in respect of such expenditures under section 127 of the Act.

Based on the Department's comments in paragraph 21 of Information Circular 70-6R2 (the "Circular") with regard to a requested interpretation relating to a contemplated or completed transaction, we are unable to provide confirmation of the income tax effects of the particular situation. However, we are prepared to offer the following general comments:

(1) Both subparagraphs 37(1)(a)(i) and 37(1)(b)(i) of the Act 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 a taxpayer under an arrangement with another taxpayer is related to the taxpayer'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 the 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. Provided the related-to-business test is met with regard to SR&ED carried on by the taxpayer in Canada and the appropriate prescribed form is filed, the taxpayer would be entitled to a deduction of SR&ED expenditures pursuant to subparagraphs 37(1)(a)(i) and 37(1)(b)(i) of the Act.

(2) In order that a SR&ED 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 that term is defined under section 2902 of the Income tax Regulations (the "Regulations").

(3) For the purposes of calculating a taxpayer's ITC, paragraph 127(11.1)(c) of the Act specifies that a qualified expenditure must be reduced by certain amounts, including a "non-government assistance" payment and a "contract payment", as these terms are defined under subsection 127(9) of the Act, 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 the taxpayer in respect of an outlay or expense, 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.

(4) Where, under a contractual arrangement, a non-resident taxpayer does not carry on any business in Canada and reimburses a taxpayer in respect of SR&ED expenditures incurred by the taxpayer in Canada and the taxpayer includes the amount of the reimbursement in computing the taxpayer's 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. Accordingly, the reimbursement would not reduce a qualified expenditure incurred by the taxpayer for ITC purposes pursuant to paragraph 127(11.1)(c) of the Act. Also, by virtue that the reimbursement would not be deductible by the non-resident person in computing Part I tax, the amount would not be a prescribed expenditure for the purpose of subparagraph 2902(e)(ii) of the Regulations. It is our view that these conclusions would not be affected whether the non-resident taxpayer owns all the rights arising under the contract and grants the taxpayer a right or license to exploit or use the results 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, it is not binding on Revenue Canada, Customs, Excise and Taxation.

We hope our comments will be of assistance to you.

Yours truly,

for Director
Manufacturing Industries,
Partnerships and Trusts Division
Rulings Directorate
Policy and Legislation Branch