Translation disclaimer
This translation was prepared by Tax Interpretations Inc. The CRA did not issue this document in the language in which it now appears, and is not responsible for any errors in its translation that might impact a reader’s understanding of it or the position(s) taken therein. See also the general Disclaimer below.
Principal Issues: [TaxInterpretations translation]
1. What meaning should be given to the word "cost" for the purposes of subsection 37(8)(a)(ii)(B)(V) of the Act? 2. Are the salaries and overhead costs incurred by the taxpayer in manufacturing the engine component part included in the cost of materials referred to in new subsection 127(27) of the Act as proposed in the Notice of Ways and Means Motion dated December 10, 1998 (the "new subsection 127(27) of the Act")? 3. A taxpayer develops a new chemical product for treating wood. Does the wood used for testing constitute material for the purposes of subparagraph 37(8)(a)(ii)(B)(V)? 4. Do the animals used for testing constitute material for the purposes of subparagraph 37(8)(a)(ii)(B)(V)?
Position:
1- Considering that the courts take a purposive approach to tax interpretation, we are of the view that the term "cost" as used in subsection 37(8)(a)(ii)(B)(V) of the Act can be interpreted to mean the cost of production, i.e., the industrial cost price of a commodity. 2- We are of the opinion that the provisions of this new subsection will not apply to salaries and overhead costs incurred for the design of the engine component, since those costs are attributable to property manufactured by the taxpayer. Those costs are therefore not attributable to property acquired from an individual or a partnership. 3-Yes 4 – Yes
Reasons:
ordinary meaning of words and the purposive approach to tax interpretation
January 6, 1999
Directorate General of Audit Headquarters
Tax Incentive Audit Section Resources, Partnerships and
M. Mel Machado, Trusts Division
Interim Manager
Attention: Michel Lefebvre Johanne Desparois, M.Fisc.
7-981672
Cost of equipment for SR&ED purposes
This is in response to your memo dated June 23, 1998, which follows a request for an opinion you received from the Sherbrooke Tax Services Office regarding the interpretation of the word “cost” for the purposes of subparagraph 37(8)(a)(ii)(B)(V) of the Income Tax Act (the “Act”). In addition, you are requesting our opinion on certain amendments proposed in the February 1998 federal budget speech. The issues raised relate to Hypothetical Situations. We apologize for the delay in responding to your request. However, we were awaiting the legislative proposals of October 27, 1998 and the Notice of Ways and Means Motion of December 10, 1998 in order to respond adequately to your memo. As agreed during our telephone conversation (Desparois/ Lefebvre) on November 30, 1998, we have reformulated your questions to take those legislative proposals into account.
YOUR QUESTIONS
1. HYPOTHETICAL SITUATION A
Two corporations (Aco and Bco) each carry on a business in Canada and carry out scientific research and experimental development (SR&ED) in Canada in connection with their business. The SR&ED project of both corporations consists of developing a process for printing cardboard boxes. For their SR&ED project, both corporations need cardboard boxes to conduct printing tests. After the tests, the cardboard boxes are destroyed.
Aco manufactures the cardboard boxes itself. The unit cost of a cardboard box before printing is $1.00 (i.e., $0.50 for raw materials, $0.30 for labour and $0.20 for overhead). Bco purchases the cardboard boxes from another corporation for a unit price of $1.20.
What meaning should be given to the word "cost" for the purposes of subsection 37(8)(a)(ii)(B)(V) of the Act? More specifically, can the “cost of materials consumed” be considered to be $1.00 to Aco and $1.20 to Bco?
To determine the “cost of materials consumed,” must Aco exclude the prescribed expenses referred to in section 2902 of the Income Tax Regulations (the “Regulations”) from its overhead costs for manufacturing cardboard boxes?
Furthermore, should we conclude that the concept of materials varies depending on the SR&ED project?
2. HYPOTHETICAL SITUATION B
An SR&ED project involves the development of a more efficient engine. The taxpayer manufactures one of the engine components. The taxpayer must carry out SR&ED activities to manufacture that engine component. At the end of the project, the taxpayer sells the engine.
Are the salaries and overhead costs incurred by the taxpayer to manufacture the engine component part included in the cost of the equipment referred to in the new subsection 127(27) of the Act as proposed in the Notice of Ways and Means Motion of December 10, 1998 (the “new subsection 127(27) of the Act”)?
3. HYPOTHETICAL SITUATION C
A taxpayer develops a custom product. For the purposes of new subsection 127(27), how should the cost of the component parts of a product developed by the taxpayer be determined where the taxpayer manufactures the component parts of the product and where another taxpayer manufactures those component parts on behalf of the taxpayer in accordance with a contract entered into by the taxpayer?
4. HYPOTHETICAL SITUATION D
A taxpayer develops a new chemical product for treating wood. Does the wood used for testing constitute equipment or supplies? More generally, can a taxpayer have an expense for “equipment” when their research project involves the development of a new process or the improvement of an existing process?
5. HYPOTHETICAL SITUATION E
A taxpayer develops a hormone or enhanced feed to increase the growth of cattle. Are the animals used for testing considered equipment or supplies? Will the provisions of new subsection 127(27) apply upon the eventual disposition of the cattle?
Subsection 37(8)(a)(ii)(B)(V) of the Act provides that the “cost of materials consumed” in the course of SR&ED carried on in Canada is an expense related to SR&ED.
The Act does not define the term “cost of materials consumed” or the words “cost,” “materials” and “consumed.” Consequently, we are of the view that these words should be given their ordinary meaning, taking into account the overall context of the text in which they are used, so that the interpretation is consistent with the spirit of the Act and the intention of Parliament. To determine the intention of Parliament, courts often refer to both the English and French texts of the Act. In the English text, the legislature used the expression “cost of materials consumed” in subsection 37(8)(a)(ii)(B)(V) of the Act.
The word “cost”
According to the 1994 edition of Le Petit Larousse illustré dictionary, the noun “coût” [in English, “cost”] means [TaxInterpretations translation] "price, amount of something (...) Production cost: industrial cost price of a commodity. The Nouveau Petit Robert dictionary defines the noun "cost" as follows: [TaxInterpretations translation] "The sum that something costs. (...) Production cost: direct and indirect expenses incurred in obtaining or manufacturing a product (excluding overheads)." The Concise Oxford dictionary defines the word "cost" as follows: “what a thing costs; the price paid or to be paid”.
Considering that the courts take a purposive approach to tax interpretation, we are of the view that the noun “cost” as used in subsection 37(8)(a) (ii)(B)(V) of the Act can be interpreted to mean the cost of production, i.e., the industrial cost price of a commodity.
The words “material” and “consumed”
According to Le Nouveau Petit Robert dictionary, the noun “matériel” [In English, “material”] means [TaxInterpretations translation] “that which constitutes the body of a thing; the set of objects, instruments, machines used in a service or operation”. The Petit Larousse illustré dictionary, 1994, defines the noun “matériel” as [TaxInterpretations translation] “all the objects and instruments necessary for the proper functioning of an operation, an establishment, the practice of a sport, an activity, etc.; material”.
The Concise Oxford dictionary defines the word “material” as follows: “the matter from which a thing is made”. Furthermore, the English-French dictionary Harrap's translates the word “material” as “substance, matière”, the noun “matériel” as “equipment” and the word “matière” as “material”.
We are of the opinion that the ordinary meaning of the word “material” is more restrictive than that of the word ‘matériel’. We must therefore determine which of the two versions, French or English, best reflects the intention of Parliament. To do this, we looked at the combination of words chosen by Parliament. In the English text, Parliament has associated the word “material” with the verb “consumed”, and in the French text, the word “matériel” is associated with the word ‘consommé’. The Le Petit Larousse illustré 1994 dictionary defines the adjective “consommé” as follows: "which is absorbed, used". The Concise Oxford dictionary defines the word "consumed" as follows: "completely destroy; reduce to nothing or to tiny particles". In general, the jurisprudence uses the latter definition.
Considering the above, we are of the opinion that the noun “matériel” should be interpreted as having the same meaning as the word “material” used in the English text. Consequently, we are of the view that the word “material” used in subsection 38(7)(a)(ii)(B)(V) refers to raw materials, substances or anything that makes up the body of a thing at a given moment in the SR&ED process. Furthermore, we are of the opinion that if Parliament had intended to cover sets of objects and equipment in subsection 37(8)(a)(ii)(B)(V), it would have used the verb “utilize” [in English, “used”] rather than the verb “consommé” [in English, “consumed”]. We are of the opinion that equipment, in the ordinary sense of the term, can be used but cannot be consumed. We also draw your attention to the wording of subparagraph 37(8)(a)(ii)(B)(VI), where parliament chose to use the verb “utilisé” [“used”] to qualify the noun "matériel” [“material”].
Furthermore, we are of the opinion that a property may constitute “materials consumed” in a given SR&ED project without constituting “materials consumed” for another project. We therefore are of the view that the use of the property is a determining factor in establishing whether the property constitutes “materials consumed” for the purposes of subsection 37(8)(a)(ii)(B)(V).
1. HYPOTHETICAL SITUATION A
In Hypothetical Situation A, the SR&ED project of both corporations consists of developing a process for printing cardboard boxes. The corporations use cardboard boxes to conduct tests. Considering that the cardboard boxes are destroyed after the tests, we are of the view that the cardboard boxes are consumed for the purposes of subsection 37(8)(a)(ii)(B)(V). It therefore remains to be determined whether the cardboard boxes used in this project constitute “material” for the purposes of that subsection.
In general, we are of the view that, in order to constitute material referred to in subparagraph 37(8)(a)(ii)(B)(V), cardboard boxes must be either raw materials or substances, or they must form the body of a thing at a given point in the SR&ED process.
We are of the view that the boxes used for printing tests are, in fact, the body of a thing at the overall SR&ED process level since they form the body of the printed boxes. In other words, the cardboard boxes intended for printing form the body of the cardboard boxes that were printed.
On the other hand, it could be argued that the cardboard boxes used for testing do not constitute material referred to in subparagraph 37(8)(a)(ii)(B)(V), since those boxes do not constitute the body of a thing in the printing process and are not raw materials or substances used to perform the printing. However, considering that the courts tend to adopt a purposive approach and considering that section 37 is a tax relieving provision, we are of the opinion that it would be preferable to adopt the first argument. Thus, the cost under subsection 37(8)(a)(ii)(B)(V) would be $1.00 to Aco and $1.20 to Bco.
Furthermore, section 2902 of the Regulations defines what constitutes a “prescribed expenditure” solely for the purposes of the definition of “qualified expenditure” in subsection 127(9) of the Act. Consequently, we are of the opinion that if the cardboard boxes are an integral part of a property in the overall SR&ED process, Aco does not have to exclude the prescribed expenses referred to in section 2902 of the Regulations from its overhead costs for manufacturing the cardboard boxes in order to determine the cost of the materials consumed referred to in subparagraph 37(8)(a)(ii)(B)(V).
2. HYPOTHETICAL SITUATION B
Generally, new subsection 127(27) reduces a taxpayer's SR&ED investment tax credit (“ITC”) where the taxpayer sells or converts to commercial use a property that was originally acquired for use in SR&ED. For this new subsection to apply, the taxpayer must, among other things, acquire from a person or partnership a property whose cost represents a qualified expenditure. Consequently, we are of the opinion that the provisions of this new subsection will not apply to salaries and overhead costs incurred for the design of the engine component, since those costs are attributable to property manufactured by the taxpayer. Those costs are therefore not attributable to property acquired from a person or partnership.
3. HYPOTHETICAL SITUATION C
Considering the comments set out in Hypothetical Situation B above, we are of the view that the cost referred to in new subsection 127(27) corresponds only to the cost of property acquired by the taxpayer from a person or partnership. Consequently, where the property sold is manufactured by the taxpayer, we are of the view that the cost referred to in new subsection 127(27) should not include the wages and overhead costs incurred by the taxpayer in manufacturing the property, since those costs are not incurred to acquire the property from a person or partnership. However, where the taxpayer contracts out the manufacturing of a property, we are of the opinion that the cost referred to in new subsection 127(27) corresponds to the price paid by the taxpayer to obtain the property.
4. HYPOTHETICAL SITUATION D
As in Hypothetical Situation A, it can be argued that the wood used to conduct tests does not constitute material referred to in subparagraph 37(8)(a)(ii)(B)(V) since, on the one hand, the wood does not form part of the body of a thing at the level of the chemical developed and, on the other hand, it is not a raw material or a substance consumed in the developed chemical product. However, considering that the courts tend to adopt a purposive approach and considering that section 37 is a tax relieving provision, we are of the view that it would be preferable to consider that the wood used for testing is in fact the body of a thing in terms of the overall SR&ED process, since it constitutes the body of the treated wood. In other words, the wood intended for testing constitutes the body of the treated wood.
5. HYPOTHETICAL SITUATION E
Considering that the courts tend to adopt a purposive approach and considering that section 37 is a tax relieving provision, we are of the opinion that cattle used for testing in Hypothetical Situation E could be an expense referred to in subparagraph 37(8)(a)(ii)(B)(V), provided that the cattle are “consumed.” In addition, we are of the view that the provisions of new subsection 127(27) could apply if, among other things, the cost of the cattle represents a “qualified expenditure” of the taxpayer.
We hope you find these comments useful. If you require any further information regarding the content of this document, please do not hesitate to contact us.
Marc Vanasse, CA
Manager
Resources, Partnerships
and Trusts Section
Income Tax Rulings and
Interpretation Directorate
Policy and Legislation Branch
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