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.
W.A. Fulton Specialty Rulings
Chief Directorate
Audit Programs Directorate D. Turner
Scientific Research Audit 957-2094
Applications Section
Attention: R.P. Laramy
Scientific Research and 7-4191
Experimental Development
("SR & ED") Corporations
This is in reply to your memorandum of July 26, 1989, concerning the statements made in our memorandum of April 28, 1989. In your memorandum you have requested the following:
21(1)(b)
Our Comments
Our comments assume that the corporation involved is a sole purpose SR & ED Company defined as a corporation that derives all or substantially all of its revenue from the prosecution of SR & ED, that the expenditures were made in and after 1973 and the expenditures are of a current nature. Given these assumptions, the definition of "investment tax credit" in subsection 127(9) of the Income Tax Act (the "Act") states that a taxpayer's investment tax credit will be a specified percentage of the taxpayer's "qualified expenditures" made in the year. In order to meet the requirements of a "qualified expenditure" in subsection 127(9) of the Act, the expenditure must be an expenditure as described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Act and not be a "prescribed expenditure" as defined in section 2902 of the Regulations to the Act (the "Regulations"). If a corporation derives all or substantially all of its revenue from the prosecution of SR & ED, its expenditures are excluded from the definition of "prescribed expenditures" in section 2902 of the regulations. However, each expenditure must still satisfy the requirements of paragraph 37(1)(a) or subparagraph 37(1)(b)(i) of the Act. As the expenditures are not capital expenditures subparagraph 37(1)(b)(i) of the Act is not applicable. Paragraph 37(1)(a) which is applicable requires that each expenditure be made on "scientific research and experimental development". Thus even a corporation which receives all or substantially all of its revere from the prosecution of SR & ED will only receive investment tax credits on its expenditures made on SR & ED.
The definitions of SR & ED and expenditures on SR & ED are contained in paragraph 37(7)(b) and 37(7)(c) of the Act. Paragraph 37(7)(b) of the Act states that SR & ED has the meaning given in section 2900 of the Regulations and clauses 37(7)(c)(ii)(A) & (B) of the Act state that for expenditures of a current nature made in Canada, an expenditure on SR & ED is an expenditure, incurred for and all or substantiallv all attributable or directly attributable, as determined bv relation (subsections 2900(2) & (3) of the Regulations), to the prosecution, or to the provision of premises, facilities or equipment for the prosecution of SR & ED. Thus for a sole purpose SR & ED company to receive investment tax credits, an expenditure must still meet the requirements of being an expenditure incurred for and all or substantially all attributable to SR & ED as defined in subsection 2900(1) or directly attributable to SR & ED as provided for in subsections 2900(2) & (3) of the Regulations.
Based on the above analysis of the law which applies to sole purpose SR & ED companies, we offer the following comments:
1) In order for Costs associated with the bidding process to be eligible for ITC's they must satisfy the requirements of either 37(7)(c)(ii)(A) of the Act as being expenditures incurred for and all or substantially all attributable to SR'& ED as defined in subsection 2900(1) of the Regulations or subsections 2900(2) or (3) of the Regulations as being directly attributable to the prosecution of SR & ED. Our comments related to these subsections are as follow:
a) Subsection 2900(1):
In our opinion, the fact that the overall purpose of a
company or program is SR & ED (as defined in subsection
2900(1) of the Regulations) does not ensure that every
expenditure of the company will qualify as SR & ED, if
this were the case, sole purpose SR & ED companies
could have been excluded from the requirements in
subparagraph 37(7)(c)(ii) of the Act. As such, each
expenditure must be looked at on its own merits and we
must consider the bidding costs themselves in relation
to the company's overall SR & ED activities when
considering whether bidding costs are eligible for
ITC's. Generally, bidding activities will not be all
or substantially all attributable to SR & ED as defined
in subsection 2900(1) of the Regulations as SR & ED
would have to be carried out in order for an
expenditure to be attributable to it. In addition,
they could not be considered to be all or substantially
all attributable to support activities such as
engineering or design, operations research,
mathematical analysis, computer programming or
psychological research. The bidding costs may or may
not eventually lead to the taxpayer receiving an SR &
ED contract and SR & ED subsequently occurring. The
bidding costs appear more likely to be substantially
all attributable to increasing the company's business.
b) Subsection 2900(2):
A review of this subsection indicates that paragraph
(c) would include the bidding costs as directly
attributable to SR & ED if they relate directly to the
prosecution of SR & ED and would not have been incurred
if such prosecution had not occurred. Bidding costs
may relate to successful and unsuccessful bids with the
following results: 1) here a bid is unsuccessful the company will not
carry out the prosecution of SR & ED against which
the bid is directly related and as such the first
test in paragraph (c) will not be met. The second
test in the paragraph will not be met either as
the unsuccessful bidding costs were made even
though prosecution of SR & ED had not occurred. 2) here the company is successful in its bid and SR &
ED occurs the second test has still not been met
as the costs would have been incurred even if the
bid were unsuccessful and such SR & ED had not
occurred. From the above, it appears that
generally bidding costs, whether successful or
unsuccessful, do not satisfy the requirements in
paragraph (c) and would not be considered directly
attributable to the prosecution of SR & ED. In
our view, bidding costs are attributable to the
creation of business for a particular company, as
opposed to SR & ED.
c) Subsection 2900(3):
This subsection would not apply to bidding costs as
they do not relate to the provision of premises,
facilities or equipment.
2) In our opinion, there is no support, in law, for a position that all current expenditures attributable to the business of the prosecution of SR & ED of a sole purpose SR & ED company would be considered to be directly related to the actual prosecution of SR & ED. Each expenditure must be considered on its own merits for purposes of Section 2900 or the Regulations. Examples of some expenditures which would not qualify under clause 37(7)(c)(ii)(A) of the Act are:
a) Expenditures not related to a sole purpose SR & ED
company's SR & ED activities. As a company need only
derive 90% of its revenue from the prosecution of SR &
ED or the sale of rights in or arising out of SR & ED
carried on by it in order to qualify as a sole purpose
SR & ED company, many expenditures may relate to its
other activities and as such not qualify. For example,
a company which carries on two businesses, one being SR
& ED and the other the marketing of widgets, would find
that none of its expenditures related only to the
widget business would qualify. In addition, it may
find that although 901 of its revenue is derived from
Sfi & ED, less than 90% of its expenditures relate to
SR & ED. As such a common or shared expenditure of the
two businesses such as for personnel services,
management, or accounting, etc. may not `meet the all
or substantially all attributable test as it is not 90%
or more attributable to SR & ED. b) In a sole purpose SR & ED company selling the results
of its SR & ED expenditures related to marketing
activities would not qualify under clause (A). c) The training of staff to carry out SR & ED activities
would likely qualify however, the training of staff to
carry out management, marketing or other functions may
not be considered to be substantially all attributable
to SR & ED. It should be noted that capital expenditures are
restricted by other provisions in the Act.
3) In our view, the criteria to be used to differentiate an expenditure than qualifies for SR & ED purposes from one that does not for sole pulpose SR & ED corporations are the same criteria as those used for any other taxpayer.
21(1)(b)
In our opinion, where paragraph 2900(2)(c) being considered, a taxpayer will meet the requirements of the paragraph where he can show that SR & ED was actually carried out which related directly to the expenditure and that the expenditure would not have occurred if the research had not occurred. Bidding, advertising, entertainment, and many other expenditures will generally not meet the above criteria as they do not directly relate to specific SR & ED activities and would be incurred whether or not SR & ED occurred.
4) Subparagraph 2902(a)(i) of the Regulations serves to restrict the eligibility for the ITC of a general administration or management expenditure which might otherwise qualify as a SR & ED expenditure as described in paragraph 37(1)(a), where the expenditure is incurred by a taxpayer who does not derive all or substantially all of his revenue from the prosecution of SR & ED or the sale of rights in or arising out of SR & ED carried on by him. The subparagraph should not be interpreted to mean that a sole purpose SR & ED company can receive ITC's on all of its general administration expenses; it simply means that it is entitled to ITC's on its general administration expenses that meet the other requirements of the Act related to SR & ED expenditures.
We trust our comments will be of assistance.
B.W. Dath Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch
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