Materials for SR&ED Policy

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Materials for SR&ED Policy

Date: December 18, 2014

Changes to the Materials for SR&ED Policy

Reasons for revision

This revision accommodates the legislative changes that have been announced.

Revision overview

As a result of the 2012 federal budget, starting January 1, 2014, expenditures for capital property or for the right to use property (lease) no longer qualify for scientific research and experimental development (SR&ED) tax incentives. The reference to capital expenditures has been removed from this policy document.

Legislation amending the wording in subclause 37(8)(a)(ii)(B)(V) of the Income Tax Act to “cost of materials consumed or transformed” was enacted in 2013.

The text of this document has been revised to reflect these changes, see Appendix B.1 Explanation of changes.

Table of contents

1.0 Purpose

The purpose of this document is to clarify the position of the Canada Revenue Agency (CRA) regarding materials when administering the scientific research and experimental development (SR&ED) legislation under the federal Income Tax Act and the Income Tax Regulations.

1.1 Introduction

This document discusses materials for SR&ED and not materials in the general sense of the word.

The cost of materials for SR&ED can be claimed in two situations:

  • when materials are consumed in the prosecution of SR&ED, or
  • when materials are transformed in the prosecution of SR&ED.

The cost of materials consumed or transformed in the prosecution of SR&ED in Canada is an SR&ED expenditure under both the traditional method and the proxy method for determining SR&ED expenditures. To claim the cost of a material, the expenditure must be an expenditure of a current nature. Generally, expenditures such as for the purchase of equipment, data, or a software license, are not expenditures of a current nature. They are rather expenditures of a capital nature.

An SR&ED expenditure, including one for materials, can result in an investment tax credit (ITC) as long as the amount in respect of the expenditure is paid in the tax year or within 180 days after the tax year. For more information on unpaid expenditures, please refer to section 4.0 of the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy, and for information on ITC, please refer to the SR&ED Investment Tax Credit Policy. For information on eligibility of work, please refer to the Eligibility of Work for SR&ED Investment Tax Credits Policy.

Material can be purchased from Canadian or foreign suppliers and its cost can be claimed as a material consumed / transformed expenditure when the material is used directly in the prosecution of SR&ED in Canada.

2.0 Legislation

2.1 Material expenditures under the traditional method

For claimants using the traditional method, a current expenditure that is all or substantially all (ASA) attributable to the prosecution of SR&ED in Canada or that is directly attributable to such prosecution is considered an SR&ED expenditure. For the purpose of the directly attributable rules, an expenditure, directly attributable to the prosecution of SR&ED , includes the cost of materials consumed or materials transformed in such prosecution in Canada.

Legislative references Income Tax Act
Subclause 37(8)(a)(ii)(A)(I) SR&ED expenditures in Canada under the traditional method – ASA
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative reference Income Tax Regulations
Paragraph 2900(2)(a) Expenditures directly attributable to the prosecution of SR&ED – Traditional method – Cost of materials consumed or transformed

2.2 Material expenditures under the proxy method

For claimants using the proxy method, a current expenditure that is in respect of the cost of materials consumed or transformed in the prosecution of SR&ED in Canada is considered an SR&ED expenditure.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed

2.3 Terminology

Neither the Income Tax Act nor the Income Tax Regulations define the expression “materials consumed or transformed in the prosecution of SR&ED in Canada” or the words “cost,” “materials,” “consumed,” and “transformed.” Therefore, these words must be given their ordinary meaning, taking into account the overall context of the Act, so that the adopted interpretation is consistent with the spirit of the Act and the legislator’s intent. Please refer to the sections below for a description and explanation of these concepts and terms.

3.0 Cost of Materials

What meaning should be given to the term “cost of materials for SR&ED” for the purposes of the Income Tax Act and the Income Tax Regulations?

In the case of merchandise purchased for resale or specifically for SR&ED, or raw materials acquired for a manufacturing process or specifically for SR&ED, cost means laid-down cost. This includes invoice cost, custom and excise duties, transportation, other acquisition costs, and storage costs. Therefore, cost in the phrase “cost of materials” means the original cost to acquire an item plus all reasonable costs to bring that particular item to its condition and location to be consumed or transformed in the prosecution of SR&ED. In general, the determination of cost of materials should follow the generally accepted accounting principles adopted by the claimant.

In the case of inventories of goods that the claimant manufactures for its commercial operations or specifically for SR&ED, cost can include the production cost or the industrial cost price of a product. It includes the laid-down cost of materials plus the costs of direct labour applied to the product and the share of overhead expense properly chargeable to production. For more details, refer to Interpretation Bulletin IT-473R, Inventory Valuation, under the section “Meaning of cost.” Note that the cost of materials for SR&ED purposes will be the same whether the claimant uses the traditional method or the proxy method. Production overhead expenses should be included in the cost of producing the material even when the claimant uses the proxy method (see Example 1).

The cost of a material for SR&ED can only be claimed as an SR&ED expenditure in the year in which the material is consumed or transformed in the prosecution of SR&ED in Canada and not when the material is removed from inventory for use in SR&ED, manufactured (with no experimental development), or received from a supplier. For information on materials consumed, see section 5.0 and for materials transformed, see section 6.0.

For examples of determining cost, see section 7.0, Example 1 and Example 2.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed

Legislative reference Income Tax Regulations
Paragraph 2900(2)(a) Expenditures directly attributable to the prosecution of SR&ED – Traditional method – Cost of materials consumed or transformed

3.1 Materials purchased from non-arm’s length parties

The SR&ED investment tax credit earned by a claimant on the cost of materials for SR&ED purchased from a non-arm’s length person or partnership is based on the cost incurred by the non-arm’s length party (it excludes any profit element), even though the actual cost the claimant incurred can be claimed as an SR&ED expenditure. For an explanation, please refer to section 12.0, “Purchase of goods and services from non-arm’s length suppliers,” of the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy.

Legislative Reference Income Tax Act
Subsection 127(11.6) Non-arm's length costs

4.0 Materials for SR&ED

According to the CRA’s interpretation, the term “materials for SR&ED” refers to all the raw materials, substances, or other items, that compose the body of a thing at a given moment in the SR&ED process.

For the purposes of this interpretation:

  • the raw materials, substances, or other items must be physical and tangible;
  • the term “thing” refers to a tangible object; and
  • the term “tangible” generally means in a solid, liquid, or gaseous state.

In applying this interpretation, the CRA considers whether a raw material, substance, or other item composes the body of a thing in the overall SR&ED process rather than restricting the interpretation to only the new or improved materials, devices, products or processes being developed. Raw materials, substances, or other items will qualify as materials for SR&ED under this interpretation if, at a given moment in the prosecution of SR&ED, they compose the body of either:

  • a tangible object on which the SR&ED is being carried out; or
  • a tangible object that results from the SR&ED that is being carried out.

Where the creating of a new process or improving an existing one involves SR&ED, the raw materials, substances, or other items may only qualify as materials for SR&ED if, at a given moment in the SR&ED process, they compose the body of a tangible object involved in testing the new or improved process.

Note
A thing may be an intermediate product, a by-product, or the final product.

To be considered an expenditure of a material for SR&ED, the expenditure must first be an expenditure of a current nature. This does not mean that an expenditure that normally would have been considered an expenditure of a capital nature can never be claimed as an expenditure for materials for SR&ED. In a situation where a component part is included in a custom product or a commercial asset, it may be considered an expenditure of a current nature. For example, a new engine, being the subject of the SR&ED, incorporated in a machine that is a commercial asset would be treated as materials for SR&ED. The engine incorporated into this machine could be claimed as a material transformed in the prosecution of SR&ED (see section 6.0) expenditure. It is important to note that when the machine is sold or converted to commercial use, the investment tax credit (ITC) recapture rules may apply to recapture the ITC relating to the cost of the engine.

For examples of what constitutes materials for SR&ED, see section 7.0, Example 3 and Example 4.

4.1 Materials vs. overhead expenditures

Determining if a particular item is a material for SR&ED is a question of fact that can only be made on a case-by-case basis. When an item does not qualify as material for SR&ED, the associated expenditure may be allowable as an overhead or other expenditure when using the traditional method.

The CRA considers that certain items, even if they may be used in carrying out SR&ED work, are not materials for SR&ED, for example:

  • cleaning products
  • discs used in computers
  • test tubes, pipettes, vials, bottles, beakers, flasks, dishes, and other similar glass or plastic ware
  • microscopes, incubators, Bunsen burners, measuring appliances
  • filter papers
  • acids, solvents, lubricants, soaps, and other similar items used in processing

These items would normally not be considered materials for SR&ED because they would not compose the body of a thing on which the SR&ED is performed at a given moment in the SR&ED process (see section 4.0), unless they are the subject of the SR&ED.

For more examples of items that are not materials for SR&ED, see section 7.0, Example 5.

4.2 Animals and growing things

Animals and growing things (for example, plants) involved in the prosecution of SR&ED can be materials for SR&ED (see section 4.0) if they compose the body of a thing at a given moment in the SR&ED process. For example, animals used in testing, as part of the SR&ED work, would normally meet this requirement. The cost of the animals or growing things may be claimable as materials consumed (see section 5.0) or transformed (see section 6.0) in the prosecution of SR&ED. However, the treatment of the cost of animals or growing things as SR&ED expenditures is a question of fact. When animals or growing things are involved in SR&ED, a control group (for example, a group that does not receive the new treatment being studied) is commonly used for comparison or monitoring purposes with the study group that is involved in SR&ED. In commercial production, animals and growing things that are part of the control group are not normally materials for SR&ED (see section 4.0), since usually no SR&ED activity is performed on them.

When the cost of the animals or growing things involved in the SR&ED work results in investment tax credit (ITC), the subsequent sale of these animals (live or in their processed form) or growing things, may result in ITC recapture.

When animals or growing things involved in SR&ED are considered to be materials for SR&ED, the animal feed, plant fertilizer, pesticides, herbicides, and fungicides, as the case may be, may also be considered to be materials for SR&ED. Generally, the CRA considers the cost incurred for the animal feed, plant fertilizer, pesticides, herbicides, and fungicides, as an expenditure for materials consumed in the prosecution of SR&ED (see section 5.0), except in situations where the SR&ED occurs in conjunction or simultaneously with commercial production. When SR&ED occurs in conjunction or simultaneously with commercial production, a portion or all of the animal feed, plant fertilizer, pesticides, herbicides, and fungicides used for the animal or growing thing, would be associated with commercial work. Consequently, only the additional (incremental) cost incurred for the animal feed, plant fertilizer, pesticides, herbicides, and fungicides that is attributable to SR&ED would be allowed as cost of materials consumed in the prosecution of SR&ED. The cost of these items that relates to what would have in any case been consumed in normal commercial production of animals or growing things is not attributable to the prosecution of SR&ED. For more information on production and SR&ED, please refer to the SR&ED During Production Runs Policy .

For an example of growing things, see section 7.0, Example 5.

4.3 Energy and water

The following discussion is specific to energy and water and should not be referred to for other situations.

Cost of utilities directly related to the prosecution of SR&ED (water, fuel, electricity, oil, etc.) are generally not materials for SR&ED. Costs related to these items are overhead and other expenditures that can be claimed only when using the traditional method. However, there are circumstances where energy used in the prosecution of SR&ED can be considered as part of the cost of materials for SR&ED (see section 4.3.1).

4.3.1 Situations where the cost of energy is considered part of the cost of materials for SR&ED

Endothermic reactions, for example, those in the chemical, petrochemical, pharmaceutical, and biotechnology industries, most metallurgical refining processes, production of cement, glass, ceramics, and other industrial raw materials, as well as most forming operations in the plastics industry require significant energy input directly into the process. In physical terms, the intermediate and final products of these processes may retain this energy in their new form.

With respect to energy as a material, some of the energy sources used in a production plant can be part of the chemical / physical process, that is, energy is part of the conversion / production process and is integral to the chemical reaction on which the process is based. Where the energy becomes part of the conversion / production process and is integral to the chemical reaction on which the process is based on, or where the energy source is the subject of the SR&ED, the cost of energy source can be claimed as materials consumed in the prosecution of SR&ED (see section 5.0) expenditure.

In some cases, a certain amount of energy may be used to produce a component that will then be used in SR&ED. If producing that component does not involve SR&ED, the cost of the energy will be considered an element of the cost of the component. Subsequently, if the component is used in SR&ED, the cost of the energy used in producing the component will not be subject to investment tax credit (ITC) recapture when the component is sold or converted to commercial use.

4.3.2 Situations where the cost of energy is not considered part of the cost of materials for SR&ED

When energy does not become part of the conversion / production process involving SR&ED, it cannot be considered materials for SR&ED.

The energy costs incurred (natural gas, electricity, oil, etc.) to operate equipment used in SR&ED do not form part of the cost of materials for SR&ED. The cost of heat energy, used to maintain the ambient temperature where the SR&ED occurs (for example, maintaining the temperature of a lab, greenhouse, furnace, facility, incubator, or plant), cannot be claimed as a cost of materials for SR&ED. However, these costs of energy could qualify as overhead and other expenditures under the traditional method if these costs are directly related and incremental to the prosecution of SR&ED.

4.3.3 Is water a material for SR&ED?

Generally, water used to carry out SR&ED work is not considered to be a material for SR&ED. Its cost could be treated as SR&ED overhead and other expenditures only under the traditional method. However, there are circumstances where the cost of water used in the prosecution of SR&ED could be considered part of the cost of materials for SR&ED.

In many industries, for example, chemical, petrochemical, oil and gas, mineral, pulp and paper, and textile industries, water is usually separated into several streams:

  • process water, like any other feed (input) material, that enters the process and becomes part of intermediate or final product, as governed by the chemical equations that the process is based on;
  • utility water, used throughout the plant; and
  • boiler feed water, used to generate steam on site.

The process water stream is often pre-treated in order to conform to specifications unique to the process. Once water enters the process, it is for all practical purposes rendered useless and valueless as process water feed even if it is recovered. In cases where SR&ED is performed, the process water stream would meet the interpretation of materials for SR&ED and would be considered as materials consumed in the prosecution of SR&ED as long as this water is not also used in commercial production.

Utility water, including water used for washing down the floor is not allowed as materials for SR&ED. Boiler feed water used to generate steam for heat or energy is also not allowable as a material for SR&ED. Where the traditional method is used, the cost of utility water or boiler feed water may be claimable as an SR&ED overhead and other expenditures.

In order to claim the cost of water as materials for SR&ED, the claimant must clearly identify and document the portion of the water consumed in the prosecution of SR&ED. Any allocation method used must be reasonable, supportable, and verifiable.

5.0 Materials consumed in the prosecution of SR&ED

The ordinary meaning of the word consumed is “absorbed, used up, or broken down into small pieces.” ”Material consumed in the prosecution of SR&ED” basically means that the material was destroyed or rendered virtually valueless as a result of the SR&ED. If a material, that meets the interpretation of a material for SR&ED (see section 4.0), is consumed so that 90% or more of its cost was consumed in the prosecution of SR&ED, then the entire cost of the material is allowable as a cost of material consumed in the prosecution of SR&ED.

Materials not consumed in SR&ED include materials in inventory or those which form part of a custom product, commercial asset, or output of commercial production. Similarly, in the case of experimental production sold for more than 10% of the original cost, the materials used in the experimental production are considered not to have been consumed in the prosecution of SR&ED. When materials for SR&ED have not been rendered virtually valueless after the SR&ED, the materials may have been transformed in the prosecution of SR&ED, see section 6.0.

Materials destroyed or rendered virtually valueless but not as a result of the SR&ED performed cannot be claimed as materials consumed in the prosecution of SR&ED.

It is important to note that the cost of materials for SR&ED can be claimed in the tax year the SR&ED material was consumed in the prosecution of SR&ED (see section 3.0).

5.1 Examples of materials consumed in the prosecution of SR&ED

  • Components destroyed in testing that was commensurate with the needs and directly in support of the basic research, applied research, or experimental development work. For more information on testing and SR&ED, please refer to the Eligibility of Work for SR&ED Investment Tax Credits Policy.
  • Input materials that formed part of the experimental production and were consumed or rendered virtually valueless in the prosecution of SR&ED.
  • The additional input materials, beyond what is normally necessary to produce a standard output, because of the SR&ED performed during commercial production. Materials that would have been consumed in performing commercial production work are not attributable to the SR&ED work. For more information, please refer to section 3.0 of the SR&ED During Production Runs Policy.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed

Legislative reference Income Tax Regulations
Paragraph 2900(2)(a) Expenditures directly attributable to the prosecution of SR&ED – Traditional method – Cost of materials consumed or transformed

5.2 Examples of items consumed but not in the prosecution of SR&ED

Often, items are consumed but do not get incorporated into a thing at any given moment of time during the SR&ED process. Such items would not meet the interpretation of materials for SR&ED (see section 4.0). Furthermore, the fact that an item was consumed while there was SR&ED performed does not necessarily mean that the item was consumed as a result of the prosecution of SR&ED. The items that would not qualify as consumed in the prosecution of SR&ED include the following:

  • broken or used lab supplies
  • cleaning supplies
  • general utilities such as water, electricity, oil, natural gas, etc.
  • CDs / DVDs
  • used lubricants such as engine oil

It is important to note that the cost of these items may qualify as overhead and other expenditures only when the traditional method for determining SR&ED expenditures is used. See also section 4.1.

Legislative reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

6.0 Materials transformed in the prosecution of SR&ED

“Materials transformed in the prosecution of SR&ED” generally means materials for SR&ED (see section 4.0) that have been changed or incorporated into another material or product as a result of the SR&ED and that still have some value either to the claimant or to another party (for example a sale greater than 10% of the original costs). A material for SR&ED rendered virtually valueless after the SR&ED would be a material consumed in the prosecution of SR&ED (see section 5.0).

The cost of materials transformed in the prosecution of SR&ED is an allowable SR&ED expenditure under both the traditional method and proxy method.

However, when a product that includes materials transformed in SR&ED is sold or converted to commercial use, the investment tax credit (ITC) recapture rules may apply to recapture all or a portion of the ITC relating to the cost of materials transformed that was claimed. Note that these rules do not apply to recapture the ITC for labour and overhead costs incurred in cases where the material (component part) is manufactured internally. It is also important to note that it is not necessarily the entire cost of the material that would be subject to ITC recapture. In general, only the cost of acquired property that is incorporated into a product sold or converted to commercial use will be subject to ITC recapture. For more information, please refer to the Recapture of SR&ED Investment Tax Credit Policy.

In the case of a custom product or commercial asset, the CRA will not automatically allow all of the costs of material transformed and apply the ITC recapture rules in the year of disposition or conversion to commercial use. Rather, only the cost of the materials transformed in the prosecution of SR&ED will be allowed.

It is important to note that the cost of materials for SR&ED can be claimed in the tax year the SR&ED material was transformed in the prosecution of SR&ED (see section 3.0).

Legislative reference Income Tax Act
Subsections 127(27) to (36) Recapture of investment tax credit

6.1 Examples of materials transformed in the prosecution of SR&ED

  • Material incorporated into a custom product or a commercial asset if the material was transformed in or as a result of the prosecution of SR&ED.
  • Input materials that form part of the experimental production resulting from experimental development (ED+EP) that were not consumed or rendered virtually valueless as a result of the SR&ED. For example, yarn converted into fabric during a production run where the context of the run is ED+EP. For more information on ED+EP, please refer to the SR&ED During Production Runs Policy.
  • Component parts used in testing that is part of the SR&ED work, but the parts were not consumed or rendered virtually valueless.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed

Legislative reference Income Tax Regulations
Paragraph 2900(2)(a) Expenditures directly attributable to the prosecution of SR&ED – Traditional method – Cost of materials consumed or transformed

6.2 Materials transformed but not in the prosecution of SR&ED

The cost of materials transformed does not qualify for SR&ED tax incentives if the work that caused the transformation was not eligible. For example, if the materials were transformed in the prosecution of work that did not contribute to the effort to achieve a technological advancement or an advancement in scientific knowledge, then the costs of these materials could not be claimed as expenditures for materials transformed in the prosecution of SR&ED. For more information on eligibility of work, please refer to the Eligibility of Work for SR&ED Investment Tax Credits Policy.

7.0 Examples

Example 1: Materials for SR&ED in a printing process

Company A and Company B each operate a business in Canada and perform SR&ED work in Canada to develop a process for printing on cardboard boxes. Both companies need cardboard boxes to test the new printing process. Once these tests are completed, the cardboard boxes have no resale value or use, and are disposed as waste in a recycle bin.

Company A manufactures the cardboard boxes. The unit cost price of an unprinted cardboard box is $1.00: $0.50 for raw materials, $0.30 for labour, and $0.20 for manufacturing overhead. Company B purchases the cardboard boxes from another company, at a unit price of $1.20. Both companies use the proxy method.

Do the cardboard boxes used to test the printing process constitute materials for SR&ED? More generally, can a claimant have expenditures for materials for SR&ED when the purpose of the claimant’s research is to develop a new process or improve an existing one?

Since the cardboard boxes have no residual value after the SR&ED tests are completed, they are considered consumed. All that remains to be determined is if these boxes constitute materials for SR&ED.

In this example, the SR&ED is in the development of a new process. To constitute materials for SR&ED, the cardboard boxes must be either raw materials, substances, or other items, that compose the body of a thing at a given moment in the SR&ED process. The boxes used for the printing tests do constitute the body of a thing in the overall SR&ED process, because they constitute the body of the printed boxes.

Since the cardboard boxes are the materials consumed in SR&ED, the cost of the cardboard boxes is $1.00 for Company A and $1.20 for Company B. The manufacturing overhead expenses of $0.20 per box for Company A is included in the cost of producing the material even though the claimant uses the proxy method, since manufacturing the cardboard boxes does not involve SR&ED work.

The ink used in the printing process can also be considered an SR&ED material consumed in the prosecution of SR&ED.

Legislative references Income Tax Act
Subparagraph 37(1)(a)(i) Pool of deductible SR&ED expenditures – Current expenditures
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed

Example 2: Service cost as cost of materials for SR&ED

A claimant is conducting SR&ED. The metal parts being developed need to be galvanized before the testing for SR&ED can occur. The claimant contracts another corporation to perform the galvanization. Then, the claimant subjects the galvanized metal parts to testing which is part of the SR&ED work. The galvanized metal parts are destroyed during the testing process.

Can the cost of the galvanization be claimed as an SR&ED expenditure?

In this example the starting material is the metal parts. The activity of galvanizing the metal parts does not qualify as SR&ED work (the contractor is not performing SR&ED on behalf of the claimant). Therefore at the time of galvanization, there was no SR&ED performed. However, the galvanization is necessary to bring the metal parts to a condition where they could be used in SR&ED. The cost of the galvanized metal comprises of the cost of galvanization and the cost of the metal. During the testing, the galvanized metal part is the object on which the SR&ED is carried out. The cost of the galvanized metal parts can be claimed as an expenditure for materials consumed in the prosecution of SR&ED.

Example 3: Chemical tested on wood

A corporation develops a new chemical for treating wood. Does the wood used to test this chemical constitute materials for SR&ED?

Although the wood does not constitute the body of the chemical being developed, the wood used in the tests does in fact constitute the body of a thing in the overall SR&ED process because once the wood has been treated with the chemical, the wood composes a part of the body of the treated wood, which is the result of testing the new chemical. It becomes a product (treated wood) that results from the SR&ED carried out.

The wood and the chemical would be considered consumed in the prosecution of SR&ED if they were destroyed or rendered virtually valueless as a result of the SR&ED. Otherwise they would be considered materials transformed in the prosecution of SR&ED.

Example 4: Materials for SR&ED, component parts, and testing of equipment

A textile manufacturer is modifying an advanced weaving machine to increase the rate of fabric production by 50%. Subsequently, the machine will be used commercially by the textile manufacturer. A series of test production runs must be carried out to validate the changes made to the weaving machine. The test runs result in production of poor-quality fabric, which is sold to a customer at 50% of the usual sale price.

In this example there are two things.

The first thing is the weaving machine. To constitute materials for SR&ED, the component parts used in the weaving machine must compose the body of the machine, on which the SR&ED is being performed, at a given moment in the SR&ED process. The component parts used in modifying the weaving machine could be claimed as materials for SR&ED, when the parts are consumed or transformed in the prosecution of SR&ED involving the machine. The whole machine cannot be a material for SR&ED because it does not qualify as an expenditure of a current nature. Any component claimed as materials transformed in the prosecution of SR&ED that comprise the machine when it is converted to commercial use would be subject to the investment tax credit recapture rules.

The second thing is the fabric produced as a result of SR&ED during production runs on the modified weaving machine. As long as the production runs are commensurate with the needs and directly in support of the SR&ED, the yarn is considered to constitute the body of a thing (the fabric, being a tangible object) in the overall SR&ED process.

Since the fabric still had some value, the yarn could not be considered a material consumed in the prosecution of SR&ED. The cost of the yarn, which does not relate to excess production, can be claimed as the cost of material transformed in the prosecution of SR&ED. The investment tax credit recapture rules would apply when the fabric is sold.

Example 5: Materials for SR&ED and growing things – Plants

Fungus infects the canola leaf tissue and causes disease. A claimant’s applied research involved creating a genetically altered canola seed to produce a plant that resists the fungus. The SR&ED process involved lab activities necessary to develop a series of genetically altered plants. These were then crossed with existing varieties. The seeds were then grown in field test plots separate from the commercial plots to assess if the genetically modified canola plants were resistant to the fungus. As a result of the testing and evaluation, the plants were rendered virtually valueless.

The following items were used in the SR&ED:

1. in the lab:

A) petri dishes, beakers, flasks, pipettes

B) utilities: gas, propane, electricity

C) seed, growth media, agar

2. in the field:

A) fungal culture and media ingredients required for fungal growth, spore production, and testing

B) fertilizers, pesticides, and herbicides applied before and after canola seeding in the test plots

To constitute materials for SR&ED, the items must at a given moment in the SR&ED process compose the body of a thing that the SR&ED is being performed on. Of the above items, those described in 1C), 2A), and 2B) would qualify as materials for SR&ED under the interpretation of this term (see sections 4.0 to 4.2). The cost of these items can be claimed as cost of materials consumed in the prosecution of SR&ED.

Items described in 1A) and B) do not meet the interpretation of "materials for SR&ED". The cost or a portion of the cost of these items could qualify as SR&ED overhead and other expenditures under the traditional method.

Appendix A – References

A.1 Legislative references

List of provisions
Income Tax Act Description
Subparagraph 37(1)(a)(i) Pool of deductible SR&ED expenditures – Current expenditures
Subclause 37(8)(a)(ii)(A)(I) SR&ED expenditures in Canada under the traditional method – ASA
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed
Subsections 127(27) to (36) Recapture of investment tax credit
List of regulations
Income Tax Regulations Description
Paragraph 2900(2)(a) Expenditures directly attributable to the prosecution of SR&ED – Traditional method – Cost of materials consumed or transformed
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

Appendix B – Revisions

B.1 Explanation of changes

The following are the explanation of changes to the Materials for SR&ED Policy as part of the revision of December 18, 2014:

Section 1.0 has been revised to delete the first sentence of the previous policy which mentioned that this policy document was a consolidation of the CRA publications.

Section 4.0 has been revised to reflect the legislative changes resulting from the 2012 federal budget measures. The reference to “capital expenditures” has been removed; as such expenditures no longer qualify for SR&ED tax incentives. The term has been replaced with an “expenditure of a capital nature” which is a term defined in the glossary. This change does not affect the French version of this policy.

Section 4.3 has been revised to clarify that the discussion in this section is specific to energy and water and should not be referred to for other situations.

Appendix A.2 "CRA publications" has been removed.

Footnote 1 of the December 19, 2012 version of this policy has been deleted as the legislation amending the wording in subclause 37(8)(a)(ii)(B)(V) of the Income Tax Act to “cost of materials consumed or transformed” was enacted in 2013. The enacted legislation is applicable to costs of material incurred after February 23, 1998. There is no change in determining the cost of materials consumed or transformed when using the proxy method. The CRA has been administrating based on the wording of “cost of materials consumed or transformed” since February 23, 1998.

Other minor formatting and editing corrections were made throughout the document.

Date modified:
2014-12-18