Traditional and Proxy Methods Policy

Date: December 18, 2014

Table of contents

• 1.0 Purpose
• 2.0 Overview
• 3.0 Choice of method
• 4.0 Traditional method
  
  • 4.1 Legislation
• 5.0 Proxy method
  
  • 5.1 Legislation
• 6.0 Traditional method vs. proxy method
  
  • 6.1 Comparison of the treatment of expenditures
  • 6.2 Salaries or wages
  • 6.3 Retirement allowances
  • 6.4 Personnel expenses
  • 6.5 Cost of training
  • 6.6 Cost of materials consumed or transformed
  • 6.7 Contract expenditures for SR&ED performed on behalf of the claimant
  • 6.8 Lease costs
  • 6.9 Capital expenditures
  • 6.10 Provincial and territorial research and development tax credits
  • 6.11 Comparison of the traditional and proxy methods
  • 6.12 Example – Additions to the expenditure pool and calculating the investment tax credit for the traditional and proxy methods
• Appendix A – References
  
  • A.1 Legislative references
• Appendix B – Revisions
  
  • B.1 Explanation of changes

1.0 Purpose

The purpose of this document is to clarify the position of the Canada Revenue Agency (CRA) regarding the traditional and proxy methods when administering the SR&ED legislation under the federal Income Tax Act and the Income Tax Regulations.

2.0 Overview

The Income Tax Act provides two methods for calculating expenditure additions to a pool of deductible SR&ED expenditures—the traditional method (see section 4.0) and the proxy method (see section 5.0). The amount that can be included in a pool of deductible SR&ED expenditures will depend on whether the claimant elects to use the proxy method or chooses to use the traditional method for a tax year. The choice of method is made on a year-by-year basis and it is irrevocable for the year. After a claim has been filed, the method of determining the SR&ED expenditures cannot be changed.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method
Subsection 37(10) Time for election

Legislative Reference Income Tax Regulations
Subsection 2900(4) Calculation of the prescribed proxy amount

3.0 Choice of method

If the traditional method (see section 4.0) is used, each amount for SR&ED overhead and other expenditures claimed must be identified and its inclusion in the pool of deductible SR&ED expenditures justified. For claimants who choose to use the traditional method, well-maintained books and records cannot be over emphasized. For more information on keeping records, please refer to the Keeping records.

A claimant may elect to use the proxy method (see section 5.0) each year on the Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim when the first claim for the year is filed. If an election is not made at the time when the first claim for the year is filed, the traditional method will apply automatically.

Legislative References Income Tax Act
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method
Subsection 37(10) Time for election

4.0 Traditional method

4.1 Legislation

Expenditures of a current nature

Under the traditional method, expenditures of a current nature on or in respect of SR&ED, include:

• An expenditure that is all or substantially all (ASA) attributable to the prosecution, or to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada;
• An expenditure that is directly attributable to the prosecution of SR&ED , or directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada.

An expenditure for the right to use capital property (lease) no longer qualifies for SR&ED tax incentives after 2013.

Expenditures of a capital nature

An expenditure of a capital nature incurred after 2013 no longer qualifies for SR&ED tax incentives.

Under the traditional method, an expenditure can be included as an expenditure of a capital nature, if it was incurred prior to January 1, 2014, and if at the time the expenditure was incurred, it was for the provision of premises, facilities or equipment, when at that time it was intended that:

• it would be used during ASA of its operating time in its expected useful life for the prosecution of SR&ED in Canada; or
• ASA of its value would be consumed in the prosecution of SR&ED in Canada.

Note

Under the traditional method, expenditures on or in respect of SR&ED, may include general purpose office equipment or furniture (GPOEF).

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method

Legislative References Income Tax Regulations
Subsection 2900(2) Expenditures directly attributable to the prosecution of SR&ED – Traditional method
Subsection 2900(3) Expenditures directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method

5.0 Proxy method

5.1 Legislation

Expenditures of a current nature

Under the proxy method, expenditures of a current nature on or in respect of SR&ED include only:

• Prior to 2014, an expenditure that is all or substantially all (ASA) attributable to the lease of premises, facilities, or equipment (other than general purpose office equipment or furniture (GPOEF)) for the prosecution of SR&ED in Canada. Please refer to the SR&ED Lease Expenditures Policy;
• an expenditure in respect of the prosecution of SR&ED in Canada directly undertaken on behalf of the claimant. Please refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy;
• the portion of an expenditure for salary or wages incurred in the year for an employee who is directly engaged in SR&ED in Canada that can reasonably be considered to be for such work, with regard to the time the employee spent performing the work. For this purpose where that portion is ASA of the expenditure, that portion shall be deemed to be the amount of the expenditures. Please refer to the SR&ED Salary or Wages Policy;
• the cost of materials consumed or materials transformed in the prosecution of SR&ED in Canada. Please refer to the Materials for SR&ED Policy; and
• Prior to 2014, half of any other current expenditure for the lease of premises, facilities, or equipment (other than GPOEF) used primarily for the prosecution of SR&ED in Canada. Please refer to the SR&ED Lease Expenditures Policy.

An expenditure for the lease of premises, facilities, or equipment after 2013, no longer qualifies for SR&ED tax incentives.

Expenditures of a capital nature

An expenditure of a capital nature incurred after 2013, no longer qualifies for SR&ED tax incentives.

Under the proxy method, an SR&ED capital expenditure made prior to January 1, 2014, for the provision of premises, facilities, or equipment, in respect of SR&ED can be included if at the time the expenditure was incurred, it was intended that:

• it would be used during ASA of its operating time in its expected useful life for the prosecution of SR&ED in Canada; or
• ASA of its value would be consumed in the prosecution of SR&ED in Canada.

Note

Under the proxy method, expenditures on or in respect of SR&ED do not include GPOEF.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

6.0 Traditional method vs. proxy method

6.1 Comparison of the treatment of expenditures

Table 1 illustrates the treatment of expenditures under the traditional and proxy methods.

Table 1 Treatment of expenditures under the traditional method and the proxy method

Expenditure	Traditional method	Proxy method
Salaries or wages of employees directly engaged in SR&ED	eligible for investment tax credit (ITC) deductible SR&ED expenditure	eligible for ITC and used to calculate the salary base for the prescribed proxy amount (PPA) deductible SR&ED expenditure
Other salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED (other than directly engaged)	eligible for ITC deductible SR&ED expenditure other salary or wages for the prosecution of SR&ED are claimed as overhead and other expenditures	not specifically identified covered in the PPA PPA is eligible for ITC deductible as regular business expenses only—not deductible as SR&ED expenditure
Overhead and other expenditures directly related to the prosecution of SR&ED and incremental	eligible for ITC deductible SR&ED expenditure	not specifically identified covered in the PPA PPA is eligible for ITC deductible as regular business expenses only—not deductible as SR&ED expenditure
Other expenditures claimed separately: materials consumed or materials transformed in performing SR&ED lease costs of SR&ED equipment, if incurred prior to January 2014 expenditures for SR&ED directly undertaken on behalf of the claimant (after 2012, 80% eligible for ITC) third-party payments (after 2012, 80% eligible for ITC)	eligible for ITC deductible SR&ED expenditure can claim lease costs of equipment where it is used all or substantially all (ASA) in SR&ED, if incurred prior to January 2014 can claim lease costs of SR&ED equipment used in SR&ED, but not used ASA as overhead and other expenditures, if incurred prior to January 2014	eligible for ITC deductible SR&ED expenditure if incurred prior to January 2014, can claim lease costs of SR&ED equipment where it is used ASA in SR&ED, excluding general purpose office equipment or furniture (GPOEF) if incurred prior to January 2014, can claim 50% of the lease costs of equipment where it is used primarily in SR&ED, excluding GPOEF

The PPA approximates overhead and other expenditures such as:

• office supplies
• GPOEF
• heat, water, electricity, and telephones
• salaries or wages of clerical and administrative staff providing a service to SR&ED employees
• other salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED and relating to work not considered to be directly engaged in SR&ED (for example, long-term planning for future SR&ED projects and contract administration that directly relate to the SR&ED work)
• contract costs for work that is not SR&ED (for example, the work of electricians, welders, and mechanics), which is directly related and incremental to the performance of SR&ED
• employer's share of related benefits
• travel and training
• property taxes
• maintenance and upkeep of SR&ED premises, facilities, or equipment
• any other eligible expenditure directly related to the performance of SR&ED that the claimant would not have incurred if the SR&ED had not been carried out

6.2 Salaries or wages

Under the traditional method (see section 4.0), salaries or wages for SR&ED related to work that is not directly engaged may be claimed as overhead and other expenditures if the expenditures are directly attributable to the prosecution of SR&ED . The portion of other salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED but who are not directly engaged in SR&ED can be claimed as SR&ED overhead and other expenditures on line 360 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim. Refer to Table 5 in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, for example of such tasks.

Additionally, expenditures that are directly related and incremental to the prosecution of SR&ED are directly attributable to SR&ED. Salary or wages incurred for clerical and administrative personnel providing a service to SR&ED employees could be considered to be directly related and incremental to SR&ED depending on the facts of the case. Claimants should be prepared to identify the work performed, and be able to show that the expenditures are directly related to the prosecution of SR&ED and that the expenditures would not have been incurred if the SR&ED had not been conducted (incremental).

If a claimant has elected to use the proxy method (see section 5.0), only salaries or wages for directly engaged SR&ED work can be claimed. Salaries or wages related to work that is not directly engaged cannot be claimed, since these amounts are captured by the PPA .

For more information on SR&ED salaries or wages, please refer to the SR&ED Salary or Wages Policy.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

6.3 Retirement allowances

Under the traditional method, a retiring allowance may be allowed as an overhead or other expenditure that is either ASA attributable or directly attributable to the prosectution of SR&ED in Canada. For more information on retirement allowances, please refer to the SR&ED Overhead and Other Expenditures Policy.

A retiring allowance cannot be claimed under the proxy method since this type of allowance is considered to be part of the PPA .

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

6.4 Personnel expenses

Under the traditional method (see section 4.0), the following personnel expenses may be allowable:

• moving expenses relating to selected candidate(s) and to relocate SR&ED employees to another facility, and
• taxable benefits to employees related to selecting and hiring SR&ED personnel.

For more information in respect of personnel expenses, please refer to the SR&ED Overhead and Other Expenditures Policy.

Under the proxy method (see section 5.0), only the taxable benefits that are included in the salary or wages of an employee who is directly engaged in SR&ED may be deductible.

Legislative References Income Tax Act
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – Current expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

Legislative Reference Income Tax Regulations
Section 2902 Prescribed expenditures

6.5 Cost of training

The cost of training can only be claimed under the traditional method. If a claimant uses the proxy method, training costs cannot be claimed since they are covered by the PPA .

For more information in respect of the cost of training, please refer to the SR&ED Overhead and Other Expenditures Policy.

Legislative References Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method
Paragraph 2900(3)(b) Expenditures directly related and incremental to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method

6.6 Cost of materials consumed or transformed

The cost of materials consumed or materials transformed in the prosecution of SR&ED may be claimed when using either the traditional method or the proxy method. For more information on materials, please refer to the Materials for SR&ED Policy.

Legislative References Income Tax Act
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – Current expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
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

6.7 Contract expenditures for SR&ED performed on behalf of the claimant

To claim the SR&ED contract costs, under the traditional method (see section 4.0) or proxy method (see section 5.0), a claimant must have contracted to have SR&ED performed in Canada on its behalf. The contractor must have performed SR&ED work as defined in subsection 248(1) of the Income Tax Act.

If the work performed by the contractor is support work, it must be commensurate with the needs and be directly in support of the SR&ED performed by the payer. Given that these requirements have been met, a payer may claim support work done by a performer regardless of the method chosen by the payer—the traditional or proxy method.

Costs for work that is not SR&ED or support work cannot be claimed as contract expenditures for SR&ED, but may be allowed under the traditional method as overhead and other expenditures.

For more information on claiming SR&ED contract costs, please refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy.

Legislative References Income Tax Act
Subparagraph 37(1)(a)(i.01) Pool of deductible SR&ED expenditures – Current expenditures, on behalf
Subsection 248(1) Definition of “SR&ED”, paragraph (d)

6.8 Lease costs

After 2013, expenditures of a capital nature and expenditures for the right to use capital property are excluded from the SR&ED program. This includes lease payments for any property that would have been capital property if the claimant had purchased it directly.

Prior to 2014, allowable lease costs generally relate to equipment. When using the proxy method, a claimant cannot include lease costs for GPOEF . Expenditures for the lease of a building are not included in the pool of deductible SR&ED expenditures. However, when using the traditional method, lease expenses that are ASA attributable to the prosecution of SR&ED, for example, for a structure, other than a building, may be allowed, prior to 2014.

For more information with respect to lease costs, please refer to the SR&ED Lease Expenditures Policy.

Legislative Reference Income Tax Act
Subparagraph 37(8)(d)(ii) SR&ED expenditures specifically excluded – Use or right to use a building

6.9 Capital expenditures

An expenditure of a capital nature incurred after 2013 no longer qualifies for SR&ED tax incentives.

For capital expenditures incurred prior to January 1, 2014, the only difference in determining capital expenditures under the traditional method (see section 4.0) and the proxy method (see section 5.0) is that GPOEF cannot be included in SR&ED expenditures under the proxy method. Under either method, capital expenditures related to the acquisition of a building are generally not allowed as an SR&ED expenditure.

For more information with respect to capital SR&ED expenditures, please refer to the SR&ED Capital Expenditures Policy.

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – Capital expenditures [Repealed]
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Subclause 37(8)(a)(ii)(B)(I) SR&ED expenditures in Canada under the proxy method – Lease costs ASA [Repealed]

6.10 Provincial and territorial research and development tax credits

The treatment of provincial and territorial research and development (R&D) tax credits is the same under both the proxy and the traditional methods in determining the amount of qualified SR&ED expenditures for the year.

Under the proxy method, the portion of the provincial or territorial R&D tax credit that relates to the PPA reduces the qualified SR&ED expenditures, because it is assistance in respect of SR&ED regardless of whether the credit is refundable or non-refundable. The portion of the provincial or territorial tax credit that relates to the PPA should also be included in income in the tax year it is received. For an example of the treatment of provincial government assistance under the traditional and proxy methods, please refer to section 6.0 of the Assistance and Contract Payments Policy.

The Quebec R&D salaries tax credit program includes in its calculation the salaries and the portion of a subcontract that is attributable to salaries, for work that assists the R&D. The cost for such work does not qualify as allowable SR&ED expenditures under the federal SR&ED program if the claimant has elected to use the proxy method and is not assistance for the purposes of calculating the pool of deductible SR&ED expenditures. For more information on this subject, please refer to section 4.5.3 of the Assistance and Contract Payments Policy.

Legislative References Income Tax Act
Paragraph 12(1)(x) Inducement, reimbursement, etc.
Paragraph 37(1)(d) Pool of deductible SR&ED expenditures – Government or non-government assistance
Subsection 127(18) Reduction of qualified expenditures

6.11 Comparison of the traditional and proxy methods

Table 2 illustrates the advantages and disadvantages under the traditional and proxy methods.

Table 2 Comparison of the traditional and proxy methods

Method	Advantages	Disadvantages
Traditional method	add the actual amount of overhead and other expenditures to the pool of deductible SR&ED expenditures can earn ITC on the overhead and other expenditures actually incurred may result in actual overhead and other expenditures being greater than the PPA do not need to calculate the salary base and determine the PPA do not need to calculate the overall cap for PPA	must show that the overhead and other expenditures are directly related and incremental to the SR&ED can be complex in certain situations, such as when SR&ED and non-SR&ED work are carried out in the same facility (for example, shop-floor SR&ED) must identify or allocate which overhead and other expenditures are for the SR&ED work must explain how the amount was determined, and provide support for the determination
Proxy method	no need to track overhead and other expenditures for SR&ED easy to determine the PPA once the salary base is established ITC is earned on the PPA	the PPA cannot be included in the pool of deductible SR&ED expenditures nor can the expenditures that the PPA represents the salary base must be calculated overall cap on the PPA may need to be calculated, and the PPA may be less than the overhead and other expenditures actually incurred

6.12 Example – Additions to the expenditure pool and calculating the investment tax credit for the traditional and proxy methods

The example below illustrates the differences in the additions to the pool of deductible SR&ED expenditures when calculating an ITC using the traditional method (see section 4.0) and proxy method (see section 5.0). It does not include the impact of any potential assistance from provincial or territorial research and development tax credits.

Acme Ltd. is a Canadian-controlled private corporation and is entitled to ITC at a rate of 35%. Acme Ltd. has incurred the following SR&ED expenditures in the tax year that just ended.

Salaries of employees directly engaged in SR&ED : $100,000
Materials for SR&ED: $15,000
Overhead expenditures: $50,000

Acme Ltd. can claim the following expenditures:	Using the traditional method	Using the proxy method
Salaries of employees directly engaged in SR&ED	$100,000	*$100,000
Materials for SR&ED	$15,000	$15,000
Overhead expenditures	$50,000	0
Total additions to the pool of deductible SR&ED expenditures	$165,000	$115,000

Calculating ITC	Using the traditional method	Using the proxy method
Allowable SR&ED expenditures	$165,000	$115,000
PPA	0	*$55,000
Total qualified SR&ED expenditures	$165,000	$170,000
Total ITC earned (at 35% of qualified SR&ED expenditures)	$57,750	$59,500

* $100,000 x 55% = $55,000, assuming a tax year starting in 2014 or later.

Appendix A – References

A.1 Legislative references

List of provisions

Income Tax Act	Description
Paragraph 12(1)(x)	Inducement, reimbursement, etc.
Subsection 37(1)	Pool of deductible SR&ED expenditures
Paragraph 37(1)(a)	Pool of deductible SR&ED expenditures – Current expenditures
Subparagraph 37(1)(a)(i.01)	Pool of deductible SR&ED expenditures – Current expenditures, on behalf
Paragraph 37(1)(b)	Pool of deductible SR&ED expenditures – Capital expenditures [Repealed]
Paragraph 37(1)(d)	Pool of deductible SR&ED expenditures – Government or non-government assistance
Clause 37(8)(a)(ii)(A)	SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B)	SR&ED expenditures in Canada under the proxy method
Subclause 37(8)(a)(ii)(B)(I)	SR&ED expenditures in Canada under the proxy method – Lease costs ASA [Repealed]
Subclause37(8)(a)(ii)(B)(II)	SR&ED expenditures in Canada under the proxy method – Contracts
Subclause 37(8)(a)(ii)(B)(V)	SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed
Subparagraph 37(8)(d)(ii)	SR&ED expenditures specifically excluded – Use or right to use a building
Subsection 37(10)	Time for election
Subsection 12 (18)	Reduction of qualified expenditures
Subsection 248(1)	Definition of “SR&ED”, paragraph (d)

List of regulations

Income Tax Regulations	Description
Subsection 2900(2)	Expenditures directly attributable to the prosecution of SR&ED – Traditional method
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
Subsection 2900(3)	Expenditures directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method
Paragraph 2900(3)(b)	Expenditures directly related and incremental to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method
Subsection 2900(4)	Calculation of the prescribed proxy amount
Section 2902	Prescribed expenditures

Appendix B – Revisions

B.1 Explanation of changes

The following are the explanation of changes to the Traditional and Proxy Methods 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 in respect of the traditional and proxy methods for calculating scientific research and experimental development expenditures.

Section 4.1 has been revised to reflect the legislative changes resulting from the 2012 federal budget measures with respect to lease expenditures and SR&ED capital expenditures.

Section 5.1 has been revised to reflect the legislative changes resulting from the 2012 federal budget measures with respect to lease expenditures and SR&ED capital expenditures.

Section 6.0 has been revised to reflect the legislative changes resulting from the 2012 federal budget measures with respect to lease expenditures, SR&ED capital expenditures, that only 80% of SR&ED contract expenditures and third-party expenditures are included as qualified expenditures, and changes to the rate for calculating the prescribed proxy amount - 60% for 2013, 55% after 2013.

Section 6.2 has been revised to agree with the wording used in section 8.4 of the SR&ED Salary and Wages Policy.

Section 6.12 example was revised to a 55% rate for the prescribed proxy amount. The numbers in the example were changed to better reflect the differences between the proxy method and the traditional method.

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

Appendix A.3 "Other reference" has been removed.

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

Date modified:

2014-12-18