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 CCRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ADRC.
Principal Issues: Does subsection 37(4) apply to deny the deduction under section 37 for costs incurred in acquiring a software development platform that is incorporated into the taxpayer's product at the development stage?
Position: Question of fact. In the case set out, we supported the SR&ED Directorate's determination that the acquisition was described in subsection 37(4).
Reasons: Previous positions.
April 24, 2003
SR&ED Directorate HEADQUARTERS
Mel Machado Bob Naufal, CMA
Financial Legislative Directorate (613) 957-2744
50 O'Connor Street, 7th Floor
Attention: Kevin Gibson
2002-016953
Expenditures made to acquire rights in or arising out of scientific
research and experimental development ("SR&ED")
We are writing in response to your memorandums dated October 16, 2002 and March 24, 2003 wherein you requested our views on the application of the expression "expenditure made to acquire rights, in or arising out of SR&ED" as found in subsection 37(4) of the Income Tax Act (the "Act"). Your memorandum dated March 24, 2003, described an actual case referred to you by the XXXXXXXXXX Tax Services Office.
The October 16, 2002 memorandum described a scenario whereby a software developer builds onto an existing base using a development platform (the "Platform") to create a new software product. The Platform generally includes libraries of object code for common task. Object code included in a library is specifically designed to become part of the end software product. The memorandum described two scenarios in which the Platform software may be acquired, namely:
1. The Platform software is acquired through a "development license" which gives the claimant the right to use, but not commercially exploit object code taken from the Platform. A separate agreement would be necessary where the software developer obtains the right to use the software internally in a commercial setting or commercially exploit the end product developed from the Platform.
2. The Platform software is acquired through a licence agreement that gives a claimant the right to use the software for development purposes. The software developer acquires the right either to use the software internally in a commercial setting or commercially exploit the end product it has developed using object code from the Platform.
You have asked whether we agree with your view that subsection 37(4) of the Act applies where the object code is acquired in both circumstances described above.
Subsection 37(4) of the Act prohibits any deduction under section 37 in respect of an expenditure made to acquire rights in, or arising out of, SR&ED. This includes expenditures made by a taxpayer to purchase, or to entitle the taxpayer to use, the results of a SR&ED program in which the taxpayer did not participate.
By contrast, subsection 37(4) of the Act will not normally apply to deny a taxpayer a deduction for an expenditure on software developed from the SR&ED efforts of others, that is used as a tool to support the taxpayer's SR&ED efforts, but which will not be incorporated into a product created by the taxpayer.
The determination as to whether subsection 37(4) of the Act would apply with respect to the acquisition of software is one of fact that can only be made by reviewing the terms of the underlying software licensing agreement. In the scenarios described in your memorandum of October 16, 2002, assuming that the Platform code is protected by copyright and that expenses incurred to create the Platform were expenditures in respect of SR&ED, then an expenditure to acquire a right to use the Platform code would be an expenditure described in subsection 37(4) of the Act regardless of whether the claimant has the right to commercially exploit the object code contained in the Platform.
Actual Fact Situation - XXXXXXXXXX
Your memorandum dated March 24, 2003 describes the following fact situation:
? XXXXXXXXXX ("Canco 1") entered into a software license agreement (the "Agreement") on XXXXXXXXXX with XXXXXXXXXX ("Canco 2").
? Under the terms of the Agreement:
? Canco 1 was granted a license to embed Canco 2's product (the "Software") into its product.
? Canco 2 is the owner of all rights, titles and interest in its products, no ownership rights were transferred to Canco 1, and no royalties were accrued or paid to Canco 2.
? Canco 1 was enjoined from distributing, sub-licensing or marketing Canco 2's product.
? Canco 1 was granted, during the term of the Agreement, a non-exclusive, worldwide license to use Canco 2's trademarks, trade names, logos and designations with respect to any of Canco 1's products embedded with the Software.
? The financial reviewer has determined that Canco 2 previously filed an SR&ED claim relating to the technology described in the Agreement.
? Canco 1 elected to use the proxy method to file their SR&ED claim for the year ended XXXXXXXXXX, claiming the amount paid in respect to the Agreement as materials consumed.
? Canco 1 has represented that the Software was used as a tool to assist in the development of its technology / product, and that the Software could not directly achieve the goals initially set out and was rendered virtually useless.
It is the claimant's position that subsection 37(4) of the Act does not apply in this situation since the Agreement is for development purposes only and Canco 1 did not have a right to commercially exploit the Software.
You have asked for our views on the following:
? Whether the expenditure for the Software was a capital expenditure?
? Whether subsection 37(4) of the Act applies to the acquisition of the Software?
Based on the facts stated above, it is our view that the expenditure for the Software was a capital expenditure and that subsection 37(4) of the Act applies to the acquisition of the Software under the terms of the Agreement. In this respect, we agree that it is possible for a taxpayer to acquire rights in, or arising out of, SR&ED in circumstances where the taxpayer acquires a software license but does not acquire the right to commercially exploit the end product in which the software is imbedded.
We trust our comments will be of some assistance.
Daryl Boychuk, LL.B
for Director
Business and Partnerships Division
Income Tax Rulings Directorate
For your information a copy of this memorandum will be severed using the Access to Information Act criteria and place in the Canada Customs and Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the client request a copy of this memorandum, they can be provided with the electronic library version, or they may request a severed copy using the Privacy Act criteria, which does not remove client identity. Requests for this latter version should be made by you to Mrs. Jackie Page at (819) 994-2898.
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