21 July 2003 External T.I. 2003-0020535 - MANUFACTURING AND PROCESSING - SR+EP

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:

1. Whether SR&ED activities are eligible for the M&P deduction.

2. Whether eligible for M&P if only activity is SR&ED.

Position:

1. Yes - included in determining "cost of M&P capital" and "cost of M&P labour".

2. No.

Reasons:

1. Paragraph (c) of definition of "qualified activities"

2. If only SR&ED, there would be no commercial production per paragraph (i) of SR&ED definition - therefore no manufacturing or processing of goods for sale or lease for purposes of M&P profits as defined in 125.1(3).

XXXXXXXXXX 						2003-002053
B. G. Dodd
(613) 957-8953
July 21, 2003 

Dear XXXXXXXXXX:

Re: Manufacturing and Processing Profits Deduction

We are writing in reply to your letter dated May 26, 2003 concerning the manufacturing and processing ("M&P") profits deduction provided in section 125.1 of the Income Tax Act (the "Act").

You describe a situation in which a corporation ("A Co.") earns income from an "active business", as defined in subsection 248(1) of the Act and which, we are assuming for purposes of this letter, meets the definition of "adjusted business income" in section 5202 of the Income Tax Regulations (the "Regulations"). A portion of A Co.'s active business income-earning activities meets the definition of "scientific research and experimental development" ("SR&ED") in subsection 248(1) of the Act. You request our views on whether A Co.'s SR&ED activities would qualify for the M&P deduction in section 125.1 of the Act.

Our Comments

Written confirmation of the tax implications inherent in particular transactions is given by this Directorate only where the transactions are proposed and are the subject matter of an advance income tax ruling request submitted in the manner set out in Information Circular 70-6R5 dated May 17, 2002. Where the particular transactions are completed, the inquiry should be addressed to the relevant tax services office. The following comments are, therefore, of a general nature only and are not binding on the Canada Customs and Revenue Agency with respect to any particular situation.

As you note, the "cost of manufacturing and processing capital" and the "cost of manufacturing and processing labour" are determined, in part, with reference to "qualified activities", as each of these terms is defined in section 5202 of the Regulations. Pursuant to paragraph (c) of the definition of qualified activities, such activities include SR&ED carried on in Canada. Provided A Co. carries on its SR&ED in Canada, it is our view that:

(1) property directly used in such SR&ED during the year would be included in determining A Co.'s cost of manufacturing and processing capital for the year where such property is included in A Co.'s "cost of capital", as defined in section 5202 of the Regulations, for the year; and

(2) salaries and wages paid or payable to employees for the portion of their time that they were directly engaged in such SR&ED during the year, and other amounts paid or payable to other persons for the performance of functions that would be directly related to such SR&ED during the year if those persons were employees of A Co., would be included in determining A Co.'s cost of manufacturing and processing labour for the year where such amounts are included in A Co.'s "cost of labour", as defined in section 5202 of the Regulations, for the year.

Accordingly, provided A Co. is otherwise eligible for the M&P deduction, its SR&ED-related capital and labour would be relevant in determining its M&P deduction as described above.

You also enquire whether A Co. would qualify for the M&P deduction in circumstances where A Co. is not carrying on any M&P activity other than its SR&ED activities. In our view, A Co. would not qualify for the M&P deduction in such circumstances. The various components involved in the determination of the M&P deduction lead ultimately to the determination of the amount of a corporation's "Canadian manufacturing and processing profits" for the year as defined in subsection 125.1(3) of the Act. Canadian manufacturing and processing profits as so defined refers to the portion of a corporation's income from an active business as is determined under regulation to be applicable to the manufacturing or processing in Canada of goods for sale or lease (i.e., commercial production). Pursuant to paragraph (i) of the definition of SR&ED in subsection 248(1) of the Act, SR&ED does not include work with respect to the commercial production of a new or improved material, device or product or the commercial use of a new or improved process. Given that SR&ED does not, by definition, include commercial production, a corporation involved solely in SR&ED activities does not manufacture or process goods for sale or lease as contemplated in the definition of Canadian manufacturing and processing profits and, therefore, would not qualify for the M&P deduction in subsection 125.1(1) of the Act.

We hope this will be of assistance.

Yours truly,

Daryl Boychuk, LL.B
for Director
Business and Partnerships Division
Income Tax Rulings Directorate