7 July 1990 Income Tax Severed Letter - Comments on the definitions of qualified expenditure, contract payment, and non-government assistance in subsection 127(9)

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.

Dear Sirs:

Re: Scientific Research and Experimental Development ("SR & ED")

We are writing in reply to your letter of January 26, 1990, wherein you requested our comments on the definitions of qualified expenditure, contract payment, and non-government assistance in subsection 127(9) of the Income Tax Act (the "Act"). We apologize for the delay in responding to your letter.

Facts

Our understanding of the facts given to illustrate the issue is as follows:

A Canadian company (the "Company") and its parent company resident in United States would enter into an agreement with respect to qualifying SR & ED activities carried on in Canada. Under the terms of this agreement, while the research contracts would be signed between the U.S. parent and independent Canadian research companies, the Company would pay the researchers on behalf of its parent company. The reimbursement received by the Company from its parent for the payments would be included in its income. The Company would be entitled to exploit the results of the research but may have to pay a royalty to its parent company. The U.S. parent would not have a permanent establishment in Canada and would not be required to file a tax return under Part 1 of the Act.

Your Questions

• 1. Would the payments made by the Company to the Canadian researchers constitute "qualified expenditures" as defined in subsection 127(9) of the Act for the purpose of claiming investment tax credit?
• 2. If the payments do constitute qualified expenditures, would the reimbursement by the U.S. parent be considered either a "contract payment" or "non-government assistance" as defined in subsection 127(9) of the Act?

Our Comments

While we are unable to provide confirmation of the income tax effects of the particular situation outlined in your letter, we can offer the following general comments related to the definitions of "qualified expenditure", "contract payment" and "non-government assistance" in subsection 127(9) of the Act.

• 1. Where a corporation that is not resident in Canada and does not carry on business in Canada ("NRCo") has entered into an agreement with its subsidiary company, a taxable Canadian corporation ("CANCo"), which provides that CANCo will pay, on behalf of NRCo, amounts owing by NRCo for SR & ED activities carried on in Canada by independent Canadian researchers, it is a question of fact whether 1) CANCo will be acting as an agent for NRCo, or 2) legal rights and obligations will exist between CANCo and the researchers which recognize CANCo's liability to the researchers. In order for a payment made by CANCo to meet the definition of qualified expenditure, it must be, inter alia, an expenditure described in subparagraph 37(1)(a)(ii) of the Act made by CANCo. If CANCo is acting as an agent for NRCo (i.e., CANCo is authorized by NRCo to merely act on behalf of and for the benefit of NRCo) and advances funds to the researchers on behalf of NRCo, it is unlikely that the payment made by CANCo to the researchers will be considered to be an expenditure made by CANCo for the purposes of subparagraph 37(1)(a)(ii) of the Act. However, should CANCo not be acting as an agent of NRCo, payments made by CANCo would normally be considered an expenditure made by CANCo for the purposes of that subparagraph.

It is also necessary that the expenditure be related to a business of CANCo and that CANCo be entitled to exploit the results of the SR & ED carried on in Canada by the research group. For the SR & ED to be related to a business of the taxpayer, there must be some connection or link between the taxpayer's business carried on at the time the expenditure is made and the SR & ED carried on. This requirement will generally be satisfied when the results of the SR & ED will, if successful, have a direct and beneficial application in the business that is carried on by the taxpayer in the year. The determination of whether a taxpayer is entitled to exploit the results is generally a question of fact dependent upon the contractual arrangements that exist between the parties. However, it is our opinion that the requirement would normally be fulfilled where the funding taxpayer (i.e. the one entitled to the deduction under subsection 37(1) of the Act) 1) receives the right to use patents that result from the SR & ED project on an exclusive or non-exclusive basis, regardless of any territorial restrictions, or 2) is entitled to distribute and market any products that result from the SR & ED. Similarly, the right to use the results of an SR & ED project based on a license agreement where the Canadian researcher charges the funding taxpayer a reasonable royalty, license fee or some other amount would also constitute an entitlement to exploit the results of SR & ED.

Where NRCo reimburses CANCo for an expenditure made by it to a research group listed in clauses 37(1)(a)(ii)(A) to (E) of the Act, subparagraph 2902(e)(ii) of the Regulations will not be applicable to the reimbursement received by the CANCo, as NRCo is not subject to Canadian income tax.

• 2. Where an amount expended by a taxpayer meets the definition of qualified expenditure, paragraph 127(11.1)(c) of the Act reduces the amount eligible for investment tax credit by, inter alia, the amount of any contract payment or non-government assistance in respect of the expenditure. As NRCo is not entitled to a deduction under subparagraph 37(1)(a)(ii) of the Act in respect of an amount it pays as a reimbursement to CANCo, the amount received by the CANCo would not meet the definition of contract payment.

Whether an amount would be considered non-government assistance to a taxpayer would depend on whether the amount must be included in income by virtue of paragraph 12(1)(x) of the Act, if the paragraph were read without reference to subparagraphs (vi) and (vii) thereof. Subparagraph 12(1)(x)(v) of the Act provides that paragraph 12(1)(x) of the Act does not apply to an amount that was otherwise included in computing a taxpayer's income for a year or a preceding taxation year under some other provision of the Act, such as subsection 9(1) of the Act. Accordingly, where an amount is included in income of the taxpayer by virtue of subsection 9(1) of the Act, pursuant to generally accepted accounting principles, it would not constitute non-government assistance. To the extent that the amount paid to a taxpayer for reimbursement of services rendered is included in its income by virtue of paragraph 12(1)(x) of the Act, as read without reference to subparagraphs (vi) and (vii) thereof, such amount would be considered non-government assistance.

As previously discussed, in the situation where CANCo is merely acting as an agent on behalf of NRCo, no deduction under subsection 37(1) of the Act would be available to CANCo. In this situation, it is possible that the expenditures made by the Canadian researchers could meet the definition of qualified expenditure. In addition, the amounts received by those Canadian researchers would not be considered contract payments as they are payable by a non-resident person not subject to Canadian income tax. It should be noted that it is not the intent of the legislation that the investment tax credit be available on the same SR & ED activity to both 1) the Canadian researcher as a result of a payment received from CANCo not meeting the definition of contract payment and 2) CANCo as a result making a payment which qualifies as an expenditure made by it under subparagraph 37(1)(a)(ii) of the Act.

These comments represent our opinion of the law as it applies generally. As indicated in paragraph 24 of Information Circular 70-6R dated December 18, 1978, this opinion is not a ruling and accordingly, it is not binding on Revenue Canada, Taxation.

We trust these comments will be of assistance.