7 December 1990 Income Tax Severed Letter - Scientific Research and Experimental Development

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.

QUESTION 1

SCIENTIFIC RESEARCH & EXPERIMENTAL DEVELOPMENT “SR&ED”)

In paragraph 14 of Interpretation Bulletin IT-151R3, Revenue Canada states that current SR&ED excludes certain overhead, which would have been incurred regardless of whether SR&ED was carried on. A simple example relating to office equipment is given. Large corporations engaged in SR&ED activities incur significant variable overhead costs which could not otherwise have been incurred if these activities were not performed. However, these costs may not be easily segregated and may not be all or substantially all attributable to SR&ED (e.g., cost of accounting for the SR&ED).

Overhead costs, together with the direct SR&ED costs, form the true economic cost of performing SR&ED. Generally accepted accounting principles (“GAAP”) require that a reasonable allocation of overhead costs be included in the “cost” of inventory and research and development for accounting purposes.

Will Revenue Canada accept the GAAP approach and allow taxpayers to include a reasonable allocation of overhead to SR&ED providing the taxpayer can demonstrate that those overheads would not have been incurred if SR&ED was not undertaken?

RESPONSE

The proviso stated in the question, that “the taxpayer can demonstrate that those overheads would not have been incurred if SR&ED was not undertaken”, is fundamental to acceptance of any allocation to SR&ED.

In addition to expenditures which are incurred for and all or substantially all attributable to the prosecution of SR&ED, subsections 2900(2) and (3) of the Regulations provide for certain expenditures that are “directly attributable” to the prosecution of SR&ED. Some expenditures are specifically described, for instance the portion of the salary of an employee who directly undertakes, supervises or supports SR &ED. The last paragraph of each of those two subsections provides for other expenditures which are “directly related to such prosecution” and that “would not have been incurred if such prosecution (or premises, facilities or equipment) had not occurred (or existed).” it is our view that this latter test refers to incremental expenditures and not apportionments of expenditures. Paragraph 2900(2)(b) refers to a “portion” of salaries and wages while paragraphs 2900(2)(c) and 2900(3)(b) do not.

Allocation of a portion of a particular expenditure to SR&ED based on the percentage of use in a qualifying activity cannot be accepted. However any overheads that would not otherwise have been incurred could be deductible. Regarding salaries and wages that would account for most of the accounting cost in your example, the requirement in paragraph 2900(2)(b) that an employee directly support the prosecution of the SR&ED is not met as the employee is not directly involved in the prosecution of the SR&ED. In such a case, the salaries and wages indirectly support the SR&ED activities.