30 April 1986 Income Tax Severed Letter

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.

MEMORANDUM

Date April 30, 1986, A

TO        Mr. S.C. Lemelin
          A/Director
          Specialized Audit

ATTENTION Mr. H.S. Terris

FROM      Scientific Research Section
          R.H. Joyce
          957-2092

Re Scientific Research Expenditures Eligible for Investment Tax Credit ("ITC")

XXX

Amendments to subsection 127(11.1) provide for the reduction of the ITC expenditure base for contract payments received, receivable or expected to be received after November 21, 1985 and for government and non-government assistance received, receivable or expected to be received after May 23, 1995. These amendments effectively override the reimbursement provision of paragraph 2902(e) of the Regulations. Accordingly, subsection 127(11.1) stops the doubling up of ITC from Novemher 21, 1985 onward.

Nevertheless, the issue of when an expenditure would he considered a prescribed expenditure by virtue of Regulation 2902(e) will still be significant during the course of audits of taxpayers that have filed designations under subsection 194(4) and are claiming a refund of Part VIII tax.

In response to numerous queries from taxpayers, their representatives and district office personnel as to what constitutes a reimbursement for the purposes of paragraph 2902(e), we have set out, in general terms, criteria which may be the helpful in the determination of when both the performer and subcontractor would be entitled to claim the ITC or, where applicable, claim a refund of Part VIII tax in respect of scientific research expenditures incurred.

- Reimbursement of I.T.C. - Contract payments, government and non-government assistance.

The following criteria have been developed to set out the situations in which we believe that the claiming of ITC by both parties to a contract to perform scientific research is in accordance with the law. The coordinator of the research project is referred to as the taxpayer, while the party contracted to perform portions of the scientific research on behalf of the taxpayer is referred to as the performer.

1. Expenditures incurred by both the taxpayer and the performer(s) must qualify as scientific research as defined in paragraph 37(7)(b) and Regulation 2900. As such, the expenditure must be incurred in the course of a systematic investigation or search carried out in a field of science or technology by means of experiment or analysis and must be in respect of either basic or applied research or development using the results of such research. It must also be related to the business of the taxpayer.

2. Included in the definition of scientific research under Regulation 2990 are activities such as engineering or design, operations research, mathematical analysis or computer programing and psychological research provided that they are undertaken directly in support of basic or applied research and development. Where such activities are performed under contract fur the taxpayer with respect to a research project, the contract payments made by him will generally be eligible for the ITC. As these activities would be in support of a research project being undertaken by the taxpayer and not the performer, the expenditures incurred by the performer in the performance of the contract would not be eligible for the ITC unless the activities meet the criteria of scientific research on their own merit. Generally this will not be the case as such activities normally are within the realm of existing technology.

3. Expenditures in respect of scientific research carried on outside Canada will not be eligible for the ITC. This exclusion will apply to the taxpayer even in situations where research which has been contracted out to Canadian performer is further subcontracted out and the subcontractor carries out some or all of the scientific research outside Canada. In that situation, the taxpayer's eligible expenditures paid to the performer would be reduced on a prorated basis.

4. Expenditures must not be made to acquire rights in, or arising out of, scientific research. An example of this type of expenditure would he the acquistion of know-how or a patent right arising out of scientific research. Another example may be an expenditure under contract to provide a "turn-key" prototype in which no financial risk to the taxpayer arises. In other words, if the finished product does not work, no money is paid by the taxpayer. In such cases the research, if any, appears to neither the related to the taxpayer's business nor be undertaken on his behalf.

5. By virtue of subsection 127(11.1) the amount of a qualified expenditure eligible for ITC incurred after May 23, 1995 will be reduced by the amount of any government or non-government assistance received or expected to be received in respect thereof. In addition, qualified expenditures incurred after November 21, 1985 will reduced by the amount of any contract payments received or expected to be received. Reference should be made to the definitions of contract payments, government assistance and non-government assistance as contained in subsection 127(9) of the Act, and to the transitional provisions related to these definition as contained in the history to this subsection.

6. Expenditures incurred prior to May 23, 1985 will be reduced to the extent that the taxpayer has received or is entitled to receive a reimbursement in respect thereof, other than a reimbursement from a government in Canada. In order to be considered a reimbursement, the arrangements must specifically provide for reimbursement of the performer's expenditure. Each contractual arrangement must be reviewed on its own merits to determine whether it constitutes a reimbursement. In general, it would, appear that contracts for a fixed fee would not be considered a reimbursement, and in fact only a cost plus, or similar contract, which specifically calls for a reimbursement of specific expenditures would be considered a reimbursement for the purpose of Regulation 2902.

7. In order for the taxpayer to claim an expenditure under subparagraph 37(1)(a)(i) made on a contract for services and/or facilities as scientific research, the research must be related to his business. The taxpayer must be able to benefit from the results of the research, otherwise it would be difficult to establish this relationship. Therefore, it will he necessary for the taxpayer to exhibit a degree of control over the service performance and/or participation in the results of the research to order for it to be considered a qualified expenditure.

We suggest that you may wish to inform the District offices of these views. This issue was discussed at the recent Refundable Investment Tax Credit Seminar in Cornwall and the participants indicated that this information would greatly assist them in resolving outstanding problems.

R.C. SHULTIS

A/Director Small Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch