15 April 1985 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.

APR 15 1985

TO        MONTREAL DISTRICT OFFICE
          Audit Review
          5th Floor

ATTENTION H. Gutenplan
          Section 142-5-4

TO        HEAD OFFICE
          Corporate Rulings Division
          E. Mikhail
          995-1723

XXXX

Meaning of Market Research and Economic Studies in Scientific Research

This is in reply to your memorandum of November 6, 1984 and the memorandum from your Mr. A. Gutenplan, Large File Case Manager, of the same date in which you requested our views on the meaning of market research and economic studies within the context of the scientific research definition in Regulation 2900 for purposes of paragraph 37(7)(b) of the Act XXXX the audit has not yet been completed and our comments are expected to have a direct bearing on the scope of your audit to be performed. XXXX had submitted a position paper on the matters and asked that the matters be referred to Head Office for consideration.

THE ISSUES

A. Market Research

Paragraph (d) of Regulation 2900 specifically excludes "market research or sales promotion" from the definition of scientific research. XXXX appears to contend that the expression market research can be equated with marketing research and that market reseaich does not include market research carried out prior to the development of a new product or process. Its other words XXXX believes market research carried out prior to the development of a new product or process qualifies as scientific research.

You contend that market research or sales promotion is meant to apply to all market research and not just market research related to sales promotion.

B. Economic Studies

XXXX contends that economic studies are performed to determine whether a new product or process be developed is likely to be economically viable. No funding for a research and development project is authorized unless the project has a potential for profitability. Profitability may be expected to be derived from lower costs developed for new products or processes over existing ones, new markets or new applications. XXXX believes that economic studies are a necessary part in this process of using basic or applied research results to create new or improved products or processes. They are-conducted before the product or process is substantially set and do not have as their primary objective the development of markets or pre-production planning. XXXX argues that economic studies are not activities specifically excluded from the definition of scientific research and therefore should be recognized as scientific research. Also, XXXX a appears to believe that since economic studies are economic feasibility studies and feasibility studies had been accepted by the Department of Industry, Trade and Commerce, as it was then called, for purposes of the Industrial Regional Development Incentives Act, they should also be accepted for purposes of the Income Tax Act.

On the other hand, you contend that economic studies are not part of scientific research except for cost studies to achieve cost optimization (profit optimization), cost minimization or the calculation of costs for various technical alternatives.

OUR COMMENTS

C. Market Research

The expression "market research" in paragraph (d) of Regulation 2900 is defined in various dictionaries as follows:

A Supplement to the Oxford English Dictionary:

"Market research. The systematic investigation of the demand for particular goods, a branch of marketing research."

Dictionary of Business and Management by Jerry M. Rosenberg:

"Market research. Part of marketing research dealing with the pattern of a market, measuring the extent and nature of the market, and identifying its characteristics. Market research precedes marketing research.

The Random House Dictionary of the English Language. The Unabridged Edition:

"Market research. The gathering and studying of data relating to consumer preferences purchasing power, etc., especially preliminary to introducting a product on the market."

A Dictionary of Canadian Economics by David Crane:

"Market research. Research, including consumer surveys, to determine consumer attitudes to existing products and those of competitors, or to a possible new product. Such research examines consumer buying habits, use of leisure time, consumer needs or wants, criticisms of existing products, perceptions of competitors' products, and other such information. Market research is used by management to determine MARKETING strategies, including product changes, new packaging, changes in product design, or revisions in advertising and promotion. It is also used to help decide whether a new product should be launched, and may include test marketing in a small number of communities, to see what the consumer reaction is likely to be."

The expression "marketing research", on the other hand, is defined as follows.:

A Supplement to the Oxford English Dictionary:

"Marketing research. The systematic study of all factors involved in marketing a product."

Dictionary of Business and Management by Jerry M. Rosenberg:

"Marketing research. The process of gathering, recording and analyzing information pertaining to the marketing fo goods and services."

The Gulf Publishing Company Dictionary of Business and Science:

"Marketing research. The gathering, recording and analyzing of all facts about problems relating to the transfer and sale of goods and services from producer to consumer."

It is our opinion that market research clearly needs to be differentiated from marketing research. We cannot support XXX contention that market research can be equated with marketing research. Paragraph (d) of Regulation 2900 merely refers to market research and not to marketing research. The expression market research should be given its ordinary dictionary meaning.

We believe the definition of market research given in the Dictionary of Canadian Economics is probably the most comprehensive and useful one from a practical point of view. However, care should be exercised to differentiate between activities making up market research and activities that follow that make use of market research. Needless to say, only those activities that constitute market research itself qualify as market research. The dictionary definition of market research clearly does not support XXXX contention that market research should be limited to existing products or processes as opposed to products or processes to be developed. The dictionary definitions clearly indicate that market research carried out to determine consumer attitudes to possible new products is market research and thus is specifically excluded from the definition of scientific research. This is so even if this market research is used a basis for the decision to proceed with the development of new products or to make changes to products already under development. The dictionary definitions clearly indicate that market research could be carried out at any time during the evolution of a new product as well as after commercial production. We believe that this is consistent with the intent of the legislators.

It appears to us that XXXX may be using the term market research in a rather loose sense and that a closer examination of the facts of particular so-called market research projects may reveal that what is described as as market research does not fit the dictionary definition. For example, the first project in your working papers called XXX indicates that primary and secondary market research efforts were used to understand how office workers perform their various functions. Although we are not familiar with all the facts of this particular project, it appears to us that research, such as time and motion studies conducted in the market place with business customers to analyse work functions, does not fit the dictionary definition of market research. Care would have to be be exercised to ensure that only proper market research is excluded from the definition of scientific research. For example, it seems to us that the XXX project (W/P 10-8 & 10-9) included field tests on a new product which appear to have involved XXXX which helped to optimize the design of the eventual new product. We believe that as long as these filed tests are undertaken directly in support of a new or improved product and this product qualifies under paragraph (c) of Regulation 2900 that these field tests carried out in the market place qualify as legitimate scientific research.

D. Economic Studies

These economic studies appear to be in the nature of economic feasibility studies. A feasibility study is certified as follows:

Dictionary of Canadian Economics by David Crane:

"Feasibility study. The examination of a proposed project to see whether it makes technical and financial sense. This type of review is made before any major capital project is undertaken."

Dictionary of Business and Management by Jerry M. Rosenberg:

"Feasibility study. An inquiry to determine that which can be achieved given certain specified resources and other constraints."

Feasibility studies undertaken directly in support of development activities described in paragraph (c) of Regulation 2900 are acceptable as scientific research. This position is consistent with the position adopted by the Department of Industry, Trade and Commerce, as it was then called, for purposes of the Industrial Research and Development Incentives Act. We believe that feasibility studies generally fall within the definition of operations research - a term that appears in the definition of scientific research in Regulation 2900. Operations research by itself is not scientifc research but if undertaken directly in support of activities in paragraph (c) of Regulation 2900 does qualify as scientific research.

Operations research is defined as follows:

Dictionary of Business and Management by Jerry M. Rosenberg:

"Operations research. The application of scientific methods, techniques, and tools to problems involving the operation of a system, to provide those in control of the system with optimum solutions to the problems."

The Random House Dictionary of the English Language. The Unabridged Edition:

"Operations research. The analysis, usually involving mathematical treatment, of a process, problem, or operation to determine its purpose and effectiveness and to gain maximum efficiency."

We do not know what the exact scope and purpose of these economic studies are except that these studies are carried out to determine the economic viability of proposed projects. Accordingly, we find it difficult to provide specific guidelines. However, as a rule of thumb we can say that studies to calculate the capital outlay required to complete the proposed project and to calculate the anticipated pay-back period of the initial project investment fall within the scope of feasibility studies that can be viewed as being undertaken directly in support of the new product or process to be developed or under development. These feasibility studies qualify as scientific research provided the product or process to which they relate is one that meets the requirements of paragraph (c) of Regulation 2900. In contrast, economic studies to show the overall economic viability of a new product or process after it has been fully developed, i.e. the profit to be generated from the commercial exploitation of the new product or process, are outside the scope of feasibility studies that are acceptable as scientific research. These studies cannot be viewed as being undertaken directly in support of the development of a new product or process.

You stated that you accept cost studies that refer to cost optimization (profit optimization), product maximization, cost minimization and the calculation of costs for various technical alternativen as scientific research. We are not familiar with the specific details of these studies and the surrounding circumstances that made you decide to accept these cost studies an scientific research. As a note of caution we would like to say that the necessary skills and knowledge for achieving process optimization, greater productivity, greater efficiency and low unit costs of production are the normal attributes of a competent management. They are represented, for example, by the function of accounting, industrial engineering, time and motion analyses, methods engineering, value analyses and engineering, tool and machine design, etc. Where these skills are used in any situation requiring an improvement, a trend toward ideal conditions will normally ensue and the law of diminishing returns will normally be the only limitation upon the attainable degree of improvement. Thus, process optimization or cost reduction do not involve any scientific uncertainty of outcome. For a given effort or application of skills, a predictable outcome results, namely improved costs, yield or quality. These activities by themselves are not scientific research. However, to the extent these studies are operations research undertaken directly in support of activities described in paragraph (c) of Regulation 2900 they qualify as scientific research. From a practical point of view, for purposes of paragraph (c) of Regulation 2900 ordinarily only operations research in support of the development of a prototype (see IT-9 paragraph 10) or pilot plant (see IT-439 paragraphs 11 and 12) qualify as scientific research.

We trust the above comments will assist you in your audit. As you indicated over the telephone XXXX engages in a diversity of market research and economic studies projects an the amounts involved are quite significant. In this regard, we would like to say that if you need further clarifications on specific projects we would welcome the opportunity to help. However, our ability to help is directly dependent on the amount of relevant facts made available to us. The more facts we are given, the more specific our guidelines can be.

Original Signed by Original signé par

R.C Shultis

Chief Merchandising and Manufacturing Corpororate Rulings Directorate Legislation Branch

EM/sc

37(7)(b) Regulation 2900

c.c.: H.A. Diguer Assistant Deputy Minister Policy and Systems Branch