SR&ED Capital Expenditures Policy

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SR&ED Capital Expenditures Policy

Date: December 18, 2014

Changes to the SR&ED Capital Expenditures Policy

Reasons for revision

This revision accommodates the legislative changes that have been announced.

Revision overview

Scientific research and experimental development (SR&ED) capital expenditures made after December 31, 2013 do not qualify for SR&ED tax incentives. The rules applicable to claiming SR&ED capital expenditures contained in this policy document are applicable to those expenditures made before 2014.

The text of this document has been revised to reflect these changes, see Appendix C.1 Explanation of changes.

Table of contents

1.0 Purpose

This policy document deals with capital expenditures made by a claimant for the prosecution of scientific research and experimental development (SR&ED) carried on in Canada. This document clarifies the position of the Canada Revenue Agency (CRA) regarding capital expenditures when administering the SR&ED legislation under the federal Income Tax Act and the Income Tax Regulations.

The purpose of this document is to:

explain that capital expenditures made after December 31, 2013 no longer qualify for SR&ED tax incentives;
explain expenditures of a current nature after 2013;
explain that capital expenditures made before 2014 may be claimed for SR&ED purposes;
provide guidelines for determining the intent of a claimant that acquired capital property for the prosecution of SR&ED carried on in Canada (SR&ED capital property) before 2014;
explain the nature of SR&ED capital property as depreciable property; and
identify issues surrounding the sale of SR&ED capital property.

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]
Paragraph 37(8)(d) SR&ED expenditures specifically excluded
Former paragraph 37(8)(d) SR&ED expenditures specifically excluded
Subsection 127(9) Definition of "qualified expenditure"

2.0 Overview

2.1 Capital expenditures made after 2013

The 2012 federal budget announced that expenditures of a capital nature made after 2013, will no longer qualify for SR&ED tax incentives. This includes capital expenditures made before 2014 (see section 3.2) for property that became available for use (see section 3.3) after 2013. Further, for SR&ED purposes, expenditures of a current nature made after 2013 exclude expenditures for capital property or the right to use capital property (see section 3.1.1).

The distinction between a current and a capital expenditure is ever more important now that capital expenditures no longer qualify for any SR&ED tax incentives. Thus, the comments in section 10.2 may provide some assistance in making this distinction.

Further, contract expenditures and third-party payments incurred after December 31, 2013 must be reduced by the amount of any related expenditure of the SR&ED performer that is not an expenditure of a current nature (see section 3.1.2).

The following sections of this policy document may be relevant to expenditures for capital property made after 2013:

Section 3.0 Legislation
Section 3.3 Available for use
Section 9.0 Sale of capital property
Section 10.2 Current vs capital expenditures
Section 10.4 Related current costs

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(1.2) Available for use
Paragraph 37(8)(d)(i) SR&ED expenditures specifically excluded – capital property
Subsection 37(14) Look-through rule

2.2 Capital expenditures made before 2014

Generally, a claimant carrying on a business in Canada in a tax year may, in calculating income from the business for the year, deduct expenditures for the prosecution of SR&ED carried on in Canada that relates to a business of the claimant.

The first step to claiming an SR&ED capital expenditure made before 2014 is to determine whether the SR&ED expenditure is current or capital in nature. The distinction between current and capital is important because of the difference in investment tax credit (ITC) refundability rates for certain corporations. The distinction is also important because some expenses that would normally be capital for accounting and tax purposes which would be deducted over many years, are fully deductible in the year as SR&ED expenditures.

For more information on rates of refundable ITC, please refer to the SR&ED Investment Tax Credit Policy.

Current expenditures made before 2014 on or in respect of SR&ED are considered to be those expenditures that do not result in the acquisition of land, a leasehold interest in land, or property that would otherwise be depreciable property (see section 5.0) to the claimant.

Capital expenditures made before 2014 for the prosecution of SR&ED carried on in Canada are only those expenditures that result in the acquisition of property that would be the claimant's depreciable property, other than a building or a leasehold interest in a building (see section 7.2). Expenditures for non-depreciable property such as the acquisition of land, property that is described in a claimant's inventory, or eligible capital property (such as goodwill) cannot be included in the pool of deductible SR&ED expenditures as an SR&ED capital expenditure (see section 7.1).

Expenditures on capital property made before 2014 that is intended (see section 6.0) to be used during all or substantially all (ASA) (see section 4.1) of its operating time (see section 4.2) in the prosecution of SR&ED carried on in Canada, or ASA of its value would be consumed in the prosecution of SR&ED carried on in Canada may qualify as SR&ED capital expenditures (see section 3.0).

The next steps to claiming an SR&ED capital expenditure are to determine whether the capital expenditures made before 2014 are for SR&ED carried on in or outside Canada (see section 7.3) and when the property became available for use (see section 3.3).

When a claimant sells their SR&ED capital property, the tax treatment of the proceeds may vary depending on whether a deduction for the property has previously been claimed (see section 9.0).

If an expenditure was not claimed on Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim by the reporting deadline, this will cause the expenditure to be classified as a normal business expense or outlay in accordance with the Act. For example, an expenditure to acquire depreciable property, which would have been an SR&ED capital expenditure deductible in the year had the filing requirements been met, would generally be treated as an acquisition of depreciable property.

For more information on the reporting deadline, please refer to the SR&ED Filing Requirements Policy.

Legislative References Income Tax Act
Subsection 13(21) Definition of "depreciable property"
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – current expenditures
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(2) Research outside Canada
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]
Subsection 37(11) Filing requirement

2.2.1 SR&ED capital expenditures as an income deduction

For expenditures made before 2014, a claimant may fully deduct its SR&ED capital expenditures (see section 3.2) incurred in the tax year when determining their income for tax purposes in the tax year. A claimant may also, to the extent that those SR&ED capital expenditures have not been deducted in the tax year, carry these expenditures forward to reduce their income for tax purposes in future tax years. The carry forward amount will be subject to certain limits if the claimant is a corporation whose control has been acquired by a person or group of persons.

For more information on deducting SR&ED expenditures, please refer to the Pool of Deductible SR&ED Expenditures Policy. For more information on acquisition of control, please refer to section 5.1 of the SR&ED Investment Tax Credit Policy.

Legislative Reference Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]

2.2.2 Introduction to shared-use-equipment

Expenditures for capital property made before 2014 that do not meet the ASA criteria (see sections 3.2.1 and 3.2.2) do not qualify as an SR&ED capital expenditure. However, where claimants perform SR&ED in an environment where their capital property is used for both SR&ED and commercial work, their capital property may qualify as shared‑use-equipment (SUE) and be included in qualified SR&ED expenditures. An expenditure on capital property that is used primarily during its operating time in SR&ED may meet the requirements of SUE provided requirements for first term and second term shared-use-equipment are met.

For more information on first term and second term shared-use-equipment, please refer to the SR&ED Shared-Use-Equipment Policy. For more information on qualified SR&ED expenditures, please refer to the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Subsection 37(2) Research outside Canada
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]
Subsection 127(9) Definition of "first term shared-use-equipment"
Subsection 127(9) Definition of "second term shared-use-equipment"

2.2.3 SR&ED capital expenditures as qualified SR&ED expenditures

A claimant may earn ITCs on SR&ED capital expenditures made before 2014 that meet the rules for qualified SR&ED expenditures. For an expenditure to be a qualified SR&ED expenditure, the expenditure must first meet the criteria as a deductible SR&ED capital expenditure (see sections 3.2 to 3.3). For more information on deductible SR&ED expenditures, please refer to the Pool of Deductible SR&ED Expenditures Policy.

An SR&ED capital expenditure made before 2014 that is included in the pool of deductible SR&ED expenditures may not necessarily be a qualified SR&ED expenditure for ITC purposes. For example, a qualified expenditure does not include prescribed expenditures such as used equipment (see sections 8.0 to 8.2).

In addition, when a claimant purchases goods or services (other than where SR&ED work is performed on behalf of the claimant) from a person with whom the claimant does not deal at arm’s length at the time of the transaction, the amount of qualified SR&ED expenditures for ITC purposes may be restricted (see section 8.2).

For more information on qualified SR&ED expenditures, please refer to the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy.

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 127(9) Definition of "qualified expenditure"

Legislative Reference Income Tax Regulations
Former paragraph 2902(b) Prescribed capital expenditures for purposes of qualified expenditures

3.0 Legislation

3.1 Capital expenditures made after 2013 cannot be claimed

Capital expenditures made after December 31, 2013 can no longer be claimed for SR&ED purposes. This is also applicable to capital expenditures (see section 3.2) deemed to have been made after 2013 due to the available for use rules (see section 3.3).

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection (37(1.2) Available for use

3.1.1 Expenditures of a current nature

For SR&ED purposes, expenditures of a current nature include any expenditures made by the claimant other than an expenditure for:

the acquisition of capital property of the claimant, or
the use of, or the right to use, property that would be capital property of the claimant if it were owned by the claimant.

These rules apply to expenditures made after 2013. For more information on the use or right to use capital property, please refer to the SR&ED Lease Expenditures Policy.

Legislative References Income Tax Act
Paragraph 37(8)(d) SR&ED expenditures specifically excluded
Section 54 Definition of “capital property”

3.1.2 Capital look-through rule and the reporting of certain payments

The look-through rule—a claimant’s particular expenditure made to a person or partnership (the performer) to be used in SR&ED purposes must be reduced by the amount of any related expenditure of the person or partnership to whom the particular expenditure is made that is not an expenditure of a current nature of the person or partnership (see section 3.1.1). In other words, any contract expenditure and third-party payment of the claimant made to an SR&ED performer must be reduced by any related expenditure of the SR&ED performer that is for capital property, or the use of, or the right to use, capital property (if the capital property were owned by the SR&ED performer).

When a claimant is required to reduce their expenditure because of the look–through rule, the SR&ED performer is required to inform the claimant in writing of the amount of the reduction. This information is to be provided without delay if requested by the claimant and in any other case no later than 90 days after the end of the calendar year in which the expenditure (of the claimant) was made.

Legislative References Income Tax Act
Subsection 37(14) Look-through rule
Subsection 37(15) Reporting of certain payments

3.2 Capital expenditures made before 2014 can be claimed

3.2.1 Criteria for SR&ED capital expenditures – Traditional method

If a claimant elects to use the traditional method, an SR&ED capital expenditure made before 2014 means an expenditure that, at the time it was incurred, was for the provision of premises, facilities, or equipment, when at that time it was intended that:

the capital property would be used during all or substantially all (see section 4.1) of its operating time (see section 4.2) in its expected useful life for the prosecution of SR&ED carried on in Canada; or
all or substantially all of its value would be consumed in the prosecution of SR&ED carried on in Canada.

When claiming an SR&ED capital expenditure, a claimant should not only consider whether the capital property will be used in SR&ED in the year the expenditure was made but should also consider the intended use over the lifetime of the capital property (see section 6.0).

Only those expenditures of a capital nature for the provision of premises, facilities or equipment for the prosecution of SR&ED carried on in Canada that meet these criteria may be claimed as an SR&ED capital expenditure.

For more information on the traditional method, please refer to the Traditional and Proxy Methods Policy.

3.2.2 Criteria for SR&ED capital expenditures – Proxy method

If a claimant elects to use the proxy method, an expenditure of a capital nature on or in respect of SR&ED made before 2014 means the same as it does in section 3.2.1 for the traditional method, except that it does not include general purpose office equipment or furniture (GPOEF) (see section 4.3).

For more information on the proxy method, please refer to the Traditional and Proxy Methods Policy.

3.2.3 Additional criteria for SR&ED capital expenditures for both traditional and proxy methods

In order to include an SR&ED capital expenditure in the pool of deductible SR&ED expenditures:

the expenditure must be made before January 1, 2014;
the capital property must be a new or used property that would otherwise be considered depreciable property (see sections 5.0 to 5.2 for further explanations regarding depreciable property, capital cost of property, capital cost allowance (CCA), and undepreciated capital cost (UCC));
the expenditure must be made by a claimant for the prosecution of SR&ED carried on in Canada that is directly undertaken by, or on behalf of, the claimant and that is related to a business of the claimant; and
the capital property must be available for use before January 1, 2014 (see section 3.3).

These criteria must be met in order for a capital expenditure to be included in the pool of deductible SR&ED expenditures when claimants use either the traditional method (see section 3.2.1) or the proxy method (see section 3.2.2) to determine their SR&ED expenditures.

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(1.2) Available for use

3.2.4 SR&ED capital expenditure deduction deemed capital cost allowance

If the pool of deductible SR&ED expenditures includes an expenditure for capital property, the same property cannot also be claimed for CCA. Therefore, a claimant is prevented from duplicating deductions for capital expenditures by claiming CCA on such expenditures as well as deducting the SR&ED capital expenditure in determining their income for tax purposes in the year.

For the purposes of the rules concerning depreciable property (definition of depreciable property, recapture rules, etc.), an SR&ED capital expenditure deducted by the claimant in determining their income for tax purposes in the year will be deemed to be an amount that has been allowed to the claimant as CCA. The SR&ED capital expenditure deducted by the claimant in the year is deemed to be claimed as CCA in order to satisfy other rules of the Income Tax Act. The treatment of the sale of SR&ED capital property is an example of these rules (see section 9.1).

SR&ED capital property is also deemed to be of a separate prescribed class for CCA. As such, an amount may be required to be included in the claimant's income as recapture of CCA if the property is disposed of (see section 9.1). For more information, please refer to the Recapture of SR&ED Investment Tax Credit Policy.

Legislative References Income Tax Act
Section 13 Rules concerning depreciable property
Subsection 13(1) Recaptured depreciation
Paragraph 20(1)(a) Deduction for capital cost of a property
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(6) Expenditures of a capital nature

Legislative Reference Income Tax Regulations
Paragraph 1102(1)(d) SR&ED deduction deemed not allowed for capital cost allowance

3.3 Available for use

A capital property must be available for use before 2014 in order for a capital expenditure for that property to be included in the pool of deductible SR&ED expenditures.

Generally, a property is considered to become available for use, for inclusion in the pool of deductible SR&ED expenditures and for investment tax credit (ITC) purposes as determined by the available for use rules concerning depreciable property.

Generally, an SR&ED capital property is considered to become available for use at the earliest of:

the time at which the property is first used by the claimant, for the purpose of earning income. For the purpose of determining when a property is first used, SR&ED activities are considered to be for the purpose of earning income.

the time the property is delivered or is made available to the claimant or to another person (or partnership) that will use the property for the benefit of the claimant, and is capable of producing or performing a commercially saleable product or service. Product or service includes an intermediate product or service that is, or will be, used or consumed by or for the benefit of the claimant or the other person (or partnership) in producing or performing any such product or service.

Legislative References Income Tax Act
Subsections 13(26) to (32) Available for use
Subsection 37(1.2) Available for use
Subsection 127(11.2) Time of an expenditure and acquisition
Subsection 248(19) When property available for use

4.0 Terms

4.1 All or substantially all

All or substantially all (ASA) is generally accepted to mean 90% or more. Generally, where an expenditure is ASA, the total amount of the expenditure is deductible.

For SR&ED capital property, the ASA test will be met where it is determined that, the property's anticipated use for other purposes during its operating time in its expected useful life does not exceed 10%, or if it is intended that not less than 90% of the value of the property is to be consumed in the prosecution of SR&ED carried on in Canada (see sections 3.2.1 and 3.2.2).

The ASA test for SR&ED capital property is based on intent as opposed to actual use even though the CRA may look at subsequent use to evaluate intent (see section 6.0).

Legislative References Income Tax Act
Subsection 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]

4.2 Operating time

SR&ED use of SR&ED capital property should be determined as a percentage of the total operating time on an annual basis. The term operating time is not defined in the Income Tax Act but generally means the time the equipment usually runs or functions during the tax year.

Time spent to set up equipment for SR&ED activities and time spent to switch the equipment back to another use will usually be considered to be operating time in which the equipment is used for the prosecution of SR&ED carried on in Canada, as long as it is reasonable in the circumstances. The time that the machine is idle is not included in the calculation (is not considered operating time).

Whether equipment is used for the prosecution of SR&ED carried on in Canada during its operating time is a question of fact that can only be determined on a case-by-case basis. The onus is on the claimant to maintain documentation, such as a logbook, which would support the SR&ED use of the equipment for the period (see section 11.0).

4.3 General purpose office equipment or furniture

General purpose office equipment or furniture (GPOEF) includes all furniture, such as desks, chairs, lamps, filing cabinets, and bookshelves. It also includes photocopiers, fax machines, telephones, pagers, typewriters, word processors, teletypes and calculators.

Computers, including hardware, software, and ancillary equipment, are not considered to be general purpose office equipment or furniture.

The only difference in determining SR&ED capital expenditures under the traditional method and the proxy method for expenditures made before 2014, is that expenditures for general purpose office equipment or furniture (GPOEF) must be excluded where the proxy method is used. If a claimant uses the proxy method, outlays to acquire GPOEF are included in a prescribed class and are eligible for capital cost allowance (CCA) (see section 5.1) at the prescribed rate.

GPOEF is excluded from the definitions of first and second term shared‑use-equipment. For more information, please refer to the SR&ED Shared-Use-Equipment Policy.

Legislative References Income Tax Act
Paragraph 20(1)(a) Deduction for capital cost of a property
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]

5.0 Depreciable property

Depreciable property is any property that has an expected useful life and / or benefit of more than 12 months and on which the claimant has claimed or would be allowed to claim capital cost allowance (CCA) (see section 5.1). The cost of this property (see section 5.2) is amortized over a number of tax years.

Only expenditures made before 2014 that result in the acquisition of new or used depreciable property, other than a building or a leasehold interest in a building are eligible for inclusion in the pool of deductible SR&ED expenditures. Consequently, expenditures for the acquisition of non‑depreciable property (including land, a leasehold interest in land, property described in the claimant's inventory, or eligible capital property) cannot be included in the pool of deductible SR&ED expenditures (see section 7.1).

Additional comments in the Interpretation Bulletin IT‑128R, Capital cost allowance - Depreciable property, may also be of assistance in determining whether a particular property is depreciable property.

Legislative References Income Tax Act
Subsection 13(21) Definition of “depreciable property”
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Former subparagraph 37(8)(d)(i) SR&ED expenditures specifically excluded – building and leasehold interest

5.1 Capital cost allowance

A claimant may acquire a depreciable property, such as equipment, to use in its business or professional activities. The cost of the property cannot be deducted when calculating net business income for the tax year. However, since these properties wear out or become obsolete over time, their cost can be deducted over a number of years. For income tax purposes this deduction is called capital cost allowance (CCA). Generally, the undepreciated capital cost (UCC) is the balance left after CCA is deducted from the capital cost of a depreciable property. As stated in section 3.2.4 an SR&ED capital expenditure deducted by the claimant in determining their income for tax purposes in the year will be deemed to be an amount that has been allowed to the claimant as CCA.

SR&ED capital expenditures may be claimed only for property owned (see section 5.1.1) by the claimant or property in which the claimant has a leasehold interest.

Legislative References Income Tax Act
Subsection 13(21) Definition of "undepreciated capital cost"
Paragraph 20(1)(a) Deduction for capital cost of a property
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(6) Expenditures of a capital nature

Legislative References Income Tax Regulations
Part XI Capital cost allowances
Schedules II to VI Capital cost allowance schedules

5.1.1 Ownership of capital property

SR&ED capital expenditures made after 2013 cannot be claimed. SR&ED capital expenditures are limited to the acquisition of depreciable property. Depreciable property is any property in which CCA can be claimed. CCA may be claimed only for property owned or deemed to be owned (see section 5.1.3) by the claimant or property in which the claimant has a leasehold interest. Thus, in order to claim an allowable SR&ED capital expenditure, the expenditure for the SR&ED capital property must result in the claimant owning, or obtaining a leasehold interest in, the SR&ED capital property. See section 7.2 for a discussion of the acquisition of buildings or leasehold interest in buildings which are not allowed as SR&ED capital expenditures.

Where a claimant acquires a capital property, ownership of the capital property will be obtained either at the time the cost was incurred or at a later date. It is a question of fact whether or not a claimant owns or has a leasehold interest in an SR&ED capital property.

A claimant who acquires or holds property as an agent or nominee for another cannot claim the property as an SR&ED capital property (and cannot claim CCA on such property).

In computing the income of a partnership, the Income Tax Act requires that partnership property (including SR&ED capital property) be accounted for as if it were owned at the partnership level. For more information, please refer to the SR&ED Claims for Partnerships Policy.

Legislative Reference Income Tax Regulations
Subsection 1102(1a) Partnership property

5.1.2 No ownership of capital property

There may be circumstances in which neither a freehold nor a leasehold interest in capital property is acquired. In these circumstances CCA cannot be claimed in respect of such capital property. For example, if a claimant constructs and incurs the cost to build a structure on land owned by another person (or otherwise incorporates capital property into property owned by another as an integral part thereof) and does not have a leasehold interest in or ownership of the structure (or capital property), CCA may not be claimed in respect of the structure (or capital property). Since CCA could not otherwise be claimed for this type of property, it would not be depreciable property. Consequently, expenditures for this type of property would not be allowed as an SR&ED capital expenditure.

Legislative References Income Tax Act
Paragraph 20(1)(a) Deduction for capital cost of a property
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]

5.1.3 Deemed ownership of leased property

When a lessor acquires new capital property that has yet to be leased and then jointly elects with its first lessee of the capital property under section 16.1 of the Act, the capital property will not be considered to have been used or acquired for use or lease for any purpose whatever before the lessee is deemed to have acquired the property.

Example:

A claimant leases a property from an arm's length party for a period exceeding one year and they jointly make an election under section 16.1 of the Act. The claimant is deemed to have acquired the property at its fair market value and borrowed an equal amount from the lessor. The lease payments are deemed to be blended payments of principal and interest.

The expenditure would not be considered to be prescribed (not allowed, see section 8.1) where the lessor acquires new property, which has yet to be leased, and then elects with the first lessee (the claimant) under section 16.1 of the Act.

The treatment of this transaction for SR&ED purposes is the same as for any other acquisition of property. The property must still meet the intent criteria (see section 6.0) and the all or substantially all (ASA) criteria (see sections 3.2.1 and 3.2.2) in order to be allowable as an SR&ED capital expenditure. SR&ED capital expenditure made after 2013 cannot be claimed.

Legislative References Income Tax Act
Section 16.1 Leasing properties
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]

5.2 Capital cost of property

These rules are used to determine the amount of SR&ED capital expenditures made before 2014 that may be included in the pool of deductible SR&ED expenditures.

When referring to depreciable property (see section 5.0) the term "capital cost of property" generally means the full cost to the claimant of acquiring the property and includes:

the purchase price;
legal, accounting, engineering, installation, and other fees that relate to the buying or construction of the property (not including the part that applies to land);
custom and excise duties, transportation and other acquisition costs, and when they are significant, storage costs;
the cost of any additions or improvements made to the property after it was acquired, provided these costs were not claimed as a current expense; and
in the case of a property a claimant manufactures for its own use, it includes material, labour, and overhead costs reasonably attributable to the property, but does not include any profit that might have been earned had the property been sold.

Legislative References Income Tax Act
Paragraph 20(1)(a) Deduction for capital cost of a property
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]

Legislative Reference Income Tax Regulations
Part XI Capital cost allowances

6.0 Intent

The sections 6.0 to 6.8 are only relevant if the capital property was acquired and available for use before 2014.

It is recognized that the determination of intent can be difficult, particularly because the determination of whether a capital property is intended to be used all or substantially all (ASA) (see section 4.1) of its operating time (see section 4.2) in its expected useful life in the prosecution of SR&ED carried on in Canada is made at the time the property is acquired. In making this determination, the intended use of the property in the year in which the expenditure was made to acquire the property as well as over its expected useful life must be considered.

Subsequent use of the property may provide evidence of the claimant's intent at the time the expenditure was made. However, when the subsequent use is contrary to the claimant's stated intent, it is the claimant's responsibility to support their contention that the property was intended to be used ASA of its operating time in its expected useful life in the prosecution of SR&ED carried on in Canada.

The determination of intent is usually a joint decision that will be made by the Financial Reviewer and Research and Technology Advisor based on all the circumstances related to the acquisition of the capital property. A Research and Technology Advisor who knows the industry and its practices can help to clarify how the property is used in the claimant's project and if the property can be used commercially. Therefore, representations provided by the claimant may assist in determining that the intent test was met.

There is neither a unique test nor exacting jurisprudence that can be fully utilized in establishing the intent of a claimant in regards to the acquisition of a capital property. If after reviewing a claimant's representation it is still unclear whether the intent test has been met or not, the following eight factors may be considered and should be helpful in reaching a decision. While these factors may be useful in the decision‑making process they are not in themselves conclusive evidence of intent:

The list of factors is not exhaustive and intent can only be determined after examining all the relevant facts.

In cases where property acquired with the intent of using it ASA in SR&ED was later used in commercial activities or was sold, the recapture rules for investment tax credit (ITC) may be applicable. For more information, please refer to the Recapture of SR&ED Investment Tax Credit Policy.

Legislative References Income Tax Act
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]

6.1 Reason for purchase

The determination as to whether capital property is intended to be used ASA (see section 4.1) of its operating time (see section 4.2) in its expected useful life in the prosecution of SR&ED carried on in Canada, or whether ASA of its value would be consumed in the prosecution of SR&ED carried in Canada is made at the time the property is acquired. To determine the intent of a claimant it is necessary to look at all the reasons for the purchase at the time the property was acquired.

6.2 Potential use of property

To determine if an acquisition of property meets the intent test it is necessary to consider the potential use of the property. The intent test will normally not be met where property is acquired for both SR&ED and commercial purposes. To establish whether or not a property may have a dual purpose, it is necessary to determine if the claimant uses similar property for commercial purposes in its business.

Property that does not lend itself to activities other than SR&ED is likely to meet the intent test. However, where similar property is used for commercial purposes the claimant has to demonstrate that their intent is to use that particular property ASA for SR&ED.

6.3 Actual use of property

The actual use of property should in most cases confirm a claimant's intent. However, while the subsequent use of property may provide evidence of the claimant's intent at the time the property was acquired, it is not conclusive evidence of intent.

The SR&ED legislation provides for an intent test as opposed to a use test. Therefore, the actual use of a property is only one factor that needs to be considered when determining the intent of a claimant. In some cases, the intent test may still be met where, due to a significant and unforeseeable change in circumstances, a property acquired with the intent of being used ASA (see section 4.1) in SR&ED was later used for other activities.

6.4 Type of SR&ED

Where the SR&ED involves the construction of a custom product or commercial asset it is necessary to determine whether the property is an instrument to facilitate SR&ED or whether it is an integral part of the end product. Where it is intended that property will become part of a custom product or commercial asset, the expenditure to acquire that property will not generally be allowed for SR&ED purposes.

In some SR&ED projects, property may be destroyed or rendered valueless through the SR&ED process. A claimant has to show that at the time the property was acquired, the claimant intended to destroy or cause the property to be rendered valueless through the SR&ED process.

The intent test will not be met, if due to unforeseen circumstances, a property acquired with the intent of being used in commercial activities is destroyed or rendered valueless during the prosecution of SR&ED carried on in Canada. In such a case the claimant may be entitled to ITC if the property is considered to be shared‑use-equipment. For more information, please refer to the SR&ED Shared-Use-Equipment Policy.

6.5 SR&ED environment

The environment in which SR&ED is undertaken will sometimes assist in determining whether a property meets the intent test. Generally, the intent test would be met where property is acquired for use in the prosecution of SR&ED carried on in Canada and the claimant is a dedicated SR&ED corporation or division. However, where the proxy method is used, the cost of general purpose office equipment or furniture (see section 4.3) cannot be claimed as a capital expenditure for SR&ED (see section 3.2).

In addition, there is some indication, though not conclusive, that the intent test would be met where a property is acquired by a start-up SR&ED corporation or by a large corporation with a dedicated SR&ED facility. In these cases, additional factors such as the reason for purchase and potential use of the property may have to be considered in determining whether the intent test has been met.

6.6 Length of SR&ED project

The length of an SR&ED project will vary depending on the type of research being undertaken. In determining whether the intent test has been met it is necessary to take into consideration the length of a research project as compared to the expected useful life of the property.

For a capital expenditure to be allowable for SR&ED purposes, a claimant must intend to use the property during ASA (see section 4.1) of its operating time (see section 4.2) in its expected useful life for the prosecution of SR&ED carried on in Canada. If a claimant intends to use capital property to carry on SR&ED over a short period of time, the intent test would not generally be met where this period is less than the expected useful life of the capital property. However, in making this determination the intended use of the property for SR&ED purposes throughout its useful life should also be considered.

The cost of a capital property may also qualify as an SR&ED capital expenditure where it is intended that ASA of the value of the property would be consumed in the prosecution of SR&ED carried on in Canada. Where it is intended that ASA of the value of the property would be consumed in the prosecution of SR&ED carried on in Canada because technology is changing rapidly or because a property is actually destroyed in the SR&ED process, the length of the SR&ED project may be irrelevant in determining whether the expenditure for this property is allowable as an SR&ED capital expenditure.

6.7 Claimants past practices

A claimant's past practices may be relevant in determining whether the intent test has been met if the claimant acquired similar property in a previous year. If an SR&ED project is carried on over a number of years, how the capital property was treated in a previous year could be a factor in determining the intent of the claimant. If the cost of property was allowed as an SR&ED capital expenditure in a previous year and if similar property is acquired for SR&ED in the current year, the CRA would generally expect the similar property to be treated in a consistent manner in the current year.

While a claimant's past practice is an indicator of intent, this factor alone is not conclusive evidence of intent. In cases where there has been a shift in business from SR&ED to commercial activities, the claimant's past practices may not be relevant in determining the intent of a claimant.

6.8 Planning documents

In some industries, where significant amounts are spent on SR&ED work and on capital property in particular, there generally are planning documents relating to an SR&ED project. Planning documents that describe the use of capital property such as a project plan, a business case, or any other document that is a request to secure funding for a research project could be helpful in determining whether the intent test was met.

Planning documents will generally contain contingencies for the eventual use of capital property in the event that a research projects fails or for when the research project is completed. Generally, one of these contingencies is that capital property will be used in the commercial activities of the business.

The SR&ED work, carried on by a claimant, is performed within the overall business environment of that claimant. From a business perspective, it is important to have contingency plans in order to remain competitive and sustain a viable business operation. Planning documents must be viewed within the context of the business operation. As a result, it is necessary to place more emphasis on the claimant's intended use of property in the SR&ED environment and less emphasis on the contingent use of property in a larger business context.

7.0 Expenditures not allowed as SR&ED capital expenditures

For expenditure made before 2014, expenditures for non-depreciable property, buildings (other than a special‑purpose building, see Appendix A), and expenditures of a capital nature that pertain to SR&ED carried on outside Canada are not deductible as SR&ED capital expenditures. Capital expenditures made after 2013, no longer qualify for SR&ED tax incentives, see sections 3.1 to 3.1.2.

7.1 Non-depreciable property

As discussed in section 3.2, only expenditures incurred before 2014 that result in the acquisition of depreciable property (other than a building or a leasehold interest in a building, see section 7.2) are eligible for inclusion in the pool of deductible SR&ED expenditures, if they meet the definition of SR&ED capital expenditures. Consequently, expenditures for the acquisition of non-depreciable property, such as, land or a leasehold interest in land, property described in the claimant's inventory, or eligible capital property (such as goodwill), cannot be included in the pool of deductible SR&ED expenditures.

Legislative References Income Tax Act
Subsection 13(21) Definition of "depreciable property"
Subparagraph 37(1)(b)(i) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]

Legislative References Income Tax Regulations
Paragraph 1102(1)(b) Property not included in Schedule II – inventory
Subsection 1102(2) Property not included in Schedule II – land
Subsection 1102(5) Property not included in Schedule II – leasehold interest in land

7.2 Expenditures for buildings

Capital expenditures made before 2014 that relate to the acquisition of a building (other than a special‑purpose building prescribed by regulation, see Appendix A) including a leasehold interest in a building, do not constitute expenditures on, or in respect of, SR&ED. They cannot be included in the pool of deductible SR&ED expenditures nor can they be included in qualified SR&ED expenditures for investment tax credit (ITC) purposes. For more information on the exclusion of lease costs (rent) for a building, please refer to the SR&ED Lease Expenditures Policy. Capital expenditures made after 2013, no longer qualify for SR&ED tax incentives, see sections 3.1 to 3.1.2.

The purchase or rental of a structure or a portable shelter (see section 7.2.1) made before 2014 is not restricted and can be included in the pool of deductible SR&ED expenditures if the definition of SR&ED capital expenditures is met.

The comments in Interpretation Bulletin IT‑128R, Capital cost allowance – Depreciable property , may be of assistance in determining whether a particular property is depreciable property.

Legislative References Income Tax Act
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Former subparagraph 37(8)(d)(i) SR&ED expenditures specifically excluded – building and leasehold interest

7.2.1 Meaning of "building"

Building is a broad term covering any structure with walls and a roof affording protection and shelter that is affixed to the land. For example, a mobile home would be considered a building if the wheels, the trailer hitch, brakes and emergency lights are removed and the unit is affixed to cement pads on the ground and services, such as hydro and water, are installed.

The term structure includes anything of substantial size that is built up from component parts and intended to remain permanently on a permanent foundation. This definition of "structure" was considered by the Supreme Court of Canada in British Columbia Forest Products Ltd v. Minister of National Revenue 71 DTC 5178, which also concluded that the term structure when used in the context of building or other structure does not mean only a structure in the nature of a building. Bridges or hydro-electric transmission towers, for example, while clearly not buildings, are structures.

Portable shelters such as housing, office, and other service units are regarded as buildings if they are installed and intended to remain in a particular location. Such things as tents, canvas marquees and air-supported fabric domes that are not part of a rigid structure are not considered to be buildings or structures.

Property that is attached to a building, however firmly, is included in capital cost allowance (CCA) Class 8 if it is acquired exclusively for those purposes stated in CCA Class 8. For example, concrete footings, foundations and structural steel exclusively for the support of machinery are regarded as CCA Class 8 property. Stairs and platforms, the sole purpose of which is to provide access to machinery, also fall within CCA Class 8, whether they are attached to the building or the machinery.

The comments in Interpretation Bulletin IT‑79R3, Capital cost allowance – Buildings or other structures, may be of assistance in distinguishing between expenditures for the acquisition of buildings and expenditures for the acquisition of other structures.

Legislative Reference Income Tax Act
Former paragraph 37(8)(d) SR&ED expenditures specifically excluded

Legislative References Income Tax Regulations
Subsection 1102(19) Additions and alterations
Schedule II Capital cost allowances

7.2.2 Exception – Third-party payments concerning buildings may be allowed

A claimant's payment enabling the recipient to acquire a building, or a leasehold interest in a building cannot be included in the pool of deductible SR&ED expenditures as a capital expenditure. These types of payments made before 2014 may be allowed as a third-party payment if one of the following conditions is met:

the recipient of the payment is an approved research institute or an approved association, provided the claimant and the recipient deal at arm’s length; or
the recipient is an approved university, college or organization, provided that the payer does not acquire an interest in that building.

For more information, please refer to section 6.2 of the Third-Party Payments Policy.

Legislative Reference Income Tax Act
Former paragraph 37(8)(d) SR&ED expenditures specifically excluded

7.3 Expenditures for capital property that is used outside Canada

The SR&ED Program is designed to encourage SR&ED in Canada. The location of the SR&ED activities will indicate whether the SR&ED is carried on inside or outside Canada. If the activity is performed outside Canada, the SR&ED is performed outside Canada.

Expenditures of a capital nature that pertain to SR&ED carried on outside Canada are not included in the pool of deductible SR&ED expenditures. These expenditures would be included on Schedule T2SCH8, Capital Cost Allowance and deducted in the normal manner.

However, expenditures of a capital nature made before 2014 for equipment acquired from outside Canada used in the prosecution of SR&ED in Canada may be included in the pool of deductible SR&ED expenditures provided all other requirements outlined in this policy are otherwise met.

Legislative References Income Tax Act
Paragraph 20(1)(a) Deduction for capital cost of property
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(2) Research outside Canada

8.0 SR&ED capital expenditures that are not allowed as qualified SR&ED expenditures

Not all expenditures for SR&ED carried on in Canada will earn an investment tax credit (ITC). The following sections discuss SR&ED capital expenditures (see section 3.2) that are not allowed as qualified SR&ED expenditures for ITC purposes.

8.1 SR&ED capital expenditures prescribed by the Income Tax Regulations

The following explains prescribed expenditures in relation to expenditures of a capital nature incurred after 2013, and prescribed expenditures of a capital nature incurred before 2014.

After 2013:

Prescribed expenditures incurred after 2013 are expenditures that are incurred in respect of:

the acquisition of property that is qualified property (see below) as defined in the Income Tax Act; and
the acquisition of property that has been used or acquired for use or lease or for any purpose before it was acquired by the claimant (see section 8.1.1).

The expenditures for the property described above are generally not expenditures of a current nature (see section 3.1.1). Prescribed expenditures are excluded from the definition of qualified SR&ED expenditures.

Before 2014:

Prescribed expenditures of a capital nature incurred before 2014 are expenditures that are incurred in respect of:

the acquisition of qualified property (see below), or
the acquisition of property that has been used or acquired for use or lease or for any purpose before it was acquired by the claimant (see section 8.1.1).

Prescribed expenditures are excluded from the definition of qualified expenditures. Consequently, an expenditure for SR&ED capital property made before 2014 that may be allowed in the pool of deductible SR&ED expenditures (see section 3.2) will not be a qualified SR&ED expenditure if it is prescribed.

Qualified property is defined in the Act and earns investment tax credits (ITCs) apart from those earned under the SR&ED Program. ITCs are prevented from being earned twice in respect of a property that is both qualified property and a qualified expenditure for SR&ED carried on in Canada.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Subclause 37(8)(a)(ii)(A)(III) SR&ED expenditures in Canada under the traditional method – ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III) SR&ED expenditures in Canada under the proxy method – ASA capital expenditures [Repealed]
Subsection 127(9) Definition of "first term shared-use-equipment"
Subsection 127(9) Definition of "second term shared-use–equipment"
Subsection 127(9) Definition of "qualified expenditure"
Subsection 127(9) Definition of "qualified property"

Legislative Reference Income Tax Regulations
Paragraph 2902(b) Prescribed expenditures for purposes of qualified expenditures
Former paragraph 2902(b) Prescribed capital expenditures for purposes of qualified expenditures

8.1.1 Acquisition of used property

After 2013:

Expenditures for capital property incurred after 2013 do not qualify for SR&ED tax incentives. Since the rules for prescribed expenditures for used property incurred after 2013 are not generally applicable to expenditures of a current nature (see section 8.1), they will generally not be applicable to expenditures incurred after 2013.

Before 2014:

Expenditures for capital property incurred before 2014 that was used or acquired for use or lease or for any purpose whatsoever before the claimant acquired it are prescribed expenditures. An expenditure made before 2014 for capital property that was used or leased before the claimant acquired it is allowed as an SR&ED capital expenditure but does not entitle the claimant to an ITC.

To be considered not to have been used, the property must not only be new when the claimant acquired it, but it must not have been acquired for use or lease or for any purpose whatever by any previous owner. As a result of these requirements, if a property that has been used or was acquired for a use (even though unused) is transferred to a new owner, eligibility for the ITC is not transferable. For a specific exception regarding leased property where an election under section 16.1 of the Act has been made, see section 5.1.3.

The cost to acquire a piece of equipment that is used regularly for demonstration purposes is considered to be a prescribed expenditure. However, new equipment that is demonstrated for or tested by a prospective purchaser of that particular piece of equipment would not normally be considered to have been used for a purpose.

Legislative Reference Income Tax Act
Subsection 127(9) Definition of "qualified expenditure"

8.1.2 Refurbishment of used property

Significant refurbishments to a claimant's SR&ED capital property before 2014 ("the equipment") will normally be an allowable SR&ED capital expenditure providing the refurbished equipment continues to satisfy all other SR&ED eligibility conditions (see section 3.2).

Where used equipment is refurbished by a vendor and those refurbishments are so significant that the equipment, when acquired by a claimant can be said to be new, the expenditure for the equipment would qualify for the ITC as a capital expenditure, provided that all other eligibility requirements are met. However, where, subsequent to the acquisition of used equipment, a claimant carries out significant refurbishments only the costs of the refurbishments may qualify as an SR&ED capital expenditure.

Based on the ordinary meaning of the word "significant" and the phrase "when acquired by the claimant, can be said to be new," the refurbishments should go beyond the simple replacement of worn parts to the point where the refurbishments bring the equipment to the current state of the art (a new state). Refurbishments that are merely performance related enhancements that do not change the essential nature of the equipment would not qualify as new.

It would be a question of fact whether particular refurbishments would bring the equipment to a new state such that the same useful life will be produced as newly manufactured equipment. The following are factors to consider when determining if particular refurbishments would bring a piece of equipment to a new state:

a considerable number of parts of the equipment, compared to the total number of parts comprising the equipment as a whole that have been replaced with new parts or parts that have been rebuilt as new (such that the same useful life will be produced as a newly manufactured equipment);
a number of major parts of the equipment, compared with other parts that are considered to be minor (in number, effect or importance) that have been replaced with new parts or parts that have been rebuilt as new (such that the same useful life will be produced as a newly manufactured equipment).

The list of factors is not exhaustive and whether particular refurbishments would bring a piece of equipment to a new state can only be determined after examining all the relevant facts.

8.2 Expenditures for purchases of SR&ED capital property from non-arm's length parties

When the claimant purchases goods or services (other than SR&ED contracts) from a person or partnership with whom they do not deal at arm’s length at the time of the transaction, the allowable amount of the qualified SR&ED expenditure for ITC purposes is limited to the cost to the non-arm's length (NAL) person of providing the goods or services.

In the case of a property sold to the claimant by a non-arm's length supplier, the eligible amount of qualified SR&ED expenditure for ITC purposes is limited to either the capital cost of the property (see section 5.2) to the claimant or the adjusted selling cost of the property to the supplier, whichever amount is less.

Determining adjusted selling cost involves tracing the costs incurred by non-arm's length parties in providing a property. The cost to the party performing the SR&ED will be the cost paid for by the NAL party who acquired the property at arm's length. There will be no inter-company profit included in the cost of the property to the performer.

For more information on non-arm’s length situations, please refer to the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy. The Income tax folio, S1-F5-C1, Related persons and dealing at arm's length, describes in general terms the criteria for determining whether persons deal with each other at arm's length.

9.0 Sale of SR&ED capital property or change in use of SR&ED capital property

9.1 Recapture of capital cost allowance for claimed and unclaimed SR&ED capital expenditures

A disposition of depreciable property (sale of SR&ED capital property) is subject to the provisions of the Income Tax Act dealing with capital cost allowance (CCA) recapture and capital gains and losses. Where any depreciable property (see section 5.0) is disposed of for proceeds in excess of the capital cost of the property (see section 5.2) to the claimant, that disposition may give rise to a capital gain. However, any loss on the disposition of depreciable property is specifically excluded from a claimant's capital loss and, as a result, no deduction is permitted for such losses.

There may be circumstances where the claimant sold SR&ED capital property during the year, but there are unclaimed expenditures for the SR&ED capital property in the pool of deductible SR&ED expenditures at the end of the year. Effectively these unclaimed expenditures represent the unclaimed CCA (deduction) (see section 3.2.4) of the SR&ED capital property.

A proportion of the proceeds of disposition for the SR&ED capital property that is sold may be allocated to the unclaimed expenditures for the SR&ED capital property, which will reduce the claimant's pool of deductible SR&ED expenditures. Generally, the sale proceeds or the amount of unclaimed expenditures for the capital property, whichever amount is less, would be included in the pool of deductible SR&ED expenditures.

A proportion of the proceeds of disposition for the SR&ED capital property that is sold may be allocated to the (previously) claimed expenditures for the SR&ED capital property, which will be included in the claimant's income calculation as CCA recapture.

Example:

Facts

The undeducted SR&ED expenditures balance carried forward from the prior year (line 450 of Form T661) is $500. An SR&ED capital property was sold during the year for $100. Its original cost was $1,000. The amount of unclaimed expenditures for the SR&ED capital property included at line 450 of Form T661 is $60.

Solution:

Determine the amount at line 440 on Form T661, whichever amount is the lesser of the proceeds of disposition ($100) and the amount of unclaimed expenditures for the SR&ED capital property ($60). Line 440 amount on the Form T661: $60.

If the sale proceeds are more than the unclaimed balance of SR&ED expenditures for the capital property, the difference is generally included in income up to the amount of recapture of CCA (the claimed deduction for the SR&ED capital property). If the sale proceeds are more than the original cost of the capital property, the excess is either a capital gain or income, depending on the facts of each case.

Determine the recaptured CCA , whichever amount is the lesser of the original cost ($1,000) and the proceeds of disposition minus the line 440 amount on Form T661 ($100 - $60 = $40). The recapture of CCA is $40 (include this amount in income for the year).

Where all the expenditures for the SR&ED capital property remain unclaimed in the previous year's pool balance of deductible SR&ED expenditures reported at line 450 of Form T661, recapture with respect to SR&ED capital expenditures will be reflected as a reduction to the pool of deductible SR&ED expenditures. In this case, provided the proceeds are less than the capital cost of the property, which is normally the case, the proceeds can be entered at line 440 of Form T661. This effectively removes the appropriate portion of unclaimed expenditures for the capital property included in the prior year balance of the pool of deductible SR&ED expenditures. In the event the proceeds exceed the capital cost of the property to the claimant, the capital cost of the property should be recorded at line 440 of Form T661 and the excess reported as capital gain. If the pool balance of deductible SR&ED expenditures at the end of the prior year is zero, the recapture should be reported on Schedule T2SCH1, Net Income (Loss) for Income Tax Purposes.

Legislative References Income Tax Act
Subsection 13(1) Recaptured depreciation
Subsection 13(7.1) Deemed capital cost of certain property
Subsection 13(21) Definition of “undepreciated capital cost”
Paragraph 20(1)(a) Deduction for capital cost of a property
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(6) Expenditures of a capital nature
Subsection 39(1) Meaning of capital gain and capital loss

9.2 Recapture of SR&ED investment tax credit

When the claimant sells the SR&ED capital property or converts it to commercial use, there may be recapture of investment tax credit (ITC) earned on SR&ED expenditures for that property. These rules are in addition to the recapture of CCA for claimed and unclaimed SR&ED capital expenditures rules noted in section 9.1.

At the outset of an SR&ED project, for equipment used for the prosecution of SR&ED carried on in Canada, a claimant may intend to use the property in SR&ED throughout its useful life, but subsequently change its use or dispose of it. The recapture rules are intended to reflect the net cost of performing SR&ED. Since this net cost cannot be determined at the outset, the recapture rules will reverse all or a portion of the ITC when the sale of the property takes place or when it is converted to commercial use.

For more information, please refer to the Recapture of SR&ED Investment Tax Credit Policy.

10.0 Related topics to SR&ED capital expenditures

10.1 Development of an asset

If capital expenditures are incurred before 2014 in the development of an asset (such as prototype, pilot plant / commercial plant, custom product / commercial asset), the SR&ED capital property acquired must be all or substantially all (ASA) attributable to the prosecution of SR&ED carried on in Canada for the expenditures to be eligible SR&ED expenditures. This would require that the capital property to which the expenditure relates:

have minimal life expectancy (less than 10%) after its involvement in the development of the asset;
have limited value (less than 10%) after its involvement in the development of the asset; or
be used in the performance of other SR&ED after its involvement in the development of the asset.

For more information, please refer to the SR&ED while Developing an Asset Policy.

Capital expenditures incurred after 2013, no longer qualify for SR&ED tax incentives.

10.2 Criteria in determining whether an expenditure is on account of capital or a current expense

The following criteria, developed by the Courts, are to be considered in determining whether an expenditure is on account of capital or a current expense. The Courts have generally taken the position that there is no rigid test to be used to determine whether an outlay is capital in nature or a current expense and that it is very much a question of fact. The circumstances specific to each case will be determinative of the issue.

enduring benefit
maintenance or betterment
integral part or separate property
relative value
acquisition of used property
anticipation of sale

For more information on these factors, please refer to Interpretation Bulletin IT‑128R, Capital Cost Allowance – Depreciable Property .

10.3 Expenditures for software and software licenses before 2014 may be capital or current expenditures

Since SR&ED expenditures cannot include expenditures for capital property or the use of, or the right to use capital property after 2013 (see section 3.1.1), the following comments apply to expenditures for software incurred before 2014.

Software and the rights or licenses to use computer and / or systems software fall within prescribed classes for capital cost allowance (CCA) purposes. For example, definitions in the Regulations, in part, read:

"Computer software includes systems software and a right or licence to use computer software" and

"Systems software means... and includes a right or licence to use [systems software]…"

Software intended to be incorporated into a product cannot be included in the pool of deductible SR&ED expenditures.

However, a deduction for an expenditure on something that is merely a tool for performing SR&ED that will not be incorporated into a product created by a claimant may be included in the pool of deductible SR&ED expenditures if it otherwise qualifies. An example would be software purchased for use as a tool in computer-aided design.

In determining whether the acquisition cost of software and software licences should be treated as a current expenditure or treated as a capital expenditure, the nature, purpose, and anticipated life of the computer software must be considered. If the acquisition would benefit only the current fiscal period the relevant cost would be considered a current expenditure. If the nature of the acquisition was of an enduring nature such that it would provide benefits beyond the current year, the acquisition should be considered capital in nature. Computer software is generally considered to have an "enduring nature" where its useful life is anticipated to last beyond one year.

In determining whether a particular expenditure is on account of capital (capital expenditure) or income (current expenditure) within the provisions of the Income Tax Act, the question to be answered is whether a payment or a legal obligation to pay was related to the acquisition of a depreciable property, (see section 5.0), or whether the payment was simply a current expenditure. When answering such a question, an expenditure is considered to have been made at the time a payment is made unless the claimant has entered into a legal obligation to make (a) future payment(s). The treatment of the payment or the debt giving rise to the legal obligation to pay must be determined at the time of payment or when a definite obligation to make the payment has been entered into.

In determining whether a payment can be considered a current expense in the form of a monthly payment or whether the individual payments or total obligation should be treated as a depreciable property (SR&ED capital property), it is not the individual payments that have to be considered but rather the total obligation to pay in relation to that which was acquired.

For discussion purposes, assume that a user needs the use of computer software and has to make a choice between a fixed term five‑year commitment and a short term month-to-month agreement for the right or licence to use computer software.

Where the fixed term five‑year commitment is chosen the claimant has the option of paying the amount in full at the commencement of the agreement, or paying the amount in monthly instalments over the term of the agreement. Since the fixed term five‑year commitment (total obligation in relation to what was acquired) fits the description of property of a prescribed class that is a depreciable property (SR&ED capital property) the expenditures for such a commitment would be SR&ED capital expenditures provided all other requirements outlined in this policy are otherwise met.

Where a short term non‑guaranteed month-to-month agreement to use the same computer software is chosen, usually these agreements allow either party to terminate the agreement by giving the other one month's notice. Under agreements such as these, the month-to-month payments will normally only benefit the period in which they were made and will not benefit future periods. Therefore, the expenditures are considered to be a current expenditure and precluded from being depreciable property provided all other requirements concerning the current expenditure are otherwise met. When there is nothing to support or no reason to believe that these monthly payments will benefit future periods, there is no basis to capitalize these payments.

Therefore, it is the total of the entire obligation that has to be considered at the time of making the obligation to determine whether it is a current expense or whether it will accrue some benefit for a future year(s). In order to be considered an amount in respect of depreciable property (right or license to use software), it is only necessary to establish that some part of the amount relates to use in a future year(s). In an agreement where there is no time guarantee for the use of the software and the payments are on a month to month basis with no time guarantee, the monthly payments in question can be considered to be current lease expenditures where it is reasonable to assume that the cost in respect to a future year(s) use is not being paid up front. Such current expenditures would be included on Form T661 as an SR&ED lease expenditure.

Legislative References Income Tax Act
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – current expenditures
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]

Legislative References Income Tax Regulations
Paragraph 1102(1)(a) Items deducted from income deemed not to be on account of capital
Subsection 1104(2) Definition of "computer software"
Subsection 1104(2) Definition of "systems software"

10.4 Related current costs

If an existing capital property (for example, equipment) is used temporarily for SR&ED, the costs (for example, maintenance and repairs) that would not have been incurred if the SR&ED had not been carried out may be included as a current expenditure in calculating the pool of deductible SR&ED expenditures, when the claimant choose to use the traditional method.

Current expenditures (for example, foreign travel expenditures) for the acquisition of equipment from outside Canada that is used in the prosecution of SR&ED in Canada may be included in the pool of deductible SR&ED expenditures provided all other requirements are otherwise met.

For more information on these types of related current costs, please refer to the SR&ED Overhead and Other Expenditures Policy.

11.0 Documentation and other evidence

It is recommended that the claimant keep a list of capital property they acquired prior to 2014 for the prosecution of SR&ED carried on in Canada to support their claim for SR&ED capital expenditures (see section 3.2). Claimants should be able to provide explanation and supporting evidence of how the capital expenditure was used in the prosecution of SR&ED carried on in Canada. Claimants should be able to provide enough information to establish the intended use of the equipment when it was acquired, as well as its actual use during its useful life.

In capturing plant (capital) costs, separate schedules should be maintained for the listing of all major equipment by name, specification, usage and actual purchase cost in addition to installation costs.

This information should be retained, ready to be provided upon request. For more information concerning documentation and other supporting evidence, please refer to Information Circular IC78-10R5, Books and Records Retention / Destruction and Keeping records.

11.1 Examples of documentation and other evidence

Examples of documentation and other evidence that support SR&ED capital expenditures are:

logbooks or other documentation that support the SR&ED use of equipment for the period;
invoices, purchase contract, cancelled cheques, and so forth; and
supporting schedules to reconcile capital expenditures on Schedule T2SCH8, Capital Cost Allowance, and Form T661 to the financial statements.

For further information on documentation, please refer to Appendix 2 of T4088, Guide to Form T661 Scientific Research and Experimental Development Expenditures (SR&ED) Claim.

Appendix A – Special‑purpose building

Special‑purpose buildings are prescribed in the Income Tax Regulations (repealed after 2013) and are approved by the Department of Finance on a building-by-building basis. To date, only one type of building has been prescribed as a special-purpose building. Special-purpose buildings are the only buildings allowed as SR&ED capital property.

A special-purpose building is a building the working areas of which are designed and constructed to have a displacement in any direction of not more than .02 micrometre and to have per .028 cubic metre of interior airspace:

not more than 350 airborne particles of a size less than or equal to .1 micrometre in diameter and no airborne particles of a size greater than .1 micrometre in diameter;
not more than 75 airborne particles of a size less than or equal to .2 micrometre in diameter and no airborne particles of a size greater than .2 micrometre in diameter;
not more than 30 airborne particles of a size less than or equal to .3 micrometre in diameter and no airborne particles of a size greater than .3 micrometre in diameter; or
not more than 10 airborne particles of a size less than or equal to .5 micrometre in diameter and no airborne particles of a size greater than .5 micrometre in diameter.

Legislative Reference Income Tax Act
Former paragraph 37(8)(d) Capital expenditures specifically excluded

Legislative Reference Income Tax Regulations
Section 2903 Special-purpose buildings [Repealed]

Appendix B - Consolidated policy references

Appendix B.1 Legislative references

List of provisions

Income Tax Act	Description
Section 13	Rules concerning depreciable property
Subsection 13(1)	Recaptured depreciation
Subsection 13(7.1)	Deemed capital cost of certain property
Subsection 13(21)	Definition of "depreciable property"
Subsection 13(21)	Definition of "undepreciated capital cost"
Subsections 13(26) to (32)	Available for use
Section 16.1	Leasing properties
Paragraph 20(1)(a)	Deduction for capital cost of a property
Subsection 37(1)	Pool of deductible SR&ED expenditures
Paragraph 37(1)(a)	Pool of deductible SR&ED expenditures – current expenditures
Paragraph 37(1)(b)	Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subparagraph 37(1)(b)(i)	Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Subsection 37(1.2)	Available for use
Subsection 37(2)	Research outside Canada
Subsection 37(6)	Expenditures of a capital nature
Subclause 37(8)(a)(ii)(A)(III)	SR&ED expenditures in Canada under the traditional method - ASA capital expenditures [Repealed]
Subclause 37(8)(a)(ii)(B)(III)	SR&ED expenditures in Canada under the proxy method - ASA capital expenditures [Repealed]
Paragraph 37(8)(d)	SR&ED expenditures specifically excluded
Former paragraph 37(8)(d)	SR&ED expenditures specifically excluded
Former subparagraph 37(8)(d)(i)	SR&ED expenditures specifically excluded – building and leasehold interest
Subparagraph 37(8)(d)(i)	SR&ED expenditures specifically excluded – building and leasehold interest
Subsection 37(11)	Filing requirement
Subsection 39(1)	Meaning of capital gain and capital loss
Section 54	Definition of “capital property”
Subsection 96(1)	Partnerships – general rules
Subsection 127(9)	Definition of "first term shared-use-equipment"
Subsection 127(9)	Definition of "qualified expenditure"
Subsection 127(9)	Definition of "qualified property"
Subsection 127(9)	Definition of "second term shared-use-equipment"
Subsection 127(11.2)	Time of an expenditure and acquisition
Subsection 248(19)	When property available for use

List of regulations

Income Tax Regulations	Description
Part XI	Capital cost allowances
Paragraph 1102(1)(a)	Items deducted from income deemed not to be on account of capital
Paragraph 1102(1)(b)	Property not included in Schedule II – inventory
Paragraph 1102(1)(d)	SR&ED deduction deemed not allowed for capital cost allowance
Subsection 1102(1a)	Partnership property
Subsection 1102(2)	Property not included in Schedule II – land
Subsection 1102(5)	Property not included in Schedule II – leasehold interest in land
Subsection 1102(19)	Additions and alterations
Subsection 1104(2)	Definition of "computer software"
Subsection 1104(2)	Definition of "systems software"
Paragraph 2902(b)	Prescribed expenditures for purposes of qualified expenditures
Former paragraph 2902(b)	Prescribed capital expenditures for purposes of qualified expenditures
Section 2903	Special-purpose buildings [Repealed]
Schedule II	Capital cost allowances
Schedules II to VI	Capital cost allowance schedules

Appendix B.2 Jurisprudence

List of court cases

Case number	Case name
71 DTC 5178	British Columbia Forest Products Ltd v. Minister of National Revenue

Appendix C – Revisions

C.1 Explanation of changes

The following are the explanation of changes to the SR&ED Capital Expenditures Policy as part of the revision of December 18, 2014:

Section 1.0 has been revised to delete the first sentence of the previous policy which mentioned that this policy document was a consolidation of the CRA publications.

New section 2.1 has been added to provide an overview for the legislative changes resulting from the federal 2012 budget, specifically that capital expenditures for SR&ED are no longer allowed after 2013. As a result, former sections 2.1, 2.2, and 2.3 have been renumbered 2.2.1, 2.2.2, and 2.2.3 respectively.

New sections 3.1 – 3.1.2 have been added to explain the legislative changes resulting from the federal 2012 budget, specifically that capital expenditures for SR&ED are no longer allowed after 2013. Explanations are also added for expenditures of a current nature, and the capital look-through rules concerning contract expenditures and third-party payments. As a result, former sections 3.1, 3.2, 3.3, 3.4 and 3.5 have been renumbered 3.2.1, 3.2.2, 3.2.3, 3.2.4, and 3.3 respectively.

Sections 8.1 and 8.1.1 have been revised to reflect the change in legislation for prescribed expenditures.

Section 10.3 has been revised to reflect the change in legislation as it pertains to expenditures for the use of or the right to use capital property and its effects on software and software licenses.

Appendix B.1 has been revised to update the legislative references.

Appendix B.3 "CRA publications" has been removed.

Legislative references have been updated throughout the document and wording throughout the document has been added to indicate capital expenditures no longer qualify for SR&ED tax incentives after 2013.

Other minor formatting and editing corrections were made throughout the document.

Date modified:: 2014-12-18

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SR&ED Capital Expenditures Policy

Changes to the SR&ED Capital Expenditures Policy

1.0 Purpose

2.0 Overview

2.1 Capital expenditures made after 2013

2.2 Capital expenditures made before 2014

2.2.1 SR&ED capital expenditures as an income deduction

2.2.2 Introduction to shared-use-equipment

2.2.3 SR&ED capital expenditures as qualified SR&ED expenditures

3.0 Legislation

3.1 Capital expenditures made after 2013 cannot be claimed

3.1.1 Expenditures of a current nature

3.1.2 Capital look-through rule and the reporting of certain payments

3.2 Capital expenditures made before 2014 can be claimed

3.2.1 Criteria for SR&ED capital expenditures – Traditional method

3.2.2 Criteria for SR&ED capital expenditures – Proxy method

3.2.3 Additional criteria for SR&ED capital expenditures for both traditional and proxy methods

3.2.4 SR&ED capital expenditure deduction deemed capital cost allowance

3.3 Available for use

4.0 Terms

4.1 All or substantially all

4.2 Operating time

4.3 General purpose office equipment or furniture

5.0 Depreciable property

5.1 Capital cost allowance

5.1.1 Ownership of capital property

5.1.2 No ownership of capital property

5.1.3 Deemed ownership of leased property

5.2 Capital cost of property

6.0 Intent

6.1 Reason for purchase

6.2 Potential use of property

6.3 Actual use of property

6.4 Type of SR&ED

6.5 SR&ED environment

6.6 Length of SR&ED project

6.7 Claimants past practices

6.8 Planning documents

7.0 Expenditures not allowed as SR&ED capital expenditures

7.1 Non-depreciable property

7.2 Expenditures for buildings

7.2.1 Meaning of "building"

7.2.2 Exception – Third-party payments concerning buildings may be allowed

7.3 Expenditures for capital property that is used outside Canada

8.0 SR&ED capital expenditures that are not allowed as qualified SR&ED expenditures

8.1 SR&ED capital expenditures prescribed by the Income Tax Regulations

8.1.1 Acquisition of used property

8.1.2 Refurbishment of used property

8.2 Expenditures for purchases of SR&ED capital property from non-arm's length parties

9.0 Sale of SR&ED capital property or change in use of SR&ED capital property

9.1 Recapture of capital cost allowance for claimed and unclaimed SR&ED capital expenditures

9.2 Recapture of SR&ED investment tax credit

10.0 Related topics to SR&ED capital expenditures

10.1 Development of an asset

10.2 Criteria in determining whether an expenditure is on account of capital or a current expense

10.3 Expenditures for software and software licenses before 2014 may be capital or current expenditures

10.4 Related current costs

11.0 Documentation and other evidence

11.1 Examples of documentation and other evidence

Appendix A – Special‑purpose building

Appendix B - Consolidated policy references

Appendix B.1 Legislative references

Appendix B.2 Jurisprudence

Appendix C – Revisions

C.1 Explanation of changes