SR&ED Salary or Wages Policy

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SR&ED Salary or Wages Policy

Date: December 18, 2014

Changes to the SR&ED Salary or Wages Policy

Reasons for revision

This revision accommodates the legislative changes that have been announced.

Revision overview

Legislation was enacted to confirm that the value of an option granted and the increase between the option price and the exercised share price (relating to stock option benefits) are not allowable scientific research and experimental development (SR&ED) expenditures.

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

Table of contents

1.0 Purpose

The purpose of this document is to clarify the position of the Canada Revenue Agency (CRA) regarding salary or wages when administering the SR&ED legislation under the federal Income Tax Act and the Income Tax Regulations.

In particular, its purpose is:

to explain what may be included in salary or wages for SR&ED purposes;
to highlight the differences between directly undertaking, supervising or supporting salary or wages under the directly attributable rules when using the traditional method and directly engaged salary or wages when using the proxy method; and
to clarify the CRA's position with respect to some issues that are common to both the traditional method and the proxy method.

2.0 Overview

The term "salary or wages" is defined in the Income Tax Act (see section 2.1) and means income from an office or employment. Salary or wages generally includes any expenditure made in respect of a benefit that would be taxable to the employee under section 6 of the Act (see section 3.0) as well as vacation pay, statutory holiday pay, sick leave pay, pay in lieu of termination notice, bonuses (see section 4.0), tips and gratuities, honorariums, director's fees, management fees and commissions. These amounts must be paid to or incurred for the employees in the year (see section 2.2).

Salary or wages do not include amounts in respect of the employer's shares of the related benefits (see section 5.1), amounts for extended vacation or sick leave (see section 5.2), stock options benefits (see section 5.3) and retiring allowances (see section 5.4). There is also a general rule that applies to exclude unpaid salary or wages (see section 11.0).

The general rules described in the sections referred to above also apply for SR&ED purposes. However, there are specific rules that apply in order for salary or wages to be an allowable SR&ED expenditure. These rules are discussed in section 7.0 for claimants using the proxy method and in section 8.0 for claimants using the traditional method.

Other specific rules apply to salary or wages for SR&ED purposes. There are rules for: specified employees (see section 6.0), administrative salary or wages under the traditional method (see section 9.0) and for salary or wages of employees performing SR&ED outside Canada (see section 10.0).

2.1 Legislation

The definition of salary or wages in the Act is as follows:

"salary or wages", except in sections 5 and 63 and the definition "death benefit" in this subsection, means the income of a taxpayer from an office or employment as computed under subdivision a of Division B of Part I and includes all fees received for services not rendered in the course of the taxpayer's business but does not include superannuation or pension benefits or retiring allowances.

Legislative reference Income Tax Act
Subsection 248(1) Definition of "salary or wages"

2.2 Expenditures incurred

To be included in the pool of deductible SR&ED expenditures for SR&ED carried on in Canada, an expenditure must be an expenditure "on or in respect of SR&ED". One of the requirements to meet this condition is that the expenditure must be incurred.

Legislative Reference Income Tax Act
Subsection 37(8) SR&ED expenditures

2.2.1 Examples of expenditures not incurred

In certain cases, expenditures are considered not to be incurred. Some examples are:

employee remuneration that is not paid within 180 days from the end of the tax year in which the expense was incurred (see section 11.0)
the value of a taxable benefit (see section 3.1)
stock option benefits (see section 5.3)

Legislative reference Income Tax Act
Subsection 78(4) Unpaid remuneration and other amounts

2.3 SR&ED salary or wages inclusions and exclusions

Amounts included in SR&ED salary or wages

Salary or wages (see section 2.0)
- If it is incurred on or in respect of SR&ED
- If electing the proxy method, salary or wages for employees directly engaged in SR&ED in Canada may be included (see section 7.0)
- If using the traditional method, salary or wages for employees directly undertaking, supervising, or supporting SR&ED may be included (see section 8.0)
- Administrative salary or wages for employees directly attributable may be included as SR&ED overhead and other expenditures provided the traditional method is used (see section 9.0).
- Permissible salary or wages for SR&ED work performed outside Canada may be included (see section 10.0)
Taxable benefits (see section 3.0)
- Cash benefit
  - May be included in SR&ED salary or wages
- Non-cash benefit (the value of the benefit)
  - May be included in SR&ED salary or wages, if:– the value is a reasonable estimate of actual costs—the value of the benefit does not include any Goods and services tax / Harmonized sales tax (GST / HST) or Provincial sales tax (PST), unless no input tax credit was claimed—the actual costs to which the non-cash benefit relates are not claimed as a business expense
Bonuses (see section 4.2)
- For employees other than specified employees
Remuneration based on profits (see section 4.1)
- For employees other than specified employees
Inducements, non-competition payments (see section 4.3)
- Considered to be remuneration for services rendered during employment (exceptions may apply)

Note
The rules discussed relate only to bonuses with respect to expenditures for salary or wages. Rules concerning bonuses affecting the prescribed proxy amount are discussed in the Prescribed Proxy Amount Policy.

Amounts excluded from SR&ED Salary or Wages

Related benefits (see section 5.1)
- Could be considered as overhead and other expenditures under the traditional method
Extended vacation or sick leave (see section 5.2)
- Considered not directly undertaking, supporting or supervising; considered not directly engaged
Stock option benefits (see section 5.3)
- Considered not to be an expenditure for SR&ED
Retiring allowance (see section 5.4)
- Could be considered as overhead and other expenditures under the traditional method

3.0 Taxable benefits

Taxable benefits are benefits or allowances an employer provides to its employees that are taxable under the Income Tax Act. For example: automobile benefits; housing, board, and meals; gifts and awards; interest-free or low-interest loans; group term life insurance policies; or tuition fees.

As stated in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, salary or wages could relate to gross wages reported on a T4 slip for the calendar year if the tax year ends at the calendar year-end.

However, when using the T4 slips as a basis for determining the allowable salary or wages, certain adjustments may be required to be made as discussed in sections 3.1 to 3.3 below.

Legislative reference Income Tax Act
Section 6 Taxable benefits

3.1 Expenditure incurred vs. value of taxable benefits

Where an employee receives a non-cash benefit, the employer must determine the value of the benefit and include that value in the employee's income. A list of all non-cash benefits is provided in Guide T4130, Employer's Guide – Taxable Benefits and Allowances. For the employer, however, the value of a benefit is not an expenditure incurred and, therefore, is not an allowable SR&ED expenditure. In certain cases, the actual costs incurred by the company may have no relation to the value of the benefits otherwise determined. In determining the allowable amount of a taxable benefit, only the actual costs incurred in respect of the taxable benefits should be included in the allowable salary or wages.

This is consistent with the existing practice applicable to the automobile standby charge (see section 3.1.1). The value of a benefit to the claimant will be allowed as an SR&ED expenditure if all the following conditions are met:

it represents a reasonable estimate of the actual cost incurred (the onus is on the claimant to demonstrate the reasonableness);
the amount of the benefit claimed does not include any GST / HST or PST (unless no input tax credit refund was claimed) (see section 3.2); and
the actual costs, including capital cost allowance (CCA), to which the value of the benefits relates are not claimed as business expenses under section 9 of the Act.

3.1.1 Example: Automobile and motor vehicle benefits

The benefit for an automobile provided by the employer for the year includes a standby charge for the year and an operating expense benefit for the year (minus any reimbursements by the employee). The value of the benefit, including the GST / HST or PST that applies, is included in box 14 of the T4 slip as "Employment income," and in the "Other information" area under code 34.

Although automobile taxable benefits, including standby charges, may not involve an expenditure incurred in the year, in practice an amount in respect of such benefits can be included as salary or wages if the amount represents a reasonable estimate of the actual costs incurred and does not include any GST / HST or PST (unless no input tax credit refund was claimed) and the automobile expenses and CCA to which the standby charge relates are not included in calculating business income.

3.2 GST / HST or PST considerations

Some taxable benefits (for example, non-cash benefits) included on the employee's T4 slip may include a GST / HST or PST component. The employer may claim an input tax credit for the GST / HST that applies on the taxable benefits (or a similar provincial credit for PST on taxable benefits). The amount of input tax credit claimed is deemed to be government assistance. Therefore, no GST / HST or PST amount should be included in the allowable SR&ED salary or wages where an input tax credit (or a similar provincial credit) is claimed in respect of these amounts.

Legislative reference Income Tax Act
Subsection 248(16) GST – Input tax credit and rebate

3.3 Value of taxable benefits – T4 slips

Other taxable non-cash benefits are based on the value of the benefits (for example, value of parking). A list of all non-cash benefits are provided in Guide T4130 Employer's Guide – Taxable Benefits and Allowances. Other than specific codes for certain non-cash benefits, it should be noted that code 40 could include the value of certain non-cash benefits as well as GST / HST or PST, depending of the type of benefits.

Claimants also have to ensure that no amounts are claimed as salary or wages for the following benefits:

Interest-free and low-interest loan (box 14 of the T4 slip and code 36 and 37 in the "Other information" of the T4) is not an expenditure incurred and does not qualify as SR&ED salary or wages.
Security options benefits (box 14 of the T4 slip and code 38 in the "Other information" of the T4) are not allowable expenditures (see section 5.3).
In certain situations, placement agency workers (box 14 of the T4 slip and code 81 in the "Other information" of the T4) are not employees of the claimant, yet the claimant pays the salary and has to prepare the T4 slip for the workers. In these situations, the salary or wages of the placement agency workers do not qualify as salary or wages expenditures for the claimant but could qualify as a contract expenditure for SR&ED performed on behalf of the claimant. For more information on contract expenditures for SR&ED performed on behalf of a claimant, please refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy.

4.0 Bonuses, remuneration based on profits and other types of remuneration

Restrictions apply to bonuses (see section 4.2) and remuneration based on profits (see section 4.1) in respect of specified employees (see section 6.0). When calculating the prescribed proxy amount (PPA), all bonuses and remuneration based on profits (both to specified and non-specified employees) are excluded from the salary base of employees directly engaged in SR&ED in Canada. For more information on the PPA, please refer to the Prescribed Proxy Amount Policy.

"Bonus" and "remuneration based on profits" are not defined in the Income Tax Act or the Regulations. Therefore, the ordinary dictionary definitions of the terms apply.

Legislative reference Income Tax Act
Subsection 37(9) Remuneration based on profits or bonus for specified employees

Legislative reference Income Tax Regulation
Subsection 2900(9) Exclusions to salary base

4.1 Meaning of "remuneration based on profits"

"Remuneration based on profit" means any remuneration to an employee that is conditional on the profit of the business or that is a portion of the profit of the business.

4.2 Meaning of "bonus"

"Bonus" is an amount in addition to the employee's normal remuneration (additional remuneration).

Unenforceable bonus

An unenforceable "bonus" refers to a payment that is not earned and is a gift or gratuity. The amount would be considered to be a bonus if it was not paid pursuant to the employee's terms of employment and the employer was under no obligation to make the payment. For this purpose, the extent to which a bonus payment is based on an employee's performance is immaterial.

Enforceable bonus

An enforceable "bonus" refers to an amount paid (premium) to an employee in recognition of achieving certain performance objectives pursuant to the employee's terms of employment (or specific agreement). In that case, the employer was under no obligation to pay the bonus until the employee met the specific performance objectives. The liability will be recognized as a bonus only in the year the legal obligation arises.

The number of times in the year that a bonus is paid does not, in itself, affect the meaning of the term "bonus".

Where an employee performs duties that are considered to be directly engaged in SR&ED under the proxy method (see section 7.0) or are considered to be directly undertaking, supervising or supporting the prosecution of SR&ED under the traditional method (see section 8.0) and the only remuneration in the year in respect of performing those duties was bonuses or remuneration based on profits, the CRA will consider an amount thereof that is commensurate with the performance of those duties to be salary or wages directly attributable to SR&ED or directly engaged in SR&ED. The determination of what is commensurate is a question of fact and may require the utilization of industrial standards published by various technological or professional associations.

The above position would apply in a situation where a company could not pay an employee (specified or other than specified) a salary throughout the year but, at year-end, was able to pay its employee a lump-sum amount. Under this position, the amount (or a portion) is considered to be salary or wages, both for the purposes of the pool of deductible SR&ED expenditure and the PPA calculation, and not a bonus / remuneration based on profit on Form T661, provided that all necessary payroll procedures have been followed and applied.

Legislative references Income Tax Act
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method
Subsection 37(9) Remuneration based on profits or bonus for specified employees

Legislative reference Income Tax Regulation
Subsection 2900(9) Exclusions to salary base

4.3 Inducement payments and non-competition payments to employees

An amount received under an agreement made immediately before, during or immediately after the period that the payee was employed by the payer (for example a signing bonus or a non-competition payment) is deemed to be remuneration for services rendered during the period of employment. This deeming rule does not apply, however, if the amount cannot reasonably be regarded as having been received under the contract of employment or for entering into a contract of employment or for a covenant with respect to what the payee is or is not to do before or after his employment terminates.

To be considered remuneration for services rendered during the period of employment, any amount payable under a written or oral agreement, as described above, must have the nature and quality of salary, wages, commissions, etc.

Inducement payments to prospective employees (often referred to as a "signing bonus") or non-competition payments to employees who terminate their employment, such as described above, are treated as regular salary or wages for services rendered during the period of employment. These types of payments do not meet the definition of "bonus" (see section 4.2).

Further, such an inducement payment that is deemed to be remuneration for services rendered during the period of employment is excluded from the salary base for the purpose of calculating the PPA . For more information on the salary base, please refer to section 3.0 of the Prescribed Proxy Amount Policy.

Legislative references Income Tax Act
Section 5 Income or loss from an office or employment
Subsection 6(3) Payments by employer to employee

Legislative reference Income Tax Regulation
Subsection 2900(9)(a) Exclusions to salary base

4.4 Expenditure on or in respect of SR&ED

To be deductible for SR&ED purposes, bonuses, remuneration based on profits and other remuneration as discussed in section 4.3 above must be an expenditure on or in respect of SR&ED. This would be the case only if the amount can reasonably be considered to be in respect of the prosecution of SR&ED under the traditional method (see section 8.0) or to relate to such prosecution under the proxy method (see section 7.0). For more information on this requirement, please refer to section 7.3.2.

Legislative references Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Subsection 37(8) SR&ED expenditures

Legislative reference Income Tax Regulation
Paragraph 2900(2)(b) Employee remuneration – Traditional method

5.0 Amounts that are not salary or wages

5.1 Related benefits

A claimant may be able to treat related benefits as overhead and other expenditures on line 360 of Form T661 under the traditional method. For more information on the treatment of related benefits as SR&ED overhead and other expenditures, please refer to section 4.3 of the SR&ED Overhead and Other Expenditures Policy.

Related benefits include the employer's share of payments to the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP), Employment Insurance (EI), the Worker's Compensation Board (WCB), or the Commission de la santé et de la sécurité du travail du Québec (CSST), an approved employee pension plan, or employee medical, dental, or optical insurance plans, and premiums to a superannuation plan.

The following expenditures can also be considered related benefits, provided such expenditures do not constitute a taxable benefit, since taxable benefits are elements of an employee's salary or wages (see section 3.0):

supplementary sick benefits; and
an employer's contributions in relation to an employee savings plan where, for example, for every $3 dollars that an employee uses to purchase shares in the parent company the employer undertakes to pay $1 dollar, up to a given maximum.

The employer's contributions to the Quebec and Ontario health insurance plans are not "related benefits," since it is not necessary to be an employee to benefit from these plans. Consequently, under the traditional method such contributions are general business expenses that can only be SR&ED overhead and other expenditures if they are directly related and incremental to the prosecution of SR&ED in Canada. For more information on SR&ED overhead and other expenditures, please refer to the SR&ED Overhead and Other Expenditures Policy.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative reference Income Tax Regulation
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

5.2 Expenditures for extended vacation or sick leave

Salary or wages relating to extended vacation or sick leave are not considered to be directly undertaking, supervising or supporting SR&ED or directly engaged in SR&ED since the employee would not be performing any duties during the leave period. Extended leave is considered to be leave in excess of the normal annual leave earned.

The employee’s total time available for work is based on the number of days the employee reports to work regardless of the task performed. For example, if the employee works 5 working days per week and assuming 11 statutory holidays per year, the employee would have total time available for work (if no vacation or sick leave were taken) of approximately 250 days.

5.2.1 Example

Facts

Employee X (a non-specified employee) receives a salary of $10,000 per month. He earns 20 days (4 weeks) of vacation and 20 days (4 weeks) of sick leave each year. He is also compensated for statutory holidays. For the purposes of the example we will use 250 days as a starting point for determining total time available for work. The tax year is from January 1 to December 31.

Year 1

Employee X was directly engaged in SR&ED for 125 days (from January to the end of June). The remaining 125 days (from beginning of July to the end of December), he performed duties that were totally unrelated to SR&ED. He did not take vacation or sick leave in Year 1. In this year, the employee’s total time available for work for the entire year is 250 days.

Year 1 — Directly engaged salary calculation:

Salary expense 12 months (January 1 to December 31) x $10,000 = $120,000
Accrued vacation expense (considered reasonable) — $9,600
Total — $129,600

Year 1 — Directly engaged portion: 125 / 250 days x $129,600 = $64,800

Year 2

Employee X was directly engaged in SR&ED for 168 days (for all of January and April, and from the beginning of July to the end of December). For 42 days (all of May and June), he performed duties that were totally unrelated to SR&ED. He took vacation for all of February and March (40 days of accrued vacation) in Year 2. He did not take any sick leave in Year 2. Thus in this year the employee’s total time available for work is 210 days (250 – 40).

Year 2 — Directly engaged salary calculation:

Salary expense 10 months (January, April, and May 1 to Dec 31) x $10,000 = $100,000
Vacation expense (considered reasonable) — $9,600
Total — $109,600

Year 2 — Directly engaged portion: 168 / 210 days x $109,600 = $87,680

Year 3

Employee X was directly engaged in SR&ED for 42 days (from the beginning of January to the end of February). For 83 days (from the beginning of March to the end of June), he performed duties that were totally unrelated to SR&ED. For the remaining 125 days of the year, he took sick leave. He did not take any vacation in Year 3. Thus in this year the employee’s total time available for work is 125 days (250 – 125).

Year 3 — Directly engaged salary calculation:

Salary expense 6 months (January 1 to June 30) x $10,000 = $60,000
Sick leave expense — $60,000
Accrued vacation expense (considered reasonable) — $4,800*
Total — $124,800

Year 3 — Directly engaged portion: 42 / 125 days x $74,400** = $24,998

*$9,600 x 6 / 12 months as the employee was sick for 6 months.

**Salary expense $60,000 (6 x $10,000) + Sick leave expense attributable to normal annual leave $9,600 (20 days) + Accrued vacation expense $4,800

5.3 Stock option benefits – Options granted or shares issued on or after November 17, 2005

5.3.1 Background – Stock option benefits

Proposed legislation announced on November 17, 2005, that received royal assent on June 26, 2013, clarifies that when the fair market value of shares issued by the corporation exceeded the exercise price payable to the corporation for its shares under an employee stock option plan, the excess will not be recognized as an expenditure for income tax purposes.

5.3.2 Treatment of stock option benefits

For income tax purposes, no expenditure will be considered to have been made by a taxpayer on shares issued on the exercise of options, except to the extent of an actual outlay or expense incurred by the taxpayer.

In determining the expenditure resulting from the claimant having granted or issued an option on or after November 17, 2005, the value of an option granted by a claimant is not considered to be an expenditure for income tax purposes.

The legislative measures provide for two (2) reductions from the related expenditure as described below.

The first reduction applies on the issuance of a share (other than on the exercise of an option). Generally, the corporation is to reduce the related expenditure by the amount, if any, by which

(i) the fair market value of the share

exceeds

(ii) that portion of the amount of the consideration that the issuing corporation has received for issuing the share that is added to, and not deducted because of a provision of the Income Tax Act from, the paid-up capital of the class of shares that includes the share.

The second reduction applies if the issuance of the share is a consequence of the exercise of an option. Generally, the corporation is to reduce the related expenditure by the amount, if any, by which

(i) the fair market value of the share

exceeds

(ii) that portion of the amount paid, pursuant to the terms of the option, by the holder to the issuing corporation for issuing the share, that is added to, and not deducted because of a provision of the Act from, the paid-up capital of the class of shares that includes the share.

The reductions do not apply to reduce an expenditure if the expenditure itself does not include an amount determined to be excesses as described in these subsections.

Legislative References Income Tax Act
Section 7 Stock options
Subsection 143.3(2) Options – Limitation
Paragraph 143.3(3)(a) Limitation concerning issuance of a share
Paragraph 143.3(3)(b) Limitation concerning exercise of an option
Subsection 143.3(5) Clarification

5.4 Retiring allowances

A retiring allowance is included in the income of the recipient. However, a retiring allowance is not considered to be salary or wages by definition. As a result, a retiring allowance cannot be allowed as salary or wages under either the traditional method or the proxy method.

A claimant may be able to treat a retiring allowance (which may include a payment described as termination or severance pay) as overhead and other expenditures on line 360 of Form T661 under the traditional method. For more information on retiring allowances as SR&ED overhead and other expenditures, please refer to the SR&ED Overhead and Other Expenditures Policy.

Legislative references Income Tax Act
Subparagraph 56(1)(a)(ii) Retiring allowance
Subsection 248(1) Definition of "salary or wages"

5.4.1 Accumulated vacation and sick leave credits upon retirement

Payments in respect of yearly accumulated vacation leave and sick leave are considered to be income from an office or employment and are taxable as salary or wages in the year in which the payment is received. However, the Supreme Court of Canada in Harel v. The Deputy Minister of Revenue of the Province of Quebec (77 DTC 5438) has confirmed that an amount received upon or after retirement in respect of unused sick leave credits qualifies as a retiring allowance.

Legislative reference Income Tax Act
Section 5 Income or loss from an office or employment

6.0 Specified employees

A specified employee is an employee who does not deal at arm’s length with the employer or who is a specified shareholder of the employer. A specified shareholder is a person who owns, directly or indirectly, at any time during the year, 10% or more of the issued shares of any class of the capital stock of the employer or of any corporation related to the employer. A specified employee could also be someone related to a specified shareholder; for example, a sister, a brother, a spouse, etc. For the purpose of determining the 10% threshold, shares owned by a person with whom the employee does not deal at arm's length are included.

Legislative references Income Tax Act
Subsection 248(1) Definition of "specified employee"
Section 251 Arm’s length

6.1 Bonuses or remuneration based on profits for specified employees

An expenditure on or in respect of SR&ED carried on in Canada does not include a bonus or remuneration based on profits, in respect of a person who is a "specified employee" of the payer.

For example, if a corporation pays or accrues a bonus to an employee who is its sole shareholder and therefore a specified employee, the bonus is not an expenditure on or in respect of SR&ED. However, a bonus paid or payable by the same corporation to an employee who is not a specified employee of the corporation could be an expenditure on or in respect of SR&ED.

Legislative reference Income Tax Act
Subsection 37(9) Remuneration based on profits or bonus for specified employees

6.1.1 Limitation regarding specified employees

The amount that a claimant can claim as an expenditure on SR&ED for salary or wages of a specified employee is subject to a limit (salary cap). The salary or wages is limited to five times the Year's Maximum Pensionable Earnings (YMPE) as determined under section 18 of the Canada Pension Plan and prorated for the number of days on which the claimant is a specified employee during the year. To obtain the YMPE for each year, use the Rates for Money Purchase limits, RRSP limits, YMPE, DPSP limits and Defined Benefits limits.

Legislative references Income Tax Act
Clause 37(8)(a)(ii)(A) SR&ED Expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED Expenditures in Canada under the proxy method
Subsection 37(9.1) Limitation re-specified employees

6.1.2 Rules for associated corporations

No expenditures may be claimed for the salary or wages of a specified employee of two or more associated corporations unless the associated corporations files an agreement with the CRA using Form T1174, Agreement Between Associated Corporations to Allocate Salary or Wages of Specified Employees for Scientific Research and Experimental Development (SR&ED).

It should be noted that individuals related to a particular corporation, certain partnerships and certain limited partnerships are deemed to be corporations associated with the particular corporation.

The amount which may be claimed as SR&ED expenditures in respect of salary or wages incurred for a specified employee is the amount allocated among associated corporations. The amount may not exceed five times the YMPE for the calendar year in which the tax year ends.

Each associated corporation should file with its tax return, a completed copy of the form, and a certified copy of the resolution of the directors authorizing the agreement, or a Directors' resolution delegating authority to an authorized officer of each corporation signed by the designated authorized officers of each corporation.

The Directors' resolution will be in effect for all subsequent years until it is rescinded.

Where two corporations are owned exclusively by one shareholder, such a transfer signed by authorized officers of each corporation will be accepted provided that a signed confirmation by the shareholder is filed with Form T1174 and states that he or she is the only shareholder of both corporations and has authorized the transfer of the qualified expenditures from one corporation to the other corporation. A Directors' resolution will not be required.

Note
Each associated corporation should file Form T1174 no later than the corporations' respective reporting deadline for the particular tax years. Otherwise the amount for the salary or wages of a specified employee is deemed not to be an expenditure on SR&ED.

Legislative references Income Tax Act
Subsection 37(9.1) Limitation re-specified employees
Subsection 37(9.2) Associated corporations
Subsection 37(9.3) Agreement among associated corporations
Subsection 37(9.4) Filing
Subsection 37(9.5) Deemed corporation

7.0 Salary or wages of employees directly engaged in SR&ED – Proxy method

Under the proxy method, an expenditure on, or in respect of, SR&ED includes the portion of an expenditure made in respect of an expense for salary or wages of an employee who is directly engaged in SR&ED in Canada. Only the portion that can reasonably be considered to relate to such work having regard to the time spent by the employee on such SR&ED can be included. When that portion represents all or substantially all (ASA) of the time spent by the employee on such work, all of the expenditure is deemed to be on, or in respect of SR&ED. For more information on the proxy method, please refer to the Traditional and Proxy Methods Policy.

However, there are restrictions concerning bonuses and remuneration based on profits of specified employees as well as a salary cap for specified employees (see section 6.1.1).

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(IV) SR&ED expenditures in Canada under the proxy method – Directly engaged salary or wages

7.1 Meaning of "directly engaged"

Directly engaged in SR&ED – Whether an employee is directly engaged in SR&ED is based on the tasks that they perform and not on the job title of the employee.

Directly engaged refers to "hands-on" work, which would be included in paragraphs (a) to (d) of the definition of SR&ED in paragraph 248(1) of the Income Tax Act.

Generally, employees, including managers and supervisors, conducting experimentation and analysis in the performance of basic research, applied research, or experimental development are considered to be directly engaged in SR&ED.

In addition, employees, including managers and supervisors, are considered to be directly engaged in SR&ED when they are performing support work that is commensurate with the needs and directly in support of the basic or applied research or experimental development work.

Managers and supervisors who supervise the ongoing SR&ED work are also considered to be directly engaged in SR&ED when they are directing the course of the ongoing SR&ED work or when they are providing direct technical input into the SR&ED work. However, any time spent by a manager or supervisor performing non-technological management activities or decision-making functions that do not directly influence the course of the SR&ED, even if it relates to the SR&ED, is not considered to be time the manager or supervisor is directly engaged in SR&ED. In most cases, work performed beyond the first-line level of supervision does not qualify as directly engaged in SR&ED. Where time is claimed for employees beyond the first-line level of supervision, the claimant will be asked to provide details of the duties the employees performed during the time they were directly engaged in SR&ED. The claimant will also have to demonstrate how these duties are "directly engaged," as described above.

The CRA does not consider clerical and administrative staff providing a service to SR&ED employees to be directly engaged in SR&ED. This includes clerks, secretaries, and receptionists engaged in accounting, payroll, finance, legal support, purchasing, sales, human resources, shipping, inventory control, maintenance, word processing, and other such activities. However, please refer to section 9.3 for more information on the treatment under the traditional method.

For example, employees, including managers and supervisors, considered to be directly engaged in SR&ED, would normally perform such tasks as:

preparing equipment and materials for experiments, tests, and analyses (this does not include time spent maintaining equipment);
carrying out experiments, tests, and analyzes;
collecting data commensurate with the needs and directly in support of the experimentation and analyses; and
directing the course of the ongoing SR&ED activities being claimed in the year;

and to the extent that the tasks are required as part of an SR&ED project:

recording measurements, making calculations, and preparing charts and graphs;
carrying out statistical surveys and interviews;
preparing computer programs; and
more generally, work with respect to engineering or design, operations research, mathematical analysis, and psychological research.

Table 3 in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditure Claim, provides assistance to claimants to determine how to handle the salary or wages for various tasks and duties. The claimant should view its employees' tasks in terms of how they correlate to the primary reason for employment when determining whether the employee's salary or wages are directly engaged in SR&ED. The determination of whether an employee is directly engaged in the prosecution of SR&ED, however, is a question of fact.

7.1.1 Non-specialized employees who are directly engaged

"Directly engaged" work could include hands-on work performed by both specialized and non‑specialized employees. Whether the work of a non-specialized employee can be considered work "directly engaged in SR&ED" is a question of fact. This would be the case only if the following conditions are met:

The work performed by the non-specialized employee must be directly in support and be an integral part of the basic or applied research or experimental development work.
The non-specialized employee's work must be supervised by staff with scientific or technological qualifications.

The term "direct" means proceeding from one point to another without deviation or interruption; straight; "directly" would mean in a direct manner, without an intervening step or intermediary. This means that only the time spent by a non-specialized employee who is involved in an SR&ED project, in a direct manner and without an intervening step or intermediary, could qualify as directly engaged in SR&ED work.

Further, an activity is considered to be directly in support of SR&ED when it is reasonable to believe that the activity is required to carry out the SR&ED. That is, it has been shown to be an integral part of the systematic investigation of a problem, and is required in the search for a theoretical or practical solution.

Tasks performed by non-specialized employees are generally not considered to be "directly engaged" in SR&ED. For example, any work related to equipment maintenance or repairs, materials-handling, and clerical and administrative support activities does not qualify under the proxy method.

However, examples of tasks performed by a non-specialized employee who could qualify as directly engaged in SR&ED include:

operating a machine for the purposes of an experiment that requires the use of this machine;
feeding raw materials into a machine for the purposes of an experiment;
performing work such as welding, machining, mechanics, electrical work and plumbing where that work is required and is an integral part of an SR&ED project (for example, construction and testing of a prototype); and
performing other tasks that are directly in support and are an integral part of an SR&ED project.

7.2 Supporting documentation and other evidence

A claimant should be able to show that the salary or wages are for SR&ED work performed by employees of the company on activities that are considered to be directly engaged in SR&ED. When applying the expenditure allocation in a claim under the proxy method, the information system used by a claimant must capture directly engaged time. Other labour costs are covered by the prescribed proxy amount (PPA).

Claimants should maintain information supporting the reasonableness of the allocation of directly engaged salary or wages, including:

a description of the allocation method used;
the rationale for the selection of the allocation method, considering the claimant's business environment; and
the internal controls that are available to test the allocations.

For more information on the allocation of salary or wages to SR&ED, please refer to section 13.0, Allocation of labour expenditures for SR&ED as well as Appendix 2, Documentation and other evidence to support your SR&ED claim, in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim.

7.3 Calculating the amount of the expenditures

Under the proxy method, the portion of an expenditure made in respect of an expense incurred in the year for the salary or wages of an employee who is directly engaged in SR&ED in Canada can only be deductible for SR&ED purpose if it can reasonably be considered to relate to such work having regard to the time spent by the employee thereon. For this purpose where that portion is ASA of the expenditure, that portion shall be deemed to be the amount of the expenditures.

Legislative Reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(IV) SR&ED expenditures in Canada under the proxy method – Directly engaged salary or wages

7.3.1 Portion of an expenditure for salary or wages

The directly engaged salary or wages or portion thereof is calculated on the time spent directly engaged in SR&ED relative to the total time worked. For example, if a salaried employee earning $100,000 per year spends all of their 1,800 regular hours directly engaged in SR&ED and works an additional 600 hours of unpaid overtime performing general administrative duties, the directly engaged salary or wages are $75,000 (1,800 / 2,400 x $100,000).

7.3.2 Only the portion of the salary or wages that can reasonably be considered to relate to SR&ED can be included

The fact that an amount is included in the calculation of salary or wages of an employee directly engaged in SR&ED does not necessarily mean that it represents salary or wages for SR&ED purposes. Where the proxy method is used, the legislation clearly indicates that only that portion of salary or wages that is reasonably related to work that is directly engaged in SR&ED can be allowed as an expenditure for SR&ED purposes.

The term "relate" means to show a logical or causal connection between; to have relationship or connection (between two things). Accordingly, there must be a reasonable connection between the amount of salary or wages and the prosecution of SR&ED. It should be noted that, in the case of employees who spend ASA of their time to the prosecution of SR&ED, all of their time is considered to be related to the prosecution of SR&ED.

In order to determine if there is a reasonable link between an amount of salary or wages and the SR&ED work being performed, the underlying reasons for paying the salary or wages would have to be determined and demonstrate how it is related to the SR&ED.

Bonus or remuneration based on profits paid or payable to an employee who is not a specified employee of a corporation has the capacity to be related to the prosecution of SR&ED, and therefore could be an expenditure on or in respect of SR&ED. For example, where a corporation is taking advantage of marginal tax rates by reducing the corporation's taxable income to or below the small business deduction limit through the payment of bonuses or remuneration based on profits from income derived from normal business operations, the bonus or remuneration based on profit could be considered to have a reasonable link to the prosecution of SR&ED.

There would be no reasonable link between the expenditure and the prosecution of SR&ED where, for example, an employee (where the ASA rules do not apply, see section 7.3.4 below) receives:

salary, including a bonus, when the income that was used to pay the amount was not earned from the ongoing, normal activities of the business. This would include an amount paid to an employee that was earned from a capital transaction such as the sale of the business, the sale of shares or the sale of an asset,
salary earned from a non-eligible activity (for example, a finder's fee), or
a bonus for the achievement of specific sales targets.

Such amounts do not have the capacity of being allocated to SR&ED (cannot be SR&ED expenditures). In other words, the allocation of salary or wages to SR&ED is made after such amounts are excluded from total remuneration.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(IV) SR&ED expenditures in Canada under the proxy method – Directly engaged salary or wages

7.3.3 Example – Reasonably be considered to relate to SR&ED

An employee who is directly engaged in the prosecution of SR&ED 60% of the time receives a regular salary of $100,000 and a commission of $15,000 on the sale of a product. The amount for the commission is not an expenditure on SR&ED as it is not directly linked to the SR&ED work being performed. The amount of the commission does not have the capacity of being allocated to SR&ED (cannot be SR&ED expenditures). Therefore, only $60,000 could be allocated to SR&ED ($100,000 x 60%).

7.3.4 All or substantially all

When the portion of the expenditure represents ASA of the time spent by the employee on SR&ED work, all of the expenditure is deemed to be on SR&ED. However, there are restrictions concerning bonuses and remuneration based on profits of specified employees, as well as a salary cap for specified employees (see section 6.1.1).

For example, subject to the "specified employee" rules, the salary or wages of an employee hired for SR&ED purposes are considered ASA attributable to the prosecution of SR&ED if 90% or more of this employee's time is spent on the prosecution of SR&ED.

There should be some form of evidence to support the use of the ASA rule for each employee.

The basis for applying the ASA rule is the tax year; it is not based on a specific period during the tax year. The Act refers the portion of an expenditure made in respect of an expense incurred in the year for the salary or wages.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(B)(IV) SR&ED expenditures in Canada under the proxy method – Directly engaged salary or wages

7.3.5 Example – All or substantially all

An employee worked 90% of the time directly engaged in SR&ED for the first 6 months of the tax year and worked in non-SR&ED activities in the remaining 6 months. The employee's salary for the tax year was $100,000.

The directly engaged salary or wages (or portion) is calculated on the time spent directly engaged in SR&ED relative to the total time worked in the year: in this case the allowable salary would be $45,000 (90% x ½ = 45% of $100,000). It would be incorrect to claim 100% of the employee's salary for the first six months.

8.0 Undertakes, supervises, supports – Traditional method

Expenditures for salary or wages that are either all or substantially all (ASA) to the prosecution of SR&ED or directly attributable to the prosecution of SR&ED can be claimed under the traditional method. For more information on the traditional method, please refer to the Traditional and Proxy Methods Policy. However, there are restrictions concerning bonuses and remuneration based on profits of specified employees as well as a salary cap for specified employees (see section 6.1.1).

An expenditure directly attributable to the prosecution of SR&ED includes the portion of the amount incurred for salary or wages of an employee who directly undertakes, supervises or supports the prosecution of SR&ED that can reasonably be considered to be in respect of such prosecution.

Legislative references Income Tax Act
Subclause 37(8)(a)(ii)(A)(I) SR&ED expenditures in Canada under the traditional method – ASA
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative reference Income Tax Regulation
Paragraph 2900(2)(b) Employee remuneration – Traditional method

8.1 Meaning of "undertakes, supervises or supports"

"Undertakes" means performing experimentation, analysis and other related activities in the performance of work described in paragraphs (a) to (d) of the definition of SR&ED in paragraph 248(1) of the Income Tax Act, that is basic research, applied research, experimental development or support work.

"Supervises" refers to the day-to-day management of work described in paragraphs (a) to (d) of the definition of SR&ED by an employee, not merely the supervision of employees who undertake or support SR&ED work. It is expected that the performance of such work would require a significant technological background based on the employee's academic or work experience, or both.

Supervision for purposes of the directly attributable rules does not include the performance of managerial functions that relate to general administration. However, supervision could include some non-technological functions, for example, long-term strategic planning, contract administration, etc., that directly relate to the prosecution of SR&ED. These functions would generally be performed in carrying out the other related duties of a technological supervisor of SR&ED (a direct supervisor with technological expertise)—see section 9.0.

The term "supports" describes the performance of any of the work described in paragraph (d) of the definition of SR&ED and other technical work that relates to the prosecution of SR&ED. The other technical work could include work performed by non-specialized employees (see section 7.1.1). Support work does not include the performance of clerical duties involved in carrying out SR&ED. Salary or wages relating to clerical or administrative staff providing a service to SR&ED employees could be included as SR&ED overhead and other expenditures if they are directly related and incremental to the prosecution of SR&ED (see section 9.3).

Legislative reference Income Tax Act
Subsection 248(1) Definition of "SR&ED"

Legislative references Income Tax Regulation
Paragraph 2900(2)(b) Employee remuneration – Traditional method
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

8.2 Supporting documentation and other evidence

The claimant must develop an appropriate allocation method for labour that is in part directly attributable to SR&ED and in part attributable to non-SR&ED activities.

Under the traditional method, SR&ED "directly attributable" salary or wages expenditures include both salary or wages of an employee who directly undertakes, supervises or support the prosecution of SR&ED and salary or wages that is directly related to the prosecution of SR&ED and that would not have been incurred had it not been for such prosecution, (directly related and incremental salary or wages). When applying the expenditure allocation in a claim under the traditional method, the information system used by a claimant must capture directly engaged time, as well as directly related and incremental time. See section 7.2 for comments regarding documentation requirements for the "directly engaged" salary or wages.

Actual expenditures that are directly related and incremental to the prosecution of SR&ED should be included in the claim (see section 9.0). The labour allocation method should provide support for the SR&ED portion of these costs to be included in the claim.

For more information on the allocation of salary or wages to SR&ED, please refer to section 13.0 Allocation of labour expenditures for SR&ED as well as Appendix 2, Documentation and other evidence to support your SR&ED claim, in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim.

8.3 Calculating the amount of the expenditures

Under the traditional method, expenditures directly attributable to the prosecution of SR&ED include the portion of salary or wages incurred for an employee who directly undertakes, supervises or supports the prosecution of SR&ED to the extent the amount incurred can reasonably be considered to relate to such prosecution. Also, where all or substantially all (ASA) of the expenditure is attributable to the prosecution of SR&ED in Canada, the portion is the amount of the expenditure.

Legislative reference Income Tax Regulation
Paragraph 2900(2)(b) Employee remuneration – Traditional method

8.3.1 Portion of an expenditure for salary or wages

The portion of salary or wages amount referred to in the Regulations is generally calculated on the time spent directly undertaking, supervising, and supporting the prosecution of SR&ED compared to the total time worked.

Legislative reference Income Tax Regulation
Paragraph 2900(2)(b) Employee remuneration – Traditional method

8.3.2 Only the portion of the salary or wages that can reasonably be considered to relate to SR&ED can be included

Where the traditional method is used, the legislation clearly indicates that only an expenditure that can reasonably be considered to relate to the prosecution of SR&ED can be allowed as an expenditure for SR&ED purposes. There must be a reasonable link between the amount of salary or wages and the SR&ED work being performed for an amount to be an allowable SR&ED expenditure. For more information on this requirement, please refer to section 7.3.2.

8.3.3 All or substantially all

Where all or substantially all ( ASA) of an employee's time is spent on SR&ED activities, the employee is considered to have spent all of the time on SR&ED. Thus, the employee's total salary or wages is treated as an allowable SR&ED expenditure (subject to the salary cap for specified employees, see section 6.1.1). There should be some form of evidence to support the use of the ASA rule for each employee.

For example, subject to the "specified employee" rules, the wages of an employee hired for SR&ED purposes are considered ASA attributable to the prosecution of SR&ED if 90% or more of this employee's time is spent on the prosecution of SR&ED.

The ASA rule only applies where an expenditure of a current nature is used 90% or more for the prosecution of SR&ED work. Therefore, in the case of salary or wages, the ASA rule can only apply to the salary or wages of an employee who directly undertakes, supervises or supports the prosecution of SR&ED as described in section 8.1. The ASA rule does not apply to other employees such as clerical and administrative staff providing a service to SR&ED employees. For more information on salary or wages for clerical and administrative staff providing a service to SR&ED employees, please refer to section 4.1 of the SR&ED Overhead and Other Expenditures Policy.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(I) SR&ED expenditures in Canada under the traditional method – ASA

8.4 Salary or wages under the traditional method and Form T661

Salary or wages incurred for an employee who directly undertakes, supervises or supports the prosecution of SR&ED are directly attributable to SR&ED. For the purposes of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, these expenditures are treated as being directly engaged salary or wages. However, under the traditional method, the portion of other salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED but who are not directly engaged in SR&ED can also be claimed as SR&ED overhead and other expenditures on line 360 of Form T661 (see section 9.0). Refer to Table 5 in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, for an example of such tasks.

Additionally, expenditures that are directly related and incremental to the prosecution of SR&ED are directly attributable to SR&ED. Salary or wages incurred for clerical and administrative personnel providing a service to SR&ED employees (see section 9.3) could be considered to be directly related and incremental to SR&ED depending on the facts of the case. These types of expenditures are also reported on line 360 of Form T661 as SR&ED overhead and other expenditures and cannot be claimed when using the proxy method.

9.0 Administrative salary or wages – Traditional method

This section explains the rules and clarifies which administrative salary or wages are "directly related" to the prosecution of SR&ED under the traditional method of calculating investment tax credits. The comments below apply to all claimants, including dedicated SR&ED performers.

9.1 "Directly attributable" tests – "Directly related" and "incremental" salary or wages

To be allowable as an expenditure directly attributable to the prosecution of SR&ED , an expenditure, or portion of an expenditure, for administrative salary or wages must satisfy two tests:

It must be "directly related" to the prosecution of SR&ED in Canada; and
the expenditure would not have been incurred had such prosecution not occurred (incremental)

By virtue of the term "directly related", all the time spent by administrative staff would not be "directly related" to the prosecution of SR&ED, unlike the time spent by staff hired to perform their duties specifically in such prosecution. However, the terms "portion" and "directly related" in the Regulations indicate that some duties of the administrative staff would meet the tests, the determination of which would be based on a finding of fact.

The work performed by a particular employee must connect with (in other words "relate to"), and be done without an intervening step or intermediary (in other words "directly") between the employee and,

the SR&ED work, or
the SR&ED staff, or
the machinery / equipment used by staff to perform SR&ED.

Expenditures for administrative salary or wages that do not meet the above tests are not expenditures on SR&ED under the Income Tax Act.

Legislative reference Income Tax Regulation
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

9.2 Application of the rules

The portion of salary or wages for hands-on work performed by administrative staff is an expenditure directly attributable to SR&ED and could qualify as salary or wages of an employee who directly undertakes, supervises or supports the prosecution of SR&ED. However, work performed by administrative staff with no technological background generally does not qualify as hands-on work. In this case, an analysis of the duties performed is required to determine the direct linkage to SR&ED work. If the expenditure for administrative salary or wages is directly related and incremental to the prosecution of SR&ED it can be claimed as SR&ED overhead and other expenditures.

There must be a direct linkage of expenditures for administrative salary or wages to specific SR&ED work, staff or machinery / equipment. To make this determination in respect of a particular employee, it is necessary to examine the duties performed by the employee.

For example, where a vice president (VP) of a company is required to hire a Personnel Manager who, in turn, is required to hire SR&ED staff, there would be no immediate contact between the VP and the SR&ED or SR&ED staff. In this situation, no portion of the VP's time could be said to meet the "directly related" test, although there may be an indirect relationship. On the other hand, any time spent by the Personnel Manager in hiring SR&ED staff could be considered to meet the "directly related" test.

Expenditures for tasks that are attributable entirely to non-SR&ED work would not qualify. For example, non-SR&ED work includes the functions of planning (non technological), direction, control, co-ordination, systems, or other functions at a managerial level.

For more information on the directly related and incremental tests under the traditional method, please refer to sections 3.0 to 4.1 of the SR&ED Overhead and Other Expenditures Policy.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

9.3 Clerical and administrative staff providing a service to SR&ED employees

A portion of the salary or wages for clerical and administrative staff providing a service to SR&ED employees may also qualify for SR&ED purposes if the functions performed are non‑technological and aid the ongoing SR&ED claimed in the year, and the salary or wages of the clerical and administrative staff providing the service are directly related and incremental to the prosecution of SR&ED.

For more information on salary or wages for clerical and administrative staff providing a service to SR&ED employees, please refer to section 4.1 of the SR&ED Overhead and Other Expenditures Policy.

Legislative reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative reference Income Tax Regulation
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

10.0 Salary or wages of employees carrying on SR&ED outside Canada

Claimants can earn SR&ED investment tax credits (ITCs) on permissible salary or wages for SR&ED work carried on outside Canada after February 25, 2008.

The SR&ED work carried on outside Canada must be directly undertaken by the employees of the claimant, and must form part of the SR&ED carried on in Canada by the claimant. Permissible salary or wages incurred by a claimant in a tax year is limited to 10% of the total of salary or wages for the SR&ED carried on in Canada.

The permissible salary or wages for the work carried on outside Canada is deemed to be an expenditure made in Canada by the claimant. Accordingly, such expenditures qualify for the SR&ED ITC and are excluded from the application of the rules for SR&ED carried on outside Canada for which no ITC can be earned.

Legislative references Income Tax Act
Subsection 37(1.5) Salary or wages for SR&ED outside Canada – Limit determined
Subsection 37(2) Research outside Canada

10.1 Calculation of permissible salary or wages for SR&ED work carried on outside Canada

In order to determine the amount that can be claimed as the permissible salary or wages for SR&ED carried on outside Canada, claimants will first have to calculate the two amounts A and B below. The lower of amount A or B can be claimed as the permissible salary or wages for SR&ED carried on outside Canada.

Amount A – Total of salary or wages for SR&ED work carried on outside Canada

The salary or wages that can be claimed for SR&ED work carried on outside Canada must meet the following criteria:

the costs were incurred after February 25, 2008;
the SR&ED work was directly undertaken by an employee of the claimant and not performed by a contractor;
the employee who performed the SR&ED work was a resident of Canada at the time the expense was incurred;
the work was related to a business of the claimant;
the SR&ED work carried on by the employee outside Canada was an integral part and solely in support of the SR&ED work carried on in Canada (see section 10.2.1); and
the salary or wages paid were not subject to income or profits tax from another country (see section 10.2.2).

Amount B – 10% of the total of SR&ED salary or wages for SR&ED carried on in Canada

This limit is calculated as 10% of the total salary or wages claimed for SR&ED carried on in Canada (see section 10.2.3). Note: Although the Income Tax Act refers to an expense incurred in the year for salary or wages paid to an employee in respect of SR&ED, it is the practice of the CRA to use the amount on line 306 of Form T661 (expenditure incurred) for the purposes of determining the 10% limit.

For the tax year that includes February 26, 2008, the 10% limit is prorated based on the number of days after February 25, 2008, that are in that tax year over the total number of days that are in that tax year.

The formula is:

(Number of days in the tax year after February 25, 2008) / (Total number of days in the tax year)

Legislative reference Income Tax Act
Subsection 37(1.5) Salary or wages outside Canada – Limit determined

10.1.1 Example

Company A's tax year end is September 30, 2008. Company A claimed one SR&ED project carried out in Canada during the tax year. Company A has five employees (other than specified employees) performing SR&ED and each are paid $9,000 per month. All employees are working 100% of their time on the SR&ED project and they all reside in Canada. Company A's SR&ED salaries for 2008 tax year are $540,000 ($9,000 x 12 months x 5 employees = $540,000).

Employee 1 performed SR&ED work outside Canada in November 2007 (30 days)
Employee 2 performed SR&ED work outside Canada in March 2008 (31 days).

The permissible salary for work carried on outside Canada is the lesser of A or B:

Amount A – Calculated

$9,000 – Eligible salary for Employee 2 only as Employee 1 performed SR&ED work before February 25, 2008.

Amount B – Calculated

$31,092 (total salary or wages for SR&ED performed in Canada) x (10%) x (proration for the number of days in the tax year after February 25, 2008 / total number of days in the tax year)

($540,000 - $18,000) x (10%) x (218 / 366)

Based on the above calculation, the amount that can be claimed as salary or wages for work carried on outside Canada on line 307 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, is $9,000.

10.2 Applying the rules

10.2.1 Meaning of "solely in support"

The SR&ED work carried on outside Canada by the claimant that is basic research, applied research, experimental development or work described in paragraph (d) of the definition of SR&ED in subsection 248(1) of the Act would qualify as being "in support" provided the work is an integral part and is solely in support of the SR&ED work carried on in Canada by the claimant.

The question whether an activity performed outside Canada is solely in support of the SR&ED work carried on in Canada is a question of fact to be determined on a case by case basis.

Where an activity is in support of both an SR&ED project carried on in Canada and another SR&ED project carried on outside Canada, that activity would not be considered to be solely in support of the SR&ED work carried on in Canada.
Where an activity performed outside Canada supports work that involves SR&ED carried on in Canada and at the same time supports non SR&ED work (dual purpose activity) performed in Canada, that activity would not be considered to be solely in support of the SR&ED work carried on in Canada.

10.2.2 Salary or wages paid were not subject to income or profits tax from another country

Salary or wages paid to an employee for SR&ED work carried on outside Canada can be included as permissible salary or wages only if the claimant reasonably believes that the salary or wages is not subject to an income or profits tax imposed, because of the employee's presence or activity in a country other than Canada, by the government of that particular country.

This rule takes into account only those taxes that are applied because of an employee's presence or activities in a foreign country—and not, for example, a tax that applies to a country's citizens regardless of where they live or work.

To determine whether the salary or wages paid to an employee for work performed outside Canada is subject to an income or profits tax imposed by a foreign government, the claimant should consider the tax treaty between Canada and the foreign country in which the SR&ED work in support of the SR&ED in Canada is performed.

Usually salary or wages paid to an employee for SR&ED work carried on outside Canada can be included as permissible salary or wages if the employee sojourns only a short period of time in the foreign country. As stated in paragraph 25 of Interpretation Bulletin IT-270R3, Foreign tax credit:

The location of the source of an individual's office or employment is considered to be the place where he or she normally performs the related duties. If those duties require the individual to spend a significant part of the time in a country other than Canada, the individual may be subject to tax in that foreign country on a portion of the remuneration.

However, it is a question of fact whether salary or wages paid to an employee is not subject to an income or profits tax imposed by a foreign jurisdiction. The onus is on the claimant to make this determination. If this condition is not satisfied—for example, if the claimant knows or has reason to believe that the amount is being taxed in the foreign country where its employees are carrying out the SR&ED—salary or wages paid to the employee would not be included in the amount of the permissible salary or wages (see section 10.1).

10.2.3 Determining amount B – Limit

Amount B is calculated as 10% of the total salary or wages claimed for SR&ED carried on in Canada.

The 10% limit is calculated on the total allowable salary or wages for SR&ED in Canada and not only on the salary or wages relating to the project(s) carried on in Canada that the work outside Canada solely supports.

For example, if the claimant carries out two SR&ED projects in Canada and testing outside Canada is required for one of the projects, the total salary or wages expenditures for SR&ED in Canada is taken into account for the calculation of the 10% limit.

Under the traditional method, Amount B can include the portion of other salary or wages of employees who directly undertake, supervise, or support the SR&ED that can be claimed as SR&ED overhead and other expenditures on line 360 of Form T661 (salary or wages of employees not directly engaged in the prosecution of SR&ED). See Table 5 in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, for examples of such tasks.

Other salary or wages that are considered SR&ED overhead and other expenditures, such as the salary or wages of clerical staff providing a service to SR&ED employees claimed on line 360 of Form T661, are not included in the total salary or wages for the purpose of calculating the 10% limit.

Legislative reference Income Tax Regulation
Paragraph 2900(2)(b) Employee remuneration – Traditional method

10.3 How to calculate permissible salary or wages for work carried on outside Canada for Form T661

The calculation of permissible salary or wages for SR&ED work carried on outside Canada (see section 10.1) is determined with respect to the total amount of salary or wages for the SR&ED inside Canada. The calculation does not distinguish between specified employees and employees other than specified employees.

However, the way Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, is structured, the total amount of permissible salary or wages for SR&ED outside Canada should be allocated between employees other than specified employees (line 307) and specified employees (line 309). The total of lines 307 and 309 cannot exceed 10% of the total amount of salary or wages for the SR&ED inside Canada (line 306 of Form T661).

Thus, when an amount is claimed on line 307 of Form T661 (for other than specified employees) the amount that may be claimed on line 309 (for specified employees) cannot exceed: 10% of the amount on line 306 of Form T661 less the amount claimed on line 307.

Legislative references Income Tax Act
Subsection 37(1.4) Salary or wages for SR&ED outside Canada
Subsection 37(1.5) Salary or wages for SR&ED outside Canada – Limit determined
Subsection 37(2) Research outside Canada
Subsection 37(9) Remuneration based on profits or bonus for specified employees

11.0 Unpaid salary or wages

Accrued salary or wages are used to calculate the portion that is directly attributable to or directly engaged in SR&ED. If the remuneration remains unpaid 180 days after the end of the year in which the expense was incurred, the expense is deemed not to have been incurred in the year but rather in the year in which the amount is paid. Where the proxy method is being used, prior unpaid amounts that are deemed to be incurred in the year actually paid are excluded from the directly engaged salary base for the purpose of calculating the prescribed proxy amount (PPA). This eliminates the possibility of the PPA approximating SR&ED overhead and other expenditures using salary or wages relating to another year.

In applying these rules, the CRA considers a payment made on the 180th day to have been made within the time limit. These rules apply to both arm's length and non-arm's length transactions. However, they do not apply to the following, that if received, would be included in the recipient’s income:

a reasonable vacation or holiday pay, or
a deferred amount payable under a salary deferral arrangement as defined in subsection 248(1) of the Income Tax Act.

Legislative reference Income Tax Act
Subsection 78(4) Unpaid remuneration and other amounts

Legislative reference Income Tax Regulation
Subsection 2900(9) Exclusions to salary base

11.1 Identification of unpaid salary or wages on Form T661

A claimant must identify, on line 315 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, for a particular tax year, an expense in respect of unpaid salary or wages that was not paid within 180 days of the tax year end, in order for the expense to be deductible as an SR&ED expenditure in the year in which it will actually be paid. In the year the expenditure is paid, it has to be reported on line 310 of Form T661.

Legislative reference Income Tax Act
Subsection 37(11) Filing requirement

11.2 Evidence of payment

Whether accrued and unpaid remuneration is actually paid within the 180-day period involves a finding of fact that can only be established after examining all the evidence that would support such a conclusion.

The best evidence of payment is that the related payroll withholdings were remitted on time. Source deductions must generally be remitted within 15 days after the month in which the amount was withheld. However, this is not the only acceptable evidence of such payment. Other evidence that would corroborate the payment of the wages would include:

the issuance of a T4 slip to the employee;
the reporting of the income by the employee;
the actual payment of the amount (by cheque, cash, or journal entry crediting the employee's account with the payer);
the directors' resolutions; and
other audit evidence which would include the overall condition of the employer's books and records, the historical practice with respect to accruing salary or wages, and the credibility of the payer and employee.

An ordinary promissory note is generally regarded as a promise to pay a debt at a later date, and not as payment of the debt on the date on which the note was issued. However, an amount may be paid by a promissory note if an agreement between the parties clearly indicates that the note was accepted as absolute payment.

11.2.1 Unpaid amounts vs. reserve

No deduction is allowed for an amount as, or on account of, a reserve, a sinking fund, or a contingent liability unless it is expressly permitted by the Act. In order for an expense that remains unpaid at the end of a tax year to be deductible for tax purposes, it must constitute a genuine liability for the claimant. If such an unpaid amount does not constitute a genuine liability, no deduction is allowed and the rules for unpaid salary, wages or other remuneration do not apply. For a genuine liability to exist there must be an enforceable claim by the creditor with a reasonable expectation that the debt will in fact be paid by the debtor.

More details on unpaid amounts can be found in Interpretation Bulletin IT-109R2, Unpaid Amounts.

Legislative reference Income Tax Act
Paragraph 18(1)(e) Reserves

12.0 Other issues related to salary or wages

12.1 Employee vs. self-employed

The criteria used by the CRA to determine whether an individual is an employee or self-employed have been established by the courts. The question to be determined is whether the contract between the parties is a contract of service, which is evidence of an employer / employee relationship, or a contract for services, which indicates a client and independent contractor relationship.

Generally, a contract of service exists if the person for whom the services are performed has the right to control the amount, the nature and the management of the work to be done, as well as the manner of completing the work. A contract for services exists when a person is engaged to achieve a defined objective and is given all the freedom required to attain the desired result.

The contract, which sets out the rights and obligations of both parties, provides important information in determining the type of relationship that exists. However, even more important than the contract is the actual circumstances surrounding the performance of services and whether such findings of facts agree with what is stated in the contract. Thus, the determination of whether there is an employer / employee relationship requires a review of the facts of each case. There is no single conclusive test that can be universally applied to determine whether a person is an employee or is self-employed.

The CRA makes every effort to ensure that taxpayers are fully aware of its administrative practices and interpretations. In this regard, the criteria the CRA uses to determine whether an individual is an employee of a particular taxpayer or is self-employed have been published in Guide RC4110, Employee or Self-Employed?, which is available on the CRA's Web site. This guide also includes the relevant jurisprudence with respect to this issue. In addition, taxpayers wishing to resolve employee / self-employed issues may seek the assistance of the CPP / EI Rulings Division at their local tax services office.

12.2 Determining the employment status of an individual

For salary or wages expenditures to be included in the claimant's SR&ED claim, it must be incurred in respect of its own employees to perform SR&ED. As stated in the Guide T4001, Employers' Guide – Payroll Deductions and Remittances, “If you or a person working for you is not sure of the worker’s employment status, either party can request a ruling to have the status determined.” A request for a ruling can also be made for determining who the true employer is. The request should be made to the CPP / EI Rulings Division at the local tax services office. For more information on employment status, please refer to the Guide RC4110, Employee or Self-Employed?

12.3 Employees of a related corporation

Confusion may occur with respect to who is in fact performing SR&ED when two or more companies that do not deal at arm’s length with each other use each other's resources (employees) to perform SR&ED.

For salary or wages expenditures to be included in the claimant's SR&ED claim, it must be incurred in respect of its own employees to perform SR&ED. Salary or wages of an employee of a related company that performed SR&ED on behalf of the claimant cannot be claimed by the claimant. In such a situation, a non-arm's length contract situation would exist between the claimant and the related company.

It is the practice of the CRA to consider work performed by the employees of the related corporation as being SR&ED if the following conditions are met:

the work is performed by the related corporation (or partnership) at a time when it does not deal at arm's length with the claimant, and
the work would be SR&ED if it were performed by the claimant.

When these conditions are met, the amount paid by the claimant to the non-arm's length company to perform SR&ED on behalf of the claimant can be treated as a non-arm's length SR&ED contract. For more information on SR&ED contracts, please refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy.

The related corporation would have to file a Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, and the use of the Form T1146, Agreement to Transfer Qualified Expenditures Incurred in Respect of SR&ED Contracts Between Persons Not Dealing at Arm's Length, could be considered for the transfer of the qualified SR&ED expenditures. For more information on the transfer of qualified SR&ED expenditures, please refer to the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy.

Legislative Reference Income Tax Act
Subsection 37(13) Non-arm's length contract – Linked work

13.0 Allocation of labour expenditures for SR&ED

Many SR&ED claimants have information systems that capture information about SR&ED work and related costs as a project progresses. These systems can be electronic or paper based and may include a variety of methods of capturing information about the SR&ED labour for the purposes of calculating SR&ED salary or wages. Where formal systems have not been implemented, claimants can determine SR&ED salary or wages using appropriate labour allocation methodologies. This section is intended to provide guidance on the elements of such methodologies and to provide an illustration of a sample application.

This section may be used by claimants for preparing the labour expenditure portion of their SR&ED claims. This section does not address technical documentation for SR&ED work.

The allocation methods outlined here are for illustrative purposes only. Other approaches may be acceptable, as long as they are reasonable within the context of a claimant's research and development (R&D) environment, are documented, and are effectively and consistently applied. The suggested approaches can be used with either the proxy method or the traditional method.

13.1 Cost allocation methods

An SR&ED cost allocation method is a systematic approach to determining which expenditures, or portion of expenditures, relate to SR&ED work. A claimant must be able to show that the cost allocation method used is based on a systematic approach, and provide a reasonable level of accuracy in calculating the SR&ED expenditures. Documentation should be kept to identify the key elements of the cost allocation method, including the controls that were used in preparing the claim.

The level of detail and sophistication of books and records will depend on many factors, such as the size of the claimant's organization, the claimant's knowledge of SR&ED policies and practices, and the size of the claim. A small business may have less sophisticated financial control systems than a large company, due to the nature of its business or because of cost constraints. A first-time claimant may have an informal system of calculating SR&ED labour expenditures, while an experienced claimant may have a more sophisticated system. Where a large organization may rely on a combination of the methods discussed in this chapter, some small businesses may have to rely on informal, naturally generated information to support their allocation of labour costs to SR&ED projects. In all cases, documentation of the labour effort and the related financial information is required to support the reasonableness of the expenditures included in a claim.

13.2 Research and development environment

All cost allocation methods use information and documentation that comes from the claimants' information systems. The CRA recognizes that the R&D environment will influence the way information is gathered and summarized. The nature and sources of available information will be a key consideration in developing an appropriate labour allocation method.

For illustrative purposes, the following four R&D environments are used to show appropriate labour allocation methods. The four environments discussed in detail in section 13.5 are as follows:

distinct well-defined R&D projects;
dedicated R&D environments;
early stage or start-up business;
shop floor R&D.

The methods used to allocate labour expenditures to SR&ED in these four R&D environments can be applied to other real-life R&D environments.

13.3 Support for labour allocation

The labour allocation must be supported by evidence that:

the allocation method is appropriate in the company's environment;
the allocation method is consistent with the Income Tax Act and the administrative practices of the CRA; and
the allocation system is functional throughout the year.

There are generally three levels at which information can be summarized:

high
medium
low

Each level offers a different view of the SR&ED project. All the levels may provide a reasonable allocation of labour expenditures to an SR&ED project provided they are part of an information system that includes controls that can be tested to evaluate the materiality and accuracy of the results. In some cases, it will be necessary for the CRA to review information at more than one level to properly evaluate whether the allocation method is reasonable or not.

13.3.1 High-level information (corporate or strategic concept level)

The documentation of a business’s overall corporate and strategic objectives is referred to as high-level information. High-level information is generated by the conceptual high-level management processes and systems that businesses (especially large businesses) use for project management and cost control. For example, the strategic planning process, cost allocation and cost control systems, and project planning and project evaluation processes may all produce information that is relevant and useful in shaping and proving SR&ED claims. High-level information may provide context for the allocation method and may, in some circumstances, contain enough information to support a claim and no further review is needed. However, medium or low level information should be available to support high-level information.

13.3.2 Medium-level information (project level)

Information related to specific work efforts within a project or subproject is referred to as medium-level information. This includes management processes associated with specific work efforts or projects undertaken by the business.

This information supports the information generated by the high-level systems. Medium-level information is generated at the project level and generally relates to a business's documentation of specific work efforts. Specific project plans that break projects into components or subprojects would be an example of medium-level information. These project plans could be revised as a result of the SR&ED process.

In some businesses, these work efforts are documented using financial reports (budget to actual), Gantt charts, time lines, resource allocation or utilization summaries, specific project cost control systems, and supervisor summaries for project team members. There should be a clear link between the SR&ED project objectives and the work undertaken by the members of the project team. Documents should identify all employees involved in an SR&ED project and should give enough information to identify SR&ED work that is included in the claim. A small sample of medium-level information should show the relevance of the high-level information and support the allocation methods that the claimant has used.

13.3.3 Low-level information (activity level)

Information related to individual tasks is referred to as low-level information. In some cases, information may be summarized at the lower level tasks undertaken to complete major work. Tasks can be documented with such things as resource allocation or utilization summaries, time sheets, and personal logs. An effective system of documenting tasks records hours worked on a project-by-project basis. There should be a clear link between the SR&ED project objectives and the tasks undertaken by the members of the team.

13.4 Sources of supporting information

The following is a list of potential sources of supporting information that could be used by claimants to support an allocation of labour expenditures to an SR&ED project. The objective is to provide key facts including:

the names of the employees performing the SR&ED work;
confirmation of employment (hire and termination dates);
verification that the individual is an employee and not a contractor;
identification of specified employee.

In addition, appropriate allocation methodologies can be used to determine the number of hours an employee spent working in SR&ED. When appropriate and effective controls are in place, each of the sources identified below may provide the information required. In some cases, more than one source of supporting information may be required to evaluate whether the labour allocation is reasonable or not.

13.4.1 Development plans

The resource-planning element of a project schedule plan may identify the resources associated with specific work to be undertaken in the claim period. Where the work relates to the technological or scientific objectives of the SR&ED project and the plan can be compared to actual results or other controls, one may be able to rely on these planning records to allocate labour to an SR&ED project.

13.4.2 Supervisors' summaries

Project managers or technical supervisors often prepare periodic weekly, monthly or quarterly summaries. The summaries document the amount of SR&ED undertaken by the R&D teams for a given period. A person who has direct involvement in managing the work of SR&ED personnel should prepare such summaries. It is expected that the summaries would identify the significant SR&ED and any non-SR&ED work undertaken during the period in question. To be effective, the summaries should be updated regularly.

13.4.3 Time sheets

Individual time sheets that allocate time to SR&ED and non-SR&ED work are a good source of supporting information. Time sheets can be used to show the reasonableness of an SR&ED labour claim. Time sheet codes may be based on business projects that do not align to SR&ED projects. In such cases, other evidence may be required to support the SR&ED labour allocation.

13.4.4 Naturally generated information

Claimants may rely on other information that is naturally generated while performing the SR&ED work. This includes:

contracts;
planning documents;
project specifications;
project objectives and milestones;
descriptions of problems to be solved;
resource allocation records and budgets;
written correspondence with customers and suppliers;
minutes of meetings;
supervisor summaries;
project, laboratory, or personal notebooks;
progress and final project reports;
organizational charts.

An allocation of labour based on naturally generated information must give the CRA a reasonable level of assurance that there is minimal risk of material error in the labour expenditure being allocated to an SR&ED project. The claimant should be able to show support for the claim in the documents and other information.

13.5 R&D environment

The business environment in which SR&ED is carried out will influence the nature and sources of evidence that are available to support the labour allocation methodology. The four R&D environments identified in section 13.2 are described below, along with sample labour allocation methods that might be appropriate in each environment.

13.5.1 Distinct well-defined R&D projects

This environment is found in situations where the claimant's organization assigns personnel and resources to specific R&D projects. Projects have a defined start date, targeted finish date, and are based on well-defined technological objectives. Where the core project is SR&ED and support work is necessary to resolve the technological challenges, the work effort can be allocated completely to the project. Controls to identify and segregate non-SR&ED work, such as negative time reporting, provides an indication that the labour allocation is reasonable. Supporting information in this setting may include a development plan that can be used to verify job functions. Where labour resources are used in many projects and in both SR&ED and non-SR&ED, labour allocations can be made based on such things as:

resource allocation or utilization summaries;
project cost control systems;
supervisor summaries;
Gantt charts;
time lines.

13.5.2 Dedicated R&D environments

In principle, these are environments where a defined group of personnel are focused exclusively on R&D for new products or processes, usually to the exclusion of all other business activities of the business. A dedicated research department may be found in any industry, but is more likely to be found in a large multidisciplinary business. It should be noted that a dedicated R&D department might be involved in SR&ED and non-SR&ED work.

Personnel in other areas of the company may also do SR&ED work. The claimant should be able to identify the SR&ED performed by the dedicated research department. The claimant should also be able to distinguish allowable SR&ED labour expenditures from the total expenditures of the dedicated research department. Additionally, the claimant should be able to provide documentation with appropriate controls supporting the allocation of SR&ED labour expenditures. A negative time reporting system that captures non-eligible labour expenditures can be quite effective in these settings. Supporting information in these environments can include such things as:

supervisor summaries;
resource allocation or utilization summaries;
Gantt charts;
time lines;
time sheets.

13.5.3 Early stage or start-up business

Early stage or start-up companies do R&D to develop new products or processes. In some situations, personnel may be focused on one SR&ED project. If so, the simplest approach may be to identify employees working on non-eligible work and subtract that portion of labour expenditures from the total labour expenditures. In this type of environment, a claimant should be able to identify the employees performing SR&ED within the business operations. The claimant should be able to distinguish allowable SR&ED labour expenditures from the total operating costs of the business. Additionally, the claimant should be able to give information supporting the allocation of personnel to an SR&ED project. Documentation in this setting can include such things as:

job descriptions;
development plans;
Gantt charts;
supervisor summaries;
time sheets.

13.5.4 Shop floor SR&ED

Shop floor SR&ED commonly occurs in a variety of industry sectors. This type of SR&ED involves creating new, or improving existing, materials, devices, products, or processes in the field or at a commercial facility. Shop floor SR&ED can involve a variety of employees from different parts of an organization. An SR&ED project of this nature could involve shop floor supervisors, engineers, machine operators, mechanics, and welders. Individuals may report their time using time sheets, a time clock system, or other methods. Because of the variety of employees involved in shop floor SR&ED, it is advantageous to claimants to develop a process to collect information at the start of a project, otherwise difficulties may be encountered in supporting the time an employee spends performing SR&ED work.

13.6 When is a labour allocation method reasonable?

The use of an allocation method in determining SR&ED labour expenditures will generally be acceptable to the CRA, as long as there is supporting information to establish the reasonableness of the method. Allocations should be supportable through effective controls and information that can be used to test the reasonableness of the amount claimed. The CRA is available to help claimants identify the type of supporting information and control systems needed to support a claim for SR&ED labour expenditures.

13.7 Example of an allocation method

The following example refers to a small start-up operation, which has developed simple allocation approaches to determine its SR&ED labour costs. The approaches used in this example are not the only acceptable methods for allocating labour expenditures to an SR&ED project. The methods a company uses to allocate labour expenditures to SR&ED work must be tailored to the way it collects and manages financial information. Other methods may be more appropriate in other industry sectors, but the concepts described in this example will be similar.

Aco is a venture-backed start-up company developing a Web-based supply chain management software program that is fully customizable by the customer. The company is developing a new architecture that will serve as the base for a family of products. The development of the initial architecture meets all the requirements to be considered SR&ED.

During the first two months after incorporation, the four founders worked together on the architecture from the home of one of the founders. During this period, each of the developers worked on source code that was annotated and accompanied by a complete revision history. Although a great deal of progress was made, in the third month it was apparent that the seed funding would not take the company far enough. Over the next two months, one of the founders focused on approaching investors to raise more financing instead of working on the experimental development.

By the end of the fifth month, the company had raised $10 million dollars and they were ready to start ramping-up the company. Over the next month, 30 employees were to be hired. The first was a system architect who became responsible for the overall development of the architecture.

Three of the founders stayed heavily involved in the experimental development. The fourth founder continued to develop the business and participated only in the technical strategy design meetings for the ongoing experimental development.

Of the 30 employees added, 3 worked in finance and administration, 5 in sales and marketing, 3 in customer care, 1 in developing technical and user documentation, 4 in quality control, 10 in the research group, and 4 in product engineering.

The system architect knew about the SR&ED Program. During the one-month ramping period, the architect began to write periodic summaries that were to be produced monthly. The summaries allocated the work as SR&ED undertaken for the given period. The report identified both the SR&ED effort and the non-SR&ED work during the period in question.

By the sixth month, the R&D group found it necessary to use project scheduling and resource allocation tools to manage the experimental development process. These tools permitted the team to identify the resources associated with the specific work. Also in the sixth month, the finance group implemented a time-sheet system. The system was intended to address the overall needs of the company. The time sheet data would enable the finance group to track total hours worked along with employee vacation, holiday and sick leave. The data would provide the information necessary to allocate expenditures to cost centres including experimental development (in other words, the system would be used to allocate researchers' time to projects). In addition, the system would provide the data necessary to bill customers for consulting services after the product was released.

By the eighth month, the company had signed contracts with a number of customers and the customer care group and product-engineering group were busy installing and improving an early release of the software. The company was not large enough to do a complete evaluation in-house. The company needed to install the software with a customer in order to evaluate it. The product was still clearly in development, because end-user technical requirements were being developed and analyzed by both the customer care team and product-engineering team to be included in future more advanced versions of the technology.

At the end of the year the finance group was responsible for calculating the expenditures incurred in the year on eligible projects. The following is a summary of the resources by department:

Personnel	Number
Founders	4
Research and development	10
Product-engineering	4
Customer care	3
Quality control	4
Documentation	1
Finance and administration	3
Sales and marketing	5
Total	34

The standard work week for the corporation is 37.5 hours. Each employee is given three weeks of vacation. The total working hours in a year are 1837.5 hours (37.5 x 49).

13.7.1 The approach

In this particular year, there was no single system that the controller could rely on to quickly get the costing associated with the SR&ED projects. It was apparent that a variety of allocation methods and control systems would have to be used to calculate the labour expenditures associated with the projects.

The controller had access to records of the salary or wages paid to the employees for the year from the payroll service. The controller set up a spreadsheet listing all of the employees along with the salary or wages data received from the payroll service. The controller then proceeded to take a look at each employee to allocate the salary or wages to SR&ED and non-SR&ED work. She also considered what information would be available to serve as a control should a review occur along with information on how to set up a better system in the future. The controller planned to file a claim using the proxy method to calculate the SR&ED tax incentives.

The founders

The controller determined that three of the founders worked on the architecture throughout the year. She explained to these individuals that for salary or wages related to ongoing SR&ED projects claimed in the year, a number of things were considered as directly engaged. These things included:

experimentation and analysis;
support work;
direct supervision of employees performing experimentation and analysis;
technological documentation for internal use;
technological planning and analysis.

The controller asked if any of the three founders did other tasks that consumed more than 10% of their effort in the year. The founders reviewed their calendars, diaries, and notebooks, and concluded that they had not performed non-SR&ED work that consumed more than 10% of their effort in the year. The controller considered these to provide a reasonable control that could serve to cross check for their conclusions during a CRA review. She concluded that these three founders were all or substantially all directly engaged in SR&ED, and therefore 100% of the effort of three of the founders should be included in the SR&ED claim.

A similar approach was used with the fourth founder. After reviewing the founder's diary, the controller noted that the founder had spent two months, 17% (2 / 12) of the time, working alongside the other founders on the architecture or doing SR&ED. After the first two months, the work switched to non-SR&ED business activities such as securing financing. The founder stated that he participated in all the technical strategy meetings providing technical direction and estimated that his total involvement in SR&ED was about 50% of his time. The controller recognized that this was an estimate and may not be acceptable to the CRA.

As a result, the controller tried to identify another approach to quantify the labour allocation. She noted that the technical strategy meetings occurred on Tuesday of every second week and that they typically lasted for three hours. That meant the fourth founder spent 60 hours in the last 10 months (3 hours x 2 (twice a month) x 10 months) involved in SR&ED or about two weeks effort. The controller confirmed the reasonableness of this approach with the founder. This was much lower than the 50% level, but did increase the level to 21% (2.5 / 12 months). Even though there were no time records for these meetings, the controller thought that the methodology was reasonable and claimed on this basis.

As a final step, the controller noted that each of the founders retained enough ownership interest to be specified shareholders and that this fact would need to be considered in any calculation.

Research and development

The R&D group operated in a dedicated environment and only spent their time performing SR&ED work. The controller planned to cost 100% of the salary or wages of each R&D team member to the project, but first planned to discuss her approach with the system architect to make sure the team members were not performing other activities.

The system architect reviewed his monthly summaries and agreed with the approach in general, with two exceptions. In one case, a team member took sick leave for two months and was not available for the project. The controller planned to reduce the percentage to account for the sick leave. In the second case a team member was loaned to the customer care group for three months. Again, the controller planned to reduce the percentage for that team member to account for the non-SR&ED work. Subject to those adjustments, the software architect agreed that the R&D team was directly engaged in the project, and that 100% of the salary or wages should be allocated to the project.

Product engineering

The system architect also pointed out that some of the product engineering team participated in the project. An analysis of the project scheduling and resource allocation tools used by the R&D team showed that in the last seven months each of the product engineers spent about two months helping with the architecture. The product engineering team was employed for only seven months of the year, so the controller planned to allocate 29% (2 / 7 months) of their time to SR&ED projects.

Customer care

It was recognized that the customer care group was developing and collecting the technical requirements that were being incorporated into the architecture. There was plenty of evidence to show that the technical requirements were being developed, collected, and presented to the R&D team. There was no indication of the percentage of time a customer-care agent spent collecting the requirements. To determine that percentage, the controller sat with a customer-care agent and reviewed the work performed by the agent in the last month. It was determined that the agent spent 20% of her time collecting and documenting technical requirements. Based on this analysis, the controller allocated 20% of the time of each customer-care agent to the project as directly engaged salary or wages.

Quality control

The quality control group performed testing and quality control functions on all codes that were written by the company, whether it came from the R&D team or the product engineering team. The controller decided to allocate to SR&ED and non-SR&ED the work of the quality control team based on the same ratio of SR&ED to non-SR&ED work performed by the R&D and product engineering teams.

Documentation

The technical writer working in the documentation group spent all of his time writing documentation for external users that was incorporated into user manuals. The controller did not include this person's work in the claim.

Other groups

The salary or wages of the finance, marketing, and sales people were clearly not directly engaged and were not included in the claim.

As a final measure, the time-sheet tracking system was reviewed to identify any extended vacation, flex days, or sick leave time that should be allocated to non-eligible activities.

Appendix A – References

A.1 Legislative references

List of provisions

*Income Tax Act*	Description
Section 5	Income or loss from an office or employment
Section 6	Taxable benefits
Subsection 6(3)	Payments by employer to employee
Section 7	Stock options
Paragraph 18(1)(e)	Reserves
Subsection 37(1)	Pool of deductible SR&ED expenditures
Subsection 37(1.4)	Salary or wages for SR&ED outside Canada
Subsection 37(1.5)	Salary or wages outside Canada – limit determined
Subsection 37(2)	Research outside Canada
Subsection 37(8)	SR&ED expenditures
Clause 37(8)(a)(ii)(A)	SR&ED expenditures in Canada under the traditional method
Subclause 37(8)(a)(ii)(A)(I)	SR&ED expenditures in Canada under the traditional method – ASA
Subclause 37(8)(a)(ii)(A)(II)	SR&ED expenditures in Canada under the traditional method – directly attributable
Clause 37(8)(a)(ii)(B)	SR&ED expenditures in Canada under the proxy method
Subclause 37(8)(a)(ii)(B)(IV)	SR&ED expenditures in Canada under the proxy method -directly engaged salary or wages
Subsection 37(9)	Remuneration based on profits or bonus for specified employees
Subsection 37(9.1)	Limitation re specified employees
Subsection 37(9.2)	Associated corporations
Subsection 37(9.3)	Agreement among associated corporations
Subsection 37(9.4)	Filing
Subsection 37(9.5)	Deemed corporation
Subsection 37(11)	Filing requirement
Subsection 37(13)	Non-arm's length contract – linked work
Subparagraph 56(1)(a)(ii)	Retiring allowance
Subsection 78(4)	Unpaid remuneration and other amounts
Subsection 143.3(2)	Options – limitation
Paragraph 143.3(3)(a)	Limitation concerning issuance of a share
Paragraph 143.3(3)(b)	Limitation concerning exercise of an option
Subsection 143.3(5)	Clarification
Subsection 248(1)	Definition of "salary or wages"
Subsection 248(1)	Definition of "specified employee"
Subsection 248(1)	Definition of "SR&ED"
Subsection 248(16)	GST – Input tax credit and rebate
Section 251	Arm’s length

List of regulations

*Income Tax Regulations*	Description
Paragraph 2900(2)(b)	Employee remuneration – traditional method
Paragraph 2900(2)(c)	Other expenditures directly related and incremental to the prosecution of SR&ED – traditional method
Subsection 2900(9)	Exclusions to salary base
Paragraph 2900(9)(a)	Exclusions to salary base

A.2 Jurisprudence

List of court cases

Case number	Case name
77 DTC 5438 (S.C.C.)	Harel v. DMR (Que.)

Appendix B – Revisions

B.1 Explanation of changes

The following are the explanation of changes to the SR&ED Salary or Wages Policy as part of the revision of December 18, 2014.

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

Section 5.3 has been revised to delete the words “proposed legislation” as section 143.3 of the Act received royal assent and consequently the reference to Alcatel Canada Inc. v. Her Majesty the Queen (2005 DTC 387) is no longer applicable.

Appendix A.3 “CRA publications” has been removed.

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

Date modified:: 2014-12-18

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SR&ED Salary or Wages Policy

Changes to the SR&ED Salary or Wages Policy

1.0 Purpose

2.0 Overview

2.1 Legislation

2.2 Expenditures incurred

2.2.1 Examples of expenditures not incurred

2.3 SR&ED salary or wages inclusions and exclusions

3.0 Taxable benefits

3.1 Expenditure incurred vs. value of taxable benefits

3.1.1 Example: Automobile and motor vehicle benefits

3.2 GST / HST or PST considerations

3.3 Value of taxable benefits – T4 slips

4.0 Bonuses, remuneration based on profits and other types of remuneration

4.1 Meaning of "remuneration based on profits"

4.2 Meaning of "bonus"

4.3 Inducement payments and non-competition payments to employees

4.4 Expenditure on or in respect of SR&ED

5.0 Amounts that are not salary or wages

5.1 Related benefits

5.2 Expenditures for extended vacation or sick leave

5.2.1 Example

5.3 Stock option benefits – Options granted or shares issued on or after November 17, 2005

5.3.1 Background – Stock option benefits

5.3.2 Treatment of stock option benefits

5.4 Retiring allowances

5.4.1 Accumulated vacation and sick leave credits upon retirement

6.0 Specified employees

6.1 Bonuses or remuneration based on profits for specified employees

6.1.1 Limitation regarding specified employees

6.1.2 Rules for associated corporations

7.0 Salary or wages of employees directly engaged in SR&ED – Proxy method

7.1 Meaning of "directly engaged"

7.1.1 Non-specialized employees who are directly engaged

7.2 Supporting documentation and other evidence

7.3 Calculating the amount of the expenditures

7.3.1 Portion of an expenditure for salary or wages

7.3.2 Only the portion of the salary or wages that can reasonably be considered to relate to SR&ED can be included

7.3.3 Example – Reasonably be considered to relate to SR&ED

7.3.4 All or substantially all

7.3.5 Example – All or substantially all

8.0 Undertakes, supervises, supports – Traditional method

8.1 Meaning of "undertakes, supervises or supports"

8.2 Supporting documentation and other evidence

8.3 Calculating the amount of the expenditures

8.3.1 Portion of an expenditure for salary or wages

8.3.2 Only the portion of the salary or wages that can reasonably be considered to relate to SR&ED can be included

8.3.3 All or substantially all

8.4 Salary or wages under the traditional method and Form T661

9.0 Administrative salary or wages – Traditional method

9.1 "Directly attributable" tests – "Directly related" and "incremental" salary or wages

9.2 Application of the rules

9.3 Clerical and administrative staff providing a service to SR&ED employees

10.0 Salary or wages of employees carrying on SR&ED outside Canada

10.1 Calculation of permissible salary or wages for SR&ED work carried on outside Canada

10.1.1 Example

10.2 Applying the rules

10.2.1 Meaning of "solely in support"

10.2.2 Salary or wages paid were not subject to income or profits tax from another country

10.2.3 Determining amount B – Limit

10.3 How to calculate permissible salary or wages for work carried on outside Canada for Form T661

11.0 Unpaid salary or wages

11.1 Identification of unpaid salary or wages on Form T661

11.2 Evidence of payment

11.2.1 Unpaid amounts vs. reserve

12.0 Other issues related to salary or wages

12.1 Employee vs. self-employed

12.2 Determining the employment status of an individual

12.3 Employees of a related corporation

13.0 Allocation of labour expenditures for SR&ED

13.1 Cost allocation methods

13.2 Research and development environment

13.3 Support for labour allocation

13.3.1 High-level information (corporate or strategic concept level)

13.3.2 Medium-level information (project level)