Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the CRA.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle de l'ARC.
Principal Issues: 1. Does subparagraph 2902(b)(ii) of the Regulations apply to materials for SR&ED (i.e., current expenditures) in respect of the acquisition of used property?
Position: 1. Yes.
Reasons: 1. Plain reading of the legislation.
Ms. Brigitte Gener Income Tax Rulings Directorate
Operational and Technical Support Section Christina Foggia, CPA, CA
SR&ED Directorate 2021-091509
Canada Revenue Agency
October 26, 2022
Re: SR&ED Prescribed Expenditures
Dear Ms. Gener:
This is in reply to your memorandum of October 26, 2021, wherein you requested our views on whether current expenditures in respect of materials for Scientific Research and Experimental Development (“SR&ED”) that are acquired used are “prescribed expenditures” under subparagraph 2902(b)(ii) of the Income Tax Regulations (the “Regulations”).
More specifically, you inquired about whether an expenditure incurred by a particular taxpayer (the “Claimant”) to acquire a previously used XXXXXXXXXX Machine, which, as you stated in your memorandum, constitutes a current expenditure in respect of a material used in the prosecution of SR&ED, meets the conditions in subparagraph 2902(b)(ii) of the Regulations to be considered a “prescribed expenditure”(herein referred to as the “Prescribed Expenditure Used Property Rule”). We understand that the particular Claimant’s SR&ED claim is the subject of an audit by a Tax Service Office (“TSO”) and you are seeking our interpretation of this provision to determine whether the particular expenditure incurred by the Claimant is a prescribed expenditure and thus not a “qualified expenditure”(within the meaning assigned by subsection 127(9) of the Income Tax Act (the “Act”)), that is eligible for an investment tax credit (“ITC”).
Our understanding of the key facts related to the Claimant’s situation is briefly summarized as follows:
- The Claimant developed a XXXXXXXXXX machine and is claiming the work performed to develop this machine as SR&ED. For purposes of this discussion, it is assumed that all work claimed meets the definition of SR&ED in subsection 248(1) of the Act.
- The Claimant purchased a used XXXXXXXXXX Machine which he used as the base and modified each sub-system as part of the SR&ED project.
- The SR&ED Technical Advisor’s Report (the “Report”) (footnote 1) indicates that the materials claimed (includes the XXXXXXXXXX Machine) were transformed in the prosecution of SR&ED (i.e., are materials for SR&ED). Further, the materials claimed are considered to be expenditures of a current nature.
TSO’s Views
The TSO has proposed to reduce the Claimant’s SR&ED qualified expenditure pool by the cost of the XXXXXXXXXX Machine as they assert that it is a “prescribed expenditure” under subparagraph 2902(b)(ii) of the Regulations, due to the fact that it was an expenditure for “the acquisition of property that has been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer”. (footnote 2) As support for its position, the TSO explained that the preamble to subparagraph 2902(b)(ii) of the Regulations refers to “expenditures” and does not specify a particular category of expenditure (i.e., current or capital) to which the Prescribed Expenditure Used Property Rule applies. Further, in the TSO’s view, since the XXXXXXXXXX Machine is both used and meets the definition of “property” in subsection 248(1) of the Act, the conditions for this rule to apply have been met. The TSO also stated that if the rule has no application for used property acquisitions after 2013, then subparagraph 2902(b)(ii) of the Regulations would not be relevant and would have been repealed as part of the legislative amendments enacted in Bill C-45. (footnote 3)
SR&ED Directorate’s Views
As set out in your memorandum, it is your view that expenditures incurred to acquire a used property which constitutes material used in the prosecution of SR&ED and thus a current expenditure, meets the conditions in subparagraph 2902(b)(ii) of the Regulations to be considered a prescribed expenditure. As such, the Claimant’s expenditure in respect of the XXXXXXXXXX Machine should be considered a prescribed expenditure and thus not a qualified expenditure that is eligible for ITC treatment. Your views expressed in your memorandum, as well as arguments raised in support of those views are in agreement with those of the TSO.
Subsection 127(5) of the Act allows a taxpayer to deduct ITCs from Part I tax otherwise payable.
In accordance with paragraph (a.1) of the definition of “investment tax credit” in subsection 127(9), SR&ED ITCs are earned by a taxpayer at a rate of 15% of its SR&ED qualified expenditure pool. Under subsection 127(10.1), an additional ITC of 20% of a taxpayer’s SR&ED qualified expenditure pool is available to a corporation that was a Canadian Controlled Private Corporation (CCPC) throughout the taxation year. (footnote 4)
A taxpayer’s SR&ED qualified expenditure pool is determined in accordance with the formula in subsection 127(9) of the Act and, among others, includes a taxpayer’s qualified expenditures incurred in the tax year. In order for a SR&ED expenditure to be eligible for the ITC, the expenditure must be a “qualified expenditure” as is defined in subsection 127(9). A qualified expenditure includes, among other things, an expenditure described under paragraph 37(1)(a) and excludes, among other things, a “prescribed expenditure” as that term is defined in section 2902 of the Regulations. Therefore, where current expenditures in respect of materials for SR&ED are considered “prescribed expenditures” they will not be eligible for the ITC.
Prescribed Expenditures
Section 2902 of the Regulations defines what a “prescribed expenditure” is for purposes of the definition of “qualified expenditure” in subsection 127(9) of the Act. The relevant portion of the definition of “prescribed expenditure” reads as follows:
“(b) an expenditure incurred by a taxpayer in respect of
(i) ….
(ii) the acquisition of property that has been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer;” [emphasis added]
As a result of certain measures introduced in the 2012 Federal Budget, paragraph 37(1)(b) of the Act, which generally allowed for a current deduction in respect of SR&ED capital expenditures, was repealed, and as a consequence, amendments were made to the wording of section 2902 of the Regulations (including the Prescribed Expenditure Used Property Rule in subparagraph (b)(ii) of this Regulation). These legislative amendments (the “Amendments”) were enacted in the 2012 year as part of Bill C-45 and are applicable to expenditures incurred after 2013.
As part of the Amendments, the preamble to subparagraph 2902(b)(ii) of the Regulations was changed to “an expenditure incurred by a taxpayer in respect of” from “an expenditure of a capital nature incurred by a taxpayer in resect of”. The result of this legislative change was to remove the words “of a capital nature” following the word “expenditure”. Thus, the current language of this paragraph no longer provides for a limitation on the specific category of expenditure that is subject to the Prescribed Expenditure Used Property Rule in subparagraph 2902(b)(ii) of the Regulations. As such, since expenditures of a capital nature are no longer eligible for benefits under the SR&ED program, and the provision is clearly not limited to expenditures of a capital nature, then it follows that the provision must apply in respect of expenditures of a current nature..
Therefore, since the facts in your memorandum provide that the cost in respect of the XXXXXXXXXX Machine is a current expenditure (in respect of a material for SR&ED), it follows that it will be subject to the Prescribed Expenditure Used Property Rule where, as stated in subparagraph 2902(b)(ii) of the Regulations, it is an expenditure in respect of “the acquisition of property that has been used or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer.” The facts in your memorandum also provide that the XXXXXXXXXX Machine was used before it was acquired by the Claimant, therefore, the only point remaining to be confirmed is whether the expenditure was in respect of the acquisition of property.
Meaning of “Property”
Subsection 248(1) of the Act defines “property” to mean:
“ . . . property of any kind whatever whether real or personal, immovable or movable, tangible or intangible, or corporeal or incorporeal and, without restricting the generality of the fore-going, includes
(a) a right of any kind whatever, a share or a chose in action,
(b) unless a contrary intention is evident, money,
(c) a timber resource property,
(d) the work in progress of a business that is a profession, and
(e) the goodwill of a business, as referred to in subsection 13(34);”
The Law Dictionary Featuring Black’s Law Dictionary (2nd Ed) (footnote 5) defines “property” as the “ownership of a thing is the right of one or more persons to possess and use it to the exclusion of others . . .” Note that the statutory definition and ordinary meaning of the word “property” do not make reference to a particular item’s characterization as either current or capital.
Furthermore, there are other instances in the Act where a phrase similar to “acquisition of property” is used and the word “property” in that context includes current expenditures. For example, as you noted, subsection 127(27) of the Act, which contains the ITC recapture rules for corporations and individuals, applies where the condition that “a taxpayer acquired a particular property from a person or partnership in a taxation year of the taxpayer or in any of the 10 preceding taxation years” amongst others, is met. Property in the context of this provision consists of SR&ED materials and more specifically, those materials that are transformed in the prosecution of SR&ED. Moreover, in the inventory valuation provision in subsection 10(1) of the Act, cost for the purpose of this rule is defined as “the cost at which the taxpayer acquired the property”. Thus, inventory which is current in nature is also considered property.
Based on the foregoing discussion, it is our view that property can include expenditures that are current in nature, and as such, the Claimant’s XXXXXXXXXX Machine appears to be “property” according to the ordinary meaning of the term, the statutory definition in subsection 248(1) of the Act, and the use of the word “property” in the other areas of the Act.
Thus, an expenditure incurred to acquire previously used property for purposes of subparagraph 2902(b)(ii) of the Regulations, which constitutes a material used in the prosecution of SR&ED and thus a current expenditure, would in our view meet the conditions in subparagraph 2902(b)(ii) of the Regulations to be considered a prescribed expenditure. Since you indicate in your memorandum that the XXXXXXXXXX Machine is considered a current expenditure for SR&ED purposes that was acquired used, it is our view that subparagraph 2902(b)(ii) of the Regulations would apply and the property would be considered a prescribed expenditure. Accordingly, the expenditure in respect of this property would be ineligible for the ITC.
Conclusion
In our view, an expenditure to purchase the previously used XXXXXXXXXX Machine, which constitutes a material used in the prosecution of SR&ED and thus a current expenditure that is in respect of the acquisition of property that has been used, or acquired for use or lease, for any purpose whatever before it was acquired by the taxpayer, meets the conditions in subparagraph 2902(b)(ii) of the Regulations to be considered a prescribed expenditure. As such, the expenditure will be excluded from being a qualified expenditure as is defined under subsection 127(9) of the Act and will be ineligible for an ITC.
Unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency’s electronic library. After a 90-day waiting period, a severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. You may request an extension of this 90-day period. The severing process removes all content that is not subject to disclosure, including information that could reveal the identity of the taxpayer. The taxpayer may ask for a version that has been severed using the Privacy Act criteria, which does not remove taxpayer identity. You can request this by e-mailing us at: ITRACCESSG@cra-arc.gc.ca. A copy will be sent to you for delivery to the taxpayer.
We trust our comments will be of assistance.
Yours truly
Pamela Burnley, CPA, CA
Manager
Business and Capital Transaction Section
Business and Employment Division
Income Tax Rulings Directorate
Legislative Policy and Regulatory Affairs Branch
FOOTNOTES
Note to reader: Because of our system requirements, the footnotes contained in the original document are shown below instead:
1 The SR&ED Research and Technology Advisor’s Project Eligibility Report and referred to in your memorandum as the RTA Report.
2 Subparagraph 2902(b)(ii) of the Regulations.
3 Section 2902 of the Regulations (which contains the Prescribed Expenditure Used Property Rule in subparagraph (b)(ii)) was amended by the 2012 Budget (enacted by Bill C-45) as a consequence of the repeal of paragraph 37(1)(b) of the Act which previously allowed a current deduction for SR&ED expenditures that were capital in nature. The amendments to this Regulation were applicable in respect of capital expenditures incurred after 2013.
4 These rates are applicable for taxation years ending after 2013. For taxation years ending prior to 2014, the base credit rate available to all claimants was 20%, and the additional credit rate for eligible CCPCs was 15% (so no change in the total credit rate of 35% for eligible CCPCs)
5 https://thelawdictionary.org/property/#:~:text=The%20ownership%20of%20a%20thing,called%20%E2%80%9Cproperty.%E2%80%9D%20Civ.
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