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.
Please note that the following document, although believed to be correct at the time of issue, may not represent the current position of the Department.
Prenez note que ce document, bien qu'exact au moment émis, peut ne pas représenter la position actuelle du ministère.
Principal Issues:
Can payments be broken into their component parts to determine the contract payment amount in 127(11.1)?
Position:
Yes, if the facts clearly indicate there is a SR&ED component and a non-SR&ED component.
Reasons:
Reading of the law.
March 12, 1998
Head Office Head Office
Appeals Branch Partnerships Section
Income Tax Appeals Division Allan Nelson
Lorraine Tremblay, Director (613) 957-9768
Attention: J.E. Nordin
8-973021
XXXXXXXXXX
Computation of the Quantum of Contract Payments
This is in reply to the memorandum of November 12, 1997, from Paul Porter, Income Tax Appeals Division, requesting our comments regarding whether a contract should be broken down into its component parts in determining the amount of the contract payments which will reduce the amount of a taxpayer's investment tax credit.
The supporting documentation attached to Mr. Porter's memorandum goes into depth discussing the varying views of Appeals and Audit concerning the treatment of certain payments made to XXXXXXXXXX in 1991 and 1992. Notwithstanding this, you indicated that our response need not include an analysis of XXXXXXXXXX case, but you request our general position concerning the computation of contract payments for the purposes of paragraph 127(11.1)(c) of the Act for taxation years prior to 1996.
Overview of the Legislation for the Years 1991 to 1995
Subparagraph 127(9)(a)(ii) of the Act defined investment tax credit to mean "...the total of all amounts each of which is the specified percentage of ...(ii) a qualified expenditure made by the taxpayer in the year,...".
The relevant wording in subsection 127(9) of the Act defined qualified expenditure to mean "...an expenditure in respect of scientific research and experimental development made/incurred by a taxpayer...an expenditure described in paragraph 37(1)(a) or subparagraph 37(1)(b)(i), but does not include (a) a prescribed expenditure..."
Section 2902 of the Regulations to the Act defined qualified expenditure for the purposes of subsection 127(9) of the Act, and excluded certain expenditures (such as current general administration expenses) from earning investment tax credit.
Subsection 127(11.1) of the Act stated "For the purposes of the definition "investment tax credit"...(c) the amount of a qualified expenditure...made by a taxpayer shall be deemed to be the amount of the qualified expenditure...less the amount of any...contract payment (that can reasonably be considered to be) in respect of the expenditure...".
For amounts payable before December 21, 1991, subsection 127(9) of the Act defined contract payment to mean "(a) an amount payable by a person resident in Canada for scientific research and experimental development related to the business of that person, (b) an amount...payable by a Canadian government...for scientific research and experimental development to be performed for it or on its behalf, or (c) an amount payable by a person not resident in Canada if that person is entitled to a deduction under clause 37(1)(a)(ii)(D) in respect of the amount".
For amounts payable after December 21, 1991 and before 1996, subsection 127(9) of the Act defined contract payment to mean "(a) an amount payable for scientific research and experimental development to the extent that it can reasonably be considered to have been performed for, or on behalf of, a person entitled to a deduction in respect of the amount because of subparagraph 37(1)(a)(i) or clause 37(1)(a)(ii)(D), or (b) an amount...payable by a Canadian government...for scientific research and experimental development to be performed for it or on its behalf".
In calculating the amount of a taxpayer's investment tax credit, paragraph 127(11.1)(c) of the Act required a reduction in the amount of the taxpayer's qualifying expenditures by the amount of contract payments in respect of those expenditures or that could reasonably be considered to be in respect of those expenditures (depending on the year in question).
Generally speaking, contract payments were defined in subsection 127(9) to mean amounts payable to a performer to do SR&ED related to the payer's business, or to do SR&ED for or on behalf of the payer. Contract payments do not include payments to reimburse a performer for non-SR&ED expenditures.
Therefore, where the facts support that payments made by a person (the "payer") pursuant to the terms of an agreement include
(i) an amount paid to the performer for SR&ED done by the performer and that payment meets the other requirements in the definition of contract payment in subsection 127(9), and
(ii) another amount paid to the performer for non-SR&ED expenditures,
it is our view that the payments must be broken down into their components and only the amounts in (i) above would constitute contract payments for the purposes of 127(11.1).
The following example illustrates that this interpretation will not allow a duplication of investment tax credit claims by the payer and the performer.
PAYER PERFORMER
The contract and facts indicate that
the Payer & Performer negotiated a $100
payment for Performer to do work. This
amount was to compensate the Performer
for $80 of SR&ED expenditures such as
direct wages + $20 of non-SR&ED
expenditures such as overhead).
Performer's actual expenses $95 ($85
SR&ED + $10 overhead).
37(1) SR&ED pool additions $80 $85
Qualified expenditures on which ITC is $80 $5 **
calculated. (Note: Total amount on
which ITC is claimed is $80 by Payer +
$5 by Performer = $85. This amount
equals the Performer's actual SR&ED
expenditures. There is no doubling of
ITC claims.)
Section 9 income inclusion for total $100
received from Payer.
**The recipient adds $85 to its 37(1) pool and can claim ITC on $5 ($85 qualified expenditure minus the $80 contract payment in respect of the $85 direct wages expenditures). Note: As per the contract between the Payer and the Performer, only $80 of the $100 payment from the Payer is payable for SR&ED and is therefore the contract payment. The $20 balance is for non-SR&ED and does not form part of the contract payment.
If, in the above example, the recipient actually spent $70 on direct wages, the Performer's qualified expenditures available on which to claim ITC would be nil (i.e. $70 qualified expenditure minus the $80 contract payment). The Payer would be able to claim ITC on $80.
Alternatively, where the facts in a particular situation do not clearly support the division of payments made by the payer as between compensation for SR&ED done by the performer and non-SR&ED done by the performer, it would be a question of fact as to the amount of the contract payment and as to what portion thereof would be in respect of, or could reasonably be considered in respect of, the performer's qualified expenditures, for the purposes of subsection 127(11.1). If the full amount of the payment is treated as qualified expenditures in the payer's hands, then we believe a good argument could be presented that the full amount of the payment would constitute a contract payment in respect of, or a contract payment reasonably considered in respect of, the performer's qualified expenditures.
During telephone discussions on February 24, 1998 (Nelson/Porter, Income Tax Appeals, and Nelson/Machado, Headquarters Tax Incentive Audit), it was ascertained that Appeals and Audit now agree that if in a contract there is an obvious division between payments to the performer for SR&ED and non-SR&ED, then the contract should be broken down into its component parts and only the SR&ED portion of the payments would be included as the performer's contract payments in the computation of its qualified expenditures, pursuant to subsection 127(11.1) of the Act.
As explained earlier in this memorandum, we concur with this interpretation.
We hope the above comments are of assistance to you.
If you have any further queries on this matter, please contact the writer.
Roy Shultis
Director General
Income Tax Rulings and Interpretations Directorate
Policy and Legislation Branch
c.c. Mel Machado, Tax Incentive Audit
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.../cont’d
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