Application Policy

NUMBER: SR&ED 95-01R
DATE: March 24, 1995
SUBJECT: Linked Activities - Regulations 2900(1)(d)

---

Issues:

1. Whether a taxpayer who performs only support activities on behalf of another taxpayer is considered to be performing SR&ED for the purposes of subsection 37(1).
2. Eligibility of support activities where the SR&ED is performed outside Canada.

Issue 1: Whether a taxpayer who performs only support activities on behalf of another taxpayer is considered to be performing SR&ED.

Background

Subsection 37(1) of the Income Tax Act (the Act) provides, among other things, for the pooling and deduction of expenditures incurred on scientific research and experimental development (SR&ED) carried on in Canada where the SR&ED is either undertaken by a taxpayer or on the taxpayer's behalf. The expressions "SR&ED" and "expenditures on or in respect of SR&ED" are defined in subsection 37(7) and paragraph 37(8)(a) respectively. Subsection 37(7) defines "SR&ED" by reference to the Income Tax Regulations (the Regulations), in particular subsection 2900(1).

Consequently, the activities, and the related expenditures, are relevant for the purposes of subsection 37(1) only to the extent that they otherwise meet other expenditure rules for SR&ED set out in section 37 and the Regulations. If those other conditions are satisfied, the expenditures incurred by the taxpayer, or on the taxpayer's behalf, in undertaking SR&ED in Canada, may be included in the taxpayer's subsection 37(1) SR&ED expenditure pool.

Policy Statement

Subsection 2900(1) of the Regulations defines SR&ED to include work under paragraphs 2900(1)(a), (b), (c) and (d) [(1)(a), (1)b), (1)(c), (1)(d)], but exclude work under paragraphs (e) to (k) [(1)(e) to (1)(k)]. The wording of (1)(d) is:

"work with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research where that work is commensurate with the needs, and directly in support, of the work described in paragraphs (a), (b) or (c)."

Note: At the time of this writing, this version of subsection 2900(1) of the Regulations is still in draft form.

It is quite clear that the categories of work enumerated in (1)(d) (support activities) are SR&ED only if they meet two requirements. The two requirements are that the support activities are commensurate with the needs, and directly in support of (1)(a), (1)(b) or (1)(c) of the taxpayer. If the requirements are not met then it follows that the activities in and of themselves are merely routine activities or standard practices. Thus, if a taxpayer undertakes, or contracts for, activities that are in support of the taxpayer's (1)(a), (1)(b) or (1)(c) SR&ED work carried on in Canada, the taxpayer may claim the related expenditures under Subsection 37(1). However, in the latter situation (contracts) the taxpayer performing the activities in support of anothertaxpayer's SR&ED, may not claim the expenditures under subsection 37(1).

Because of the interaction of subsection 37(1) of the Act and subsection 2900(1) of the Regulations, the Science Advisor (SA) and the Auditor (AU) must recognize that the issue is a joint one, but understand each other's role and responsibility. In the situation when taxpayer A (A), a corporation resident in Canada, performs activities in support of taxpayer B's (B) (1)(a), (1)(b) or (1)(c) work, it is the responsibility of the SA to convey the correct conclusion to the AU. It is the responsibility of the AU to disallow the claim of A. Therefore, it is important that the correct conclusion is stated in the SA's report. The following conclusion, or words to the effect, is suggested:

"The activities claimed by A are directly in support of another taxpayer's SR&ED work. A is not performing SR&ED for the purpose of subsection 37(1)."

An example of the above situation is a Canadian subsidiary performing activities in Canada which are directly in support of the foreign parent's (1)(a), (1)(b) or (1)(c) work that is performed outside Canada. The Canadian subsidiary is not performing SR&ED for itself in Canada and consequently the related expenditures do not qualify for the purpose of subsection 37(1).

Similarly, a taxpayer cannot claim the support activities that are performed in Canada under contract for a foreign company where the activities are directly in support of the foreign company's (1)(a), (1)(b) or (1)(c) work performed outside Canada.

Isuue 2: SR&ED performed outside Canada.

Background

One of the requirements of subsection 37(1) is that the taxpayer who is claiming SR&ED expenditures must be undertaking SR&ED in Canada or have SR&ED performed on its behalf in Canada. Therefore, expenditures for SR&ED performed outside Canada are not deductible under subsection 37(1); they are deductible under subsection 37(2). It is the location of the work which determines whether the expenditures are deductible under subsection 37(1) or 37(2).

As in the support activities issue discussed above, the issue of SR&ED performed outside Canada is a joint science-audit one.

The SA and the AU must inform each other of any relevant information in such a situation.

Policy Statement

In a situation where a Canadian taxpayer undertakes (1)(a), (1)(b) or (1)(c) work will be deductible under subsection 37(1) whereas expenditures related to the support activities will be deductible under subsection 37(2).

The converse of the above situation is when a taxpayer performs the support activities in Canada, but undertakes or contracts for (1)(a), (1)(b) or (1)(c) work outside Canada. This taxpayer cannot be said to be performing activities in support of (1)(a), (1)(b) or (1)(c) work in Canada with respect to the support activities for the purpose of subsection 37(1).

Consequently, expenditures for the support activities are not deductible under subsection 37(1). However, expenditures for the (1)(a), (1)(b) or (1)(c) work are deductible under subsection 37(2).

Original Signed By
J.P. Lavigne
Director, Audit Programs Division

Issued by: Specialized Audit Programs Section and Scientific Research Services Section.