Application Policy

NUMBER - SR&ED 2002 - 01
DATE - March 12, 2002
SUBJECT - Expenditures incurred for administrative salaries or wages - "directly related" test

Purpose

The purpose of this Application Policy is to clarify what administrative salaries or wages are "directly related" to the prosecution of SR&ED, under the traditional method of calculating investment tax credits. The comments in this paper apply to all claimants, including dedicated SR&ED performers.

This Application Policy replaces and cancels Application Policy SR&ED 94-02 "Expenditures of Sole-Purpose SR&ED Performers" issued on July 12, 1994.

For comments regarding the treatment of administrative salaries or wages when the proxy method is used, please refer to Application Policy SR&ED 96-06.

What's New

Application policy SR&ED 94-02 stated that corporate costs are generally not allowable SR&ED expenditures, whether or not they are incurred by dedicated SR&ED performers. However, it did not provide further details. The new Application Policy clarifies the deductibility rules for administrative salaries or wages. For example, the paper clarifies that salaries and wages incurred for the financing of the SR&ED and for evaluating, recruiting and hiring SR&ED personnel are expenditures directly related to the prosecution of SR&ED.

Background

There have been cases where dedicated SR&ED performers have claimed, under the traditional method, all or a large portion of, the expenditures incurred for administrative salaries or wages. The expenditures were claimed either as all or substantially all (ASA) attributable to, or directly attributable to, the prosecution of SR&ED in Canada.

Questions have arisen on the deductibility of such expenditures for SR&ED purposes. The Income Tax Rulings Directorate (Rulings) provided an opinion on this issue in March 2001 (2001-006974). This Application Policy clarifies the opinion rendered, as a result of further discussion with Rulings.

Legislation and Interpretation

ASA TEST

It is a question of fact whether a particular expenditure for administrative salaries or wages would be ASA attributable to the prosecution of SR&ED under subclause 37(8)(a)(ii)(A)(I) of the Act.

Paragraph 18 of Interpretation Bulletin IT-151R5 specifies that, to be ASA attributable to the prosecution of SR&ED, 90 % or more of an expenditure of a current nature must be used for SR&ED. For example, 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 devoted to the prosecution of SR&ED".

DIRECTLY ATTRIBUTABLE TESTS

To meet the requirements under paragraph 2900(2)(c) of the Regulations, an expenditure must satisfy two tests:

1. It must be "directly related" to the prosecution of SR&ED (work) and,
    
2. The expenditure would not have been incurred had such prosecution not occurred (incremental).

By virtue of the words "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 words "portion" and "directly related" in paragraph 2900(2)(c) of 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 dictionary definitions of the words "direct", "directly", "relate" and "related", respectively, are:

1. "direct" means proceeding from one point to another without deviation or interruption; straight;
2. "directly" would mean, in a direct manner; without an intervening step or intermediary;
3. "relate" would mean, to show a logical or causal connection between; to have relationship or connection (between two things);
4. "related" (as past tense of "relate") would take the meaning expressed in (c).

The work performed by particular employee(s) or department(s) must connect with (i.e. "related to"), and be done without an intervening step or intermediary between the employee/department (i.e."directly") and,

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

Expenditures for administrative salaries or wages that do not meet the above tests are not expenditures on SR&ED under subsection 37(1).

Policy

The portion of salaries or wages for hands-on work* performed by administrative staff is an expenditure directly attributable to SR&ED by virtue of paragraph 2900(2)(b) of the Regulations. 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.

* Note: Information Circular 86-4R3 (2.10.3) states, "qualified personnel having relevant experience in science, technology, or engineering are responsible for directing or performing the work".

There must be a direct linkage of expenditures for administrative salaries 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 VP 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.

Examples of tasks performed by administrative staff, or work performed in certain departments of a corporation that are directly related to SR&ED work follow, as well as examples of tasks that are generally not directly related to SR&ED work.

TASKS/DEPARTMENTS THAT ARE DIRECTLY RELATED TO SR&ED WORK

• Financing of SR&ED (is "directly related" if the funds are used to perform SR&ED)
• Evaluating, recruiting and hiring of SR&ED personnel
• Technical implementation and control of scientific projects; defining future SR&ED direction; supervision of SR&ED group and SR&ED project selection/evaluation. Such tasks are usually performed by a VP Technology.
• Evaluating the technological feasibility of a product and the potential SR&ED efforts and costs involved
• Technological planning for on-going SR&ED projects (assignment of technological personnel, job priority, development of technological strategies, assessment of quality of materials used)
• Work performed by clerical staff for tasks directly related to payroll, purchasing and accounting.

TASKS/DEPARTMENTS THAT ARE GENERALLY NOT DIRECTLY RELATED TO SR&ED WORK

• Bidding costs
• Purchasing (other than direct purchasing of material/SR&ED equipment)
• Taxation and Legal services
• Sales, marketing and advertising
• Employee relations
• Development of benefits program for SR&ED personnel
• Corporate secretary and reporting to shareholders
• Initiating and closing of licensing agreements
• Feasibility studies (non-technological) leading to potential SR&ED collaborations and assessing the commercial feasibility of a given technology
• Commercialisation of existing intellectual property
• Review and approval of SR&ED budgets
• Patent application

Any concerns or questions regarding this matter should be referred to Mel Machado, Manager, Financial Legislative Application Section.

Original Signed by

Norine Heselton

Director General
SR&ED Directorate