What happens if SR&ED is performed outside Canada?
Globalization of the workforce means that Scientific Research and Experimental Development (SR&ED) work undertaken outside Canada is something that should be considered. There are a number of reasons why a company may need to carry out SR&ED outside Canada. These reasons may include:
- Segments of the research have geographical limitations that require them to be carried out at a specific foreign location;
- The company has contracted another non-Canadian entity to complete certain portions of the SR&ED; or
- The organization has pre-existing facilities abroad that undertake support work for primary SR&ED research performed within Canada.
We will address the topic of SR&ED undertaken outside Canada in three different posts.
In this post, we will address:
- The basic treatment of SR&ED outside Canada under the Income Tax Act; and
- Contract agreements and expenditures for the purchase of rights for work outside of Canada.
Since the application of these laws depends on numerous factors within each individual case, this is a fairly complex topic of discussion. As such, this article is only meant to provide a basic understanding of the subject matter discussed within and does not serve to replace legal advice provided by experts on a case-to-case basis.
SR&ED Outside Canada in the Income Tax Act
Subsection 37 (2) “Research Outside Canada” under the Income Tax Act (ITA) states:
In computing the income of a taxpayer for a taxation year from a business of the taxpayer, there may be deducted expenditures of a current nature made by the taxpayer in the year;
(a) on scientific research and experimental development carried on outside Canada, directly undertaken by or on behalf of the taxpayer, and related to the business (except to the extent that subsection (1.4) deems the expenditures to have been made in Canada); or,
(b) by payments to an approved association, university, college, research institute or other similar institution to be used for scientific research and experimental development carried on outside Canada related to the business provided that the taxpayer is entitled to exploit the results of that scientific research and experimental development.1
Contract Agreements for SR&ED Performed Outside Canada
Section 9.0 of the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy clarifies the application of subsection 37 (2) for us. The Canada Revenue Agency (CRA) states that:
A claimant may enter into a contract with an arm’s length party where all or a portion of the SR&ED will be carried on outside Canada. Where an entire contract relates to SR&ED work carried on outside Canada, no portion of the contract amount is allowed as an SR&ED expenditure.2
However, as stated above in the ITA, current expenditures on SR&ED contracts for work performed outside Canada can be deducted when computing the income of a taxpayer for a particular taxation year.
If a contract involves work conducted both inside and outside Canada, the claimant must allocate the contract amount and specify what was expended between the SR&ED carried on inside and outside Canada.
The method used to allocate the contract amount must be reasonable and may be based on the fair market value of the SR&ED work. Once the allocation is complete, the SR&ED work inside Canada will be allowable as a qualified SR&ED expenditure, and the expenditure on SR&ED performed outside Canada will be deducted as per subsection 37 (2) of the ITA.
Expenditures for Purchase of Rights on SR&ED Performed Outside Canada
As mentioned by the CRA under section 4.0 of the Pool of Deductible SR&ED Expenditures Policy and in the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy, the main aim of the SR&ED tax incentive is to encourage research and development in Canada.3
Incentives are provided to encourage claimants to enter into SR&ED contracts, if required, with Canadians or non-Canadians who have a permanent establishment within the country.4
Granting SR&ED tax credits for work performed outside of Canada would be contrary to the SR&ED program’s aim (encouraging R&D in Canada). Therefore, any expenditures from the purchase of rights for SR&ED work conducted outside Canada are ineligible for the purpose of SR&ED tax credit claims.
In summary, regarding the treatment of SR&ED contracts outside Canada, as discussed under the Income Tax Act and Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy, all expenditures for the purchase of rights on SR&ED performed outside Canada are ineligible for income tax credit purposes.
Any expenditures on contracts for SR&ED work performed outside Canada will not be allowed as qualified expenditures for SR&ED income tax credit calculations; however, they can be directly deducted while computing the income of a claimant for a particular taxation year.
This article is based on CRA policy documents and the Income Tax Act available at the date of publication. Please consult the CRA website and the Justice Laws website for the most recent versions of these documents.
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- Canada – Justice Laws Website. (September 14, 2017.) Income Tax Act (R.S.C., 1985, c. 1 (5th Supp.)). (Accessed: September 28, 2017.) Retrieved from: http://laws-lois.justice.gc.ca/eng/acts/I-3.3/section-37-20140101.html#wb-cont. ↩
- Canada Revenue Agency. (December 18, 2014.) Contracts that include SR&ED work outside Canada. In Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy (Chapter 9). (Accessed: September 28, 2017.) Retrieved from: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/contract-expenditures-performed-on-behalf-a-claimant-policy.html#s9_0. ↩
- Canada Revenue Agency. (December 18, 2014.) No deduction is allowed for an expenditure made to acquire rights in, or arising out of SR&ED. In Pool of Deductible SR&ED Expenditures Policy (Chapter 4.0). (Accessed: September 28, 2017.) Retrieved from: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/pool-deductible-expenditures-policy.html#s4_0. ↩
- Canada Revenue Agency. (December 18, 2014.) Tax policy intent of taxable supplier rules. In Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy (Chapter 9.2). Retrieved from: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/total-qualified-expenditures-investment-tax-credit-purposes-policy.html#s9_2. ↩