SR&ED Third-Party Payments vs. Contracts (T661 Line 340, 345 and 370)
Updated to Reflect New Policies (2022)Â*** Some of the policies referenced were updated 2021-08-13. This article has been updated and is accurate as of 2022. ***Â |
When applying to the Canada Revenue Agency for Scientific Research & Experimental Development (SR&ED) investment tax credits, the information you provide in each section can ultimately decide its fate in the hands of a discerning CRA agent. Make sure you are on target for a successful application by considering the information provided below.
What is a third-party payment? It’s not a contract and it’s not a partnership. Understanding what a third-party payment is is essential to making sure you don’t slip up on your T661 in Lines 340, 345 and 370. This article explains each line, and how to complete it.
Line 340: Arm’s Length Contracts
Line 340 is where you enter arm’s length contract expenditures. The arm’s length contract expenditures are the payments you or your company make to subcontractors who performed SR&ED work on your behalf. 1
Arm’s length refers to a situation where two parties that deal with each other are not related to each other and no control exists between them.2
For example, if you pay two independent contractors in your tax year to perform SR&ED work on your behalf, and you paid the first contractor $65,000 and the second $20,000, you would enter $85,000 in Line 340.3
Line 345: Non-Arm’s Length Contracts
Line 345 is where you enter the amount paid to non-arm’s length contractors. These contractors will be distinct from the arm’s length contractors mentioned above. When someone performs SR&ED on your behalf and you do not deal with each other at arm’s length, your SR&ED expenditures are deductible but do not qualify for SR&ED investment tax credit (ITC) purposes.4
Non-arm’s length refers to a situation where two related parties that deal with each other and one party exerts control over the other. In other words, the parties are not dealing at arm’s length.5
If you’re concerned that your non-arm’s length contract will render your SR&ED claim ineligible, not to fear – we’ve previously written about how to maintain eligibility despite the contract type.
Line 370: Third-Party Payments
Line 370 is where you will enter the total of all third-party payments for SR&ED that you reported on Form(s) T1263.6
A third party payment is generally a payment made by a claimant to an entity to be used for SR&ED carried on in Canada, that is related to a business of the claimant and the claimant must be entitled to exploit the results of the SR&ED.7
For your expenditure to be deductible, your payment must be for work that relates to your own company with respect to:
- SR&ED work taking place: There must be some research and analysis to advance the existing knowledge base taking place under the supervision of the third party. For example, you cannot simply claim that a donation to a hospital’s general faculty was a third-party payment: while some of the funds donated may be used for SR&ED, some of the funds may be, and probably will be, used for purposes that are not SR&ED.8Â In that case, the payment will not qualify as a third-party payment.
- The relevance of the research performed to your business: The SR&ED work carried out by your third party could be basic research (i.e., research without a specific practical application in mind). This research must be related to a business of the claimant.9 For example, a pharmaceutical corporation might fund basic research in chemistry or biology. The results could have the potential of benefiting the corporation. Therefore this kind of research could be related to its business. However, a corporation in the software business funding basic research in chemistry would probably not be able to use the results of any such research. 10
- Beneficial to your business: The basic research must have a direct and beneficial application in the business that is carried on by the claimant.11 This applies to the example above: if you are a pharmaceutical company, you are likely to benefit from basic research in biology and chemistry and use the results of this work to create new products with your company.
If the work you made an expenditure for does not match the criteria, it does not qualify as a third-party payment and is therefore not deductible.
Contracts vs. Third Party Payments
As mentioned above, it is important to differentiate between a third-party payment and a contract. A contractor performing SR&ED work usually only has one payer, while a third party may have multiple funders. The results of the SR&ED work of a contractor are also exclusive: they belong solely to the claimant who has paid them to perform SR&ED, whereas with a third party the results are publicly published and multiple claimants may benefit from the found results. The SR&ED work of a contractor may be commercially focused, solely for the advancement of a company’s knowledge base, as opposed to a third party who may carry out basic research, the application of which (be it commercial or not) is not known. Â Unlike contracts, which are undertaken directly on your behalf, a third party may be paid for SR&ED not directly undertaken by you or on your behalf.12
This table is from the CRA’s Guide to the T661 and offers some differences between SR&ED contracts and third-party payments.
It is important to note that if you are going to be claiming a Third-Party Payment, you must complete Form T1263, Third-Party Payments for Scientific Research and Experimental Development (SR&ED), for each payment and attach it to Form T661.13
Summary: SR&ED Contract Payments vs. SR&ED Third-Party Payments
Supporting publicly-available basic research can advance your own company’s knowledge base, as well as reaping benefits in other ways (read more about how to benefit from Third Party Payments). However, you still must put in effort when identifying Third-Party Payments: an improperly filled out Line 370Â and T1263 can be difficult to explain should you be marked for an audit. The same goes for Lines 340 and 345: it is useful to familiarize yourself with the definitions presented in this article regarding what is a contractor, the difference between an arm’s length and a non-arm’s length contractor, and how they all differ from a Third-Party Payment.