Principal Issues: (1) [TaxInterpretations translation] What is the amount of investment tax credits - generated by SR & ED expenditures - that can be allocated to a partner who is not a specified member of a partnership? (2) What about refundable ITCs?
Position: (1) The reasonable portion of ITCs that may be allocated to a partner who is not a specified member of the partnership must be determined in light of the investments in the partnership, including that represented by debt obligations of each of the members of the partnership who were not specified members. (2) We are generally of the view that the ITCs of a partnership that are reallocated by subsections 127(8.3) and (8.31) to partners who are not specified members may qualify for the refundable ITC provided in section 127.1.
Reasons: The Income Tax Act.
XXXXXXXXXX 2010-035746
July 6, 2011
Dear Sir,
Subject: SR & ED Investment Tax Credit
This is in response to your email of February 15, 2010 in which you requested our comments on the scope of the amendments, applicable to the 2007 and subsequent taxation years, made to subsections 127(8.3) and (8.31) of the Income Tax Act (the “Act") dealing with investment tax credits ("ITCs") generated by scientific research and experimental development ("SR & ED") expenditures allocated to a partner other than a specified member of a partnership.
You also asked us to show by way of example the application of those provisions to a partnership where the member, who is not a specified member, is a Canadian-controlled private corporation (a "CCPC"), or where the specified member is a corporation other than a CCPC.
Unless otherwise indicated, all statutory references herein are to the provisions of the Act.
Our Comments
The new wording and division of subsection 127(8.3) into two subsections - (8.3) and (8.31) - apply for taxation years ending in 2007. The new provisions read as follows:
(8.3) For the purpose of subsection (8), and subject to subsection (8.4), if a taxpayer is a member of a partnership (other than a specified member) throughout a fiscal period of the partnership, there shall be added to the amount that can reasonably be considered to be that member’s share of the amount determined under subsection (8) the amount, if any, that is such portion of the amount determined under subsection (8.31) in respect of that fiscal period as is reasonable in the circumstances (having regard to the investment in the partnership, including debt obligations of the partnership, of each of those members of the partnership who was a member of the partnership throughout the fiscal period of the partnership and who was not a specified member of the partnership during the fiscal period of the partnership).
(8.31) For the purpose of subsection (8.3), the amount determined under this subsection in respect of a fiscal period of a partnership is the amount, if any, by which
(a) the total of all amounts each of which is an amount that would, if the partnership were a person and its fiscal period were its taxation year, be determined in respect of the partnership under paragraph (a), (a.1), (a.4), (a.5), (b) or (e.1) of the definition investment tax credit in subsection (9) for a taxation year that is the fiscal period,
exceeds
(b) the total of
(i) the total of all amounts each of which is the amount determined under subsection (8) in respect of the fiscal period to be the share of the total determined under paragraph (a) of a partner of the partnership (other than a member of the partnership who was at any time in the fiscal period of the partnership a specified member of the partnership), and
(ii) the total of all amounts each of which is the amount determined under subsection (8), with reference to subsection (8.1), in respect of the fiscal period to be the share of the total determined under paragraph (a) of a partner of the partnership who was at any time in the fiscal period of the partnership a specified member of the partnership.
(iii) [Repealed…] (Footnote p. 3)
In reading subsection 127(8.3), the Canada Revenue Agency ("CRA") is of the view that the reasonable portion of ITCs that may be allocated to a partner who is not a specified member of a partnership must be determined in light of the investment in the partnership, including that represented by debt securities, of each of the partners in the partnership who were not specified members. That way of proceeding has the effect that no ITC is lost.
In our view, that approach is not only consistent with the wording of the legislative provisions in issue but accurately reflects the intention of the legislature, as evidenced by the Explanatory Notes issued by the Department of Finance at the time of the tabling of the bill amending subsection 127(8.3) and introducing subsection 127(8.31).
However, since only a reasonable portion of ITCs determined under subsection 127(8.31) can be allocated to a partner who is not a specified member, the CRA reserves the right to invoke another provision of the Act in order to dispute the amount of ITCs that are allocated to a partner who is not a specified member for purposes of subsection 127(8.3).
Furthermore, we are generally of the view that partnership ITCs that are reallocated by subsections 127(8.3) and (8.31) to partners who are not specified members may be eligible for an amount of refundable ITCs under section 127.1.
ITCs reallocated to a partner who is not a specified member under subsections 127(8.3) and (8.31) are also allocated for the purposes of subsection 127(8). Paragraph (b) of the definition of "investment tax credit" in subsection 127(9) provides that a taxpayer's ITCs include the amounts to be added under subsection 127(8). Finally, under subparagraph (d)(ii) of the definition of "refundable investment tax credit" in subsection 127.1(2), ITCs allocated to a taxpayer under paragraph (b) of the definition "investment tax credit" in subsection 127(9) during the year is included in the calculation of refundable ITCs. Thus, a member other than a specified member may be entitled to refundable ITCs for ITCs that have been reallocated to the member by virtue of subsection 127(8.3). We believe that that "advantage" could mostly take place in the context of associated corporations.
We note that a qualifying corporation is defined in subsection 127.1(2) as a Canadian-controlled private corporation ("CCPC") the taxable income of which for its immediately preceding taxation year does not exceed its business limit for the year. For 2010, the maximum business limit for a qualifying corporation is $500,000. Where a qualifying corporation is associated with another corporation in the particular year, its taxable income for its last taxation year ending in the preceding calendar year and the taxable income of the corporations with which it is associated in the particular taxation year for their taxation years each ending in such preceding calendar year shall not exceed the qualifying corporation's business limit.
Example
To illustrate the effect of the above provisions, we offer you the following example:
• A partnership consists of two partners: the first is a partner other than a specified member, which is a CCPC, and makes a contribution of $1,000 to the partnership. The second is a specified member which is a corporation that is not a CCPC and which contributes $999,000 to the partnership. They share the profits in proportion to their contributions. No loans are made by the partnership.
• The two partners are associated corporations as defined in subsection 256(1).
• The partnership therefore has $1,000,000 available to it, which it uses in full to make eligible SR & ED expenditures. These expenses are eligible for an ITC of 20%, or $200,000.
• The total taxable income of the member who is not a specified member and the taxable income of the specified member exceeds the business limit of the partner who is not a specified member.
Subsection 127(8) allows ITCs to be allocated to the members of a partnership in accordance with what it is reasonable to consider as each partner's share thereof at the end of the partnership's taxation year. The CRA generally considers that an ITC allocation is reasonable if it corresponds to the proportions in which the partners have agreed to share the partnership's profits. Paragraph 127(8)(b) does not permit the allocation of ITCs for eligible SR & ED expenditures to a partner who is a specified member, which is the case for the specified member.
Thus, subsection 127(8) first allocates $200 of ITCs to the partner who is not a specified member, whereas the amount of $199,800, which would accrue to the specified member, cannot be allocated under paragraph 127(8)(b).
Current legislation allows a partner, who is not a specified member for the purposes of subsection 127(8), to add under subsection 127(8.3) and (8.31) to the previously determined $200 ITC, all ITCs that were previously unallocated under subsection 127(8), or $199,800 for a total ITC of $200,000. That result is explained by the fact that in determining the amount of ITCs that it is reasonable to allocate it is only necessary to consider the investment of partners who are not specified members. Since in this example there is only one, it can be assigned all of the unallocated ITCs.
Furthermore, only a qualifying corporation may claim an amount as refundable ITCs in respect of ITCs that would have been allocated to it under subsection 127(8.3). Based on the facts of the example above, since the total of the taxable income of the partner who is not a specified member and the taxable income of the specified member exceeds the business limit of the partner who is not a specified member, the partner who is not a specified member is not a qualifying corporation as defined in subsection 127.1(2). That partner would therefore not be entitled to the refundable ITCs provided for in section 127.1 in respect of the amounts that would have been allocated to it under subsection 127(8.3).
Access to Information
For your information, unless exempted, a copy of this memorandum will be severed using the Access to Information Act criteria and placed in the Canada Revenue Agency's electronic library. A severed copy will also be distributed to the commercial tax publishers for inclusion in their databases. The severing process will remove all material that is not subject to disclosure, including information that could disclose the identity of the taxpayer. Should the taxpayer request a copy of this memorandum, they may request a severed copy using the Privacy Act criteria, which does not remove taxpayer identity. Requests for this latter version should be made by you to Ms. Celine Charbonneau at (613) 957-2137. In such cases, a copy will be sent to you for delivery to the taxpayer.
Best regards,
François Bordeleau, LL.B.
Manager
Business and Partnerships Section
Business and Partnerships Division
Income Tax Rulings Directorate
FOOTNOTES
Due to our system requirements, footnotes contained in the original document are reproduced below:
1 The amendment to allow the allocation of unallocated ITCs resulting from apprenticeship expenditures applies to taxation years ending after May 1, 2006.
2 Paragraph 127(8.31)(a) was amended by the second Budget Implementation Act, 2007 to add the reference to paragraph (a.5) (child care space amount) which applies as of March 19, 2007.
3 Subparagraph 127(8.31)(b)(iii) was repealed by the second Budget Implementation Act, 2007, retroactive to the time of its implementation.