16 May 1990 Income Tax Severed Letter AC58213 - Scientific Research and Experimental Development in Aquaculture

24(1)                                     J.D. Brooks
                                          (613) 957-2097

19(1)

Dear Sirs:

Re: Scientific Research and Experimental Development ("SR & ED") in Aqua-Culture

We are writing in response to your letter of June 6, 1989 in which you requested our opinions regarding the application of subclause 37(7) (c)(ii) (0) of the Income Tax Act (the "Act") and subsection 2900(2) of the Income Tax Regulations (the "Regulations") to a situation as described below. We apologize for the delay in responding.

Confirmation of the tax consequences of proposed transactions is only provided in response to a request for an advance income tax ruling, as described in our Information Circular 70-6R dated December 18, 1978. Although we are unable to provide any binding confirmation in response to your request, we have stated below some general comments.

Our understanding of the typical situation with which you are concerned is as follows:

A.

B.
                   24(1)
C.
          is approximately 10%.

D.       Although the goal of the taxpayer's project is the
project results in a saleable product,     24(1).  Only a small  
portion of the     24(1)      is required  for further SR & ED. 

You raised the following concerns:

24(1)

Our Comments

As noted in paragraph 18 of Interpretation Bulletin IT-151R3 , paragraph 37(1)(b) of the Act permits the deduction (within the overall limits-of section 37) for capital expenditures that are made in Canada on SR & ED carried on in Canada. While all expenditures on SR & ED might be classed as capital, for the purposes of section 37 only those expenditures that result in the acquisition of tangible assets are referred to as capital expenditures. Paragraph 37(1)(b) refers to those tangible assets which would otherwise be depreciable property.

Paragraph 37(1) (a) provides for the deduction of current expenditures on SR & ED carried on in Canada, where the SR & ED is directly undertaken by the taxpayer and is related to a business of the taxpayer. To be considered as being in respect of SR & ED (carried on in Canada) for purposes of subsection 37(1), an expenditure must be one which is described in either clause 37(7)(c)(ii)(A) or (B) of the Act. Clause (B) refers to expenditures of a current nature that are "directly attributable" to the prosecution of SR & ED, and subsection 2900(2) of the Regulations defines what is meant by the phrase "directly attributable".

It is difficult to make meaningful general comments with respect
to your queries since questions of fact play a significant role. 
For instance, in view of the statements in paragraph D above, an
observer might have difficulty in distinguishing the purported
SR & ED activity from that of a typical commercial operation and it
is noted that, where a new or improved process is used
commercially, paragraph 2900(l)(h) of the Regulations
specifically excludes the activities with respect thereto from
being SR & ED activities.  Perhaps one would reach the conclusion
in a fact situation that the purported SR & ED activities are an
integral part of the commercial activities, with no incremental
costs incurred as a result of performing research.  That being
so, perhaps none of the expenditures would qualify under section
37 of the Act.  If the quantity of     24(1)      far exceeds the
number required to draw reasonable conclusions from the projects,
this would suggest that the projects are of a commercial nature
rather than SR & ED.  On the other hand, where there is SR & ED
activity, the expenditures which qualify as SR & ED expenditures
are generally those incremental expenditures which are incurred
for the purpose of SR & ED.

Where SR & ED results in a saleable product, the costs of producing that product may be considered to be other than SR & ED expenditures.

In that case, as stated in paragraph 15 of our Interpretation Bulletin IT-151R3 ,where the taxpayer applies the income derived from the experimental production to reduce the amount of current SR & ED expenditures, the Department considers the direct production costs to be all or substantially all attributable to the prosecution of SR & ED. With respect to the situation described, it would be appropriate to treat income derived from the sale off 24(1) as an offset to expenditures in the 37(1) pool.

Assuming that the projects you referred to do constitute SR & ED activities rather than activities which are a component of a taxpayer's commercial activities, we have the following comments with respect to the treatment of the specific expenditures to which you referred:

24(1)

3. Where an employee directly undertakes, supervises or supports the SR & ED activities, the portion of that person's salary or wages and related benefits that relate to the projects would generally qualify under paragraph 2900(2)(b) of the Regulations as being directly attributable to the prosecution of SR & ED.

Our comments in this letter represent our general views with respect to the subject matter of your letter. The facts of a particular situation may lead to a different conclusion. Our comments in this letter are not rulings and, in accordance with the guidelines set out in Information Circular 70-6R dated December 18, 1978, are not binding on the Department.

Yours truly,

for Director Business and General Division Specialty Rulings Directorate Legislative and Intergovernmental Affairs Branch