Assistance and Contract Payments for SR&ED: Key Differences

November 7, 2018 SRED

What are assistance and contract payments, what is the difference between assistance and contract payments, and how do these affect your SR&ED tax credits?

When SR&ED work is completed with the help of outside parties, a contract is essential to determine which company is eligible to claim SR&ED and how it will impact the potential refund.

Disclaimer: Contract law is usually a complicated topic. Since various factors influence its application and enforcement, it normally requires expertise to be applied on a case-by-case basis. This article is meant to provide a basic understanding of the subject matter discussed within, and does not serve to replace legal advice. For more insight, please contact a tax lawyer specializing in SR&ED.

Definition of “Contract Payment”

According to the Assistance and Contract Payments Policy,

A contract payment is:

an amount paid or payable to a claimant by a taxable supplier in respect of the amount for SR&ED:

for, or on behalf of, a person or partnership entitled to a deduction for the amount as a current expenditure or as a third-party payment to a corporation; and

at a time when the claimant and the person or partnership (the taxable supplier) are dealing at arm’s length; or

an amount for an expenditure of a current nature (other than a prescribed amount) payable by a Canadian government, municipality or other Canadian public authority (see section 4.1.1) or by a person exempt from Part I tax under section 149 of the Income Tax Act for SR&ED to be performed for it or on its behalf.

In this context, a prescribed amount is an amount received from the Canadian Commercial Corporation in respect of an amount received by that corporation from a foreign government, foreign municipality or other foreign public authority.¹

Definition of “Assistance”

The Assistance and Contract Payments Policy explains government assistance as being “defined in the Income Tax Act [ITA] as assistance from a government, municipality, or other public authority whether as a grant, subsidy, forgivable loan, deduction from tax, investment allowance, or any other form of assistance other than the federal investment tax credit (ITC).” ²

The policy also describes non-government assistance as being “an amount that can reasonably be considered to have been received as an inducement, reimbursement, contribution, allowance or as assistance for the cost of a property or for an outlay or expense. Non-government assistance may be in the form of a grant, subsidy, forgivable loan, deduction from tax, allowance or any other form of inducement or assistance.” ³

The policy continues to list factors that are used to determine whether a paid amount is considered assistance, including:

The absence of firm terms of repayment on a loan could indicate that the amount received is not a loan, but is assistance. […]

A review of the facts indicates that the repayments are not mandatory and the amount given is to be used for SR&ED. […]

The absence of a business motive on the part of the payer may indicate that the claimant is in receipt of assistance. […]

To the extent that a government is not making an ordinary commercial investment for the contributions that it makes to a claimant, the government would be providing assistance as per the definition of “government assistance”. […] [Emphasis added.] ⁴

Any repayment provisions in an assistance agreement are not strictly enforceable. A contract is a commercial arrangement between two or more parties, subject to legal liabilities and enforceable in the case of default.

A contract arrangement implies authority of the payer over the deliverables and sometimes over the whole work process. Assistance does not generally extend such implications. However, some assistance agreements could include restrictions in respect of such things as how the work is to be done or where a product can be sold. [Emphasis added.] ⁵

Effectively, contract payments are made with authority over how the money is spent and assistance payments are paid with no expectation of authority by the payer (however, the assistance may have been paid under the restriction that the money would be spent on certain things (e.g. a grant from an organization)).

Are Assistance and Contract Payments Eligible for SR&ED?

Assistance Payments

In the case of assistance payments, the Assistance and Contract Payments Policy highlights that “government or non-government assistance reduces SR&ED expenditures on a project-by-project basis.” ⁶ The policy also provides the following example to further explain this:

Example – Reduction of qualified SR&ED expenditures

Corporation A receives $30,000 of assistance for SR&ED in its 2012 tax year. It incurs $50,000 of qualified SR&ED expenditures before any reduction due to assistance. The corporation’s qualified SR&ED expenditures will be reduced by the $30,000 of assistance it received. As a result, Corporation A can only claim an ITC based on the qualified SR&ED expenditures of $20,000 ($50,000 – $30,000).⁷

Therefore, assistance payments are taken into account when claiming SR&ED, however, they themselves are not eligible for SR&ED. If an SR&ED project obtains assistance payments, the amount paid in assistance is deducted from the total amount of SR&ED expenditures.

Contract Payments

Even though a contract may state that a given payment is or is not a contractual payment, this does not automatically equate to an eligible contract payment for the purpose of SR&ED, unless it was specified in the legal agreement. As an example, the Assistance and Contract Payments Policy highlights that the contract should specify that SR&ED was to be carried out by the contractor:

Does the contract state that the contractor was required to perform specific SR&ED work (for example, “The contractor shall design, integrate, test, and verify performance.”)? The question is not whether SR&ED work was carried out, but whether SR&ED was carried out because it was required under the contract.⁸

In the absence of such specification, or if the substance of the contract or the work performed is different from the agreement in the contract, the following criteria should be applied to determine who is eligible to claim SR&ED:

Does the contractor bear financial risk for the project?

Is there a ceiling price beyond which the contractor would not have been paid? […] A ceiling price clause may raise doubts as to whether the contractor had to perform SR&ED on behalf of the payer. If the contractor agreed to absorb extra costs related to the project, this may indicate that the SR&ED was being carried out by, and at the risk of, the contractor and not on behalf of the payer. [Emphasis added.] ⁹

Does the intellectual property for the work belong to the claimant?

If the rights to the intellectual property (IP) of the SR&ED work belong to the contractor, this may indicate that the contractor was not required to perform SR&ED for or on behalf of the payer since the results of the SR&ED remain with the contractor.

The payer may have a conditional right to use the results of the SR&ED. However, the existence of a conditional right suggests that the SR&ED was not performed on behalf of the payer, since the payer is not permitted to use the results of the SR&ED as desired. [Emphasis added.] ¹⁰

Is the contract for services or for “the sale of goods”?

A contract for service may indicate that the SR&ED work was being performed on behalf of the payer. However, a contract for the sale of a good does not necessarily mean that the SR&ED work was not being performed on behalf of the payer.¹¹

What is essential in each of these criteria is that the SR&ED work undertaken by the contractor must have been undertaken on behalf of the claimant. (We discuss “on behalf of” in contract payments in a separate article.)

Conclusion

Assistance and contract payments are established by determining the reason for the payment (e.g. whether the payment has firm terms for repayment, etc.) and whether or not the payment was made for a party to undertake SR&ED work on behalf of the claimant.

While assistance payments received must be deducted from the claimant’s total SR&ED claim, contract payments paid for SR&ED work can be claimed, however, there must be proof that the contract payments were paid for SR&ED work to be undertaken by the contractor on behalf of the claimant.