SR&ED Salary or Wages Policy (Draft) CRA s SR&ED Policy Review Process KPMG Submission

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1 SR&ED Salary or Wages Policy (Draft) CRA s SR&ED Policy Review Process KPMG Submission 30 April 2011

2 Contents Introduction 1 Review of SR&ED Salary or Wages Policy (Draft) Paper 2 1. Is the language easy to understand? 2 2. Is the information well organized? 7 3. Are there any gaps or omissions in the information? 7 4. Is there any information that is not necessary? What are the best features of the document? Do you have any other comments or suggestions to improve the document? 14 Appendix 15 CRA Policy Document: SR&ED Salary or Wages Policy - Draft 15

3 Introduction As part of the CRA s SR&ED Policy Review Project, stakeholders were asked to comment on the CRA s SR&ED Salary or Wages Policy (Draft) Paper. KPMG Canada LLP s (KPMG) response to this draft policy paper outlines the firm s views and recommendations for this part of the SR&ED Policy Review Project. Our comments are not exhaustive we have highlighted selected areas of the draft paper that we believe may benefit the most from being revised. This document specifically addresses the SR&ED Salary or Wages Policy (Draft) Paper and is organized to address the six questions that the CRA has outlined in its process document, namely: 1. Is the language easy to understand? 2. Is the information well organized? 3. Are there any gaps or omissions in the information? 4. Is there any information that is not necessary? 5. What are the best features of the document? 6. Do you have any other comments or suggestions to improve the document? For ease of reference, the CRA s draft policy paper is reproduced in the appendix. We support the CRA s initiative and welcome the opportunity to participate in the consultations. Submitted on behalf of KPMG in Canada by: Carlo Ciaramitaro, CA Partner - Tax Canadian and Americas Practice Leader R&D Tax Incentives Practice T E David Regan, CA Partner - Tax T E Carl Deslongchamps, CA Partner - Tax T E Ed Zacharuk, CA Partner - Tax Western Canada SR&ED Practice Leader T E Gregory Brennan, CA Partner - Tax T E David Durst, MBA, CMA Associate Partner - Tax T E 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 1

4 Review of SR&ED Salary or Wages Policy (Draft) Paper 1. Is the language easy to understand? KPMG s overall impression of the document is that the language used is reasonably easy to understand and is a good source of information. We did, however, note that in several situations the language could be viewed as somewhat vague and thus taxpayers could misinterpret it. Our comments address the following sections of the document. Section 4.2 Meaning of bonuses Unenforceable "Bonus" refers to a payment that is not earned Enforceable "Bonus" also refers to an amount paid (premium) The paragraph and sentence structure in this section may lead to confusion. As such, KPMG suggests the following revision: Unenforceable Bonuses An unenforceable "Bonus" refers to a payment that is not earned Enforceable Bonuses An enforceable "Bonus" also refers to an amount paid (premium) Section Employees who are directly engaged In addition, employees are considered to be directly engaged in SR&ED when they are performing technical support work such as engineering, design, operations research, mathematical analysis, computer programming, (non-routine) data collection, testing or psychological research commensurate with the needs and directly in support of the basic or applied research or experimental development work. [emphasis added] This paragraph appears to be inconsistent with the current definition of Scientific research and experimental development found in subsection 248(1) of the Income Tax Act (Canada) ( ITA ). To make this paragraph more consistent with the definition in the ITA, we suggest removing the word non-routine, which we ve underlined above. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 2

5 Section 7.2 Supporting documentation and other evidence Proxy Method A claimant should be able to show that the salary or wages are for SR&ED work performed by employees of the company on activities that are considered to be directly engaged in SR&ED. When applying the expenditure allocation in a claim under the proxy method, the information system used by a claimant must capture directly engaged time. Other labour costs are covered by the prescribed proxy amount. KPMG submits that this paragraph seems to establish an expectation of claimants information systems that seems to be contrary to CRA s previous positions that taxpayers can rely on documentation normally generated from systems presently used to run their operations and are not required to implement new systems solely for SR&ED purposes. Such information systems tend to track business costs rather than directly engaged employee time. As a result, many claimants normally generated information would need to be reviewed and filtered to arrive at SR&ED eligible expenditures. As such, KPMG suggests revising this paragraph along the following lines: A claimant should be able to show that the salary or wages are for SR&ED work performed by employees of the company on activities that are considered to be directly engaged in SR&ED. When applying the expenditure allocation in a claim under the proxy method, the information system, along with other systems and forms of contemporaneous documentation used by a claimant, may be used to illustrate directly engaged time. Other labour costs would be covered by the prescribed proxy amount. Section 8.1 Meaning of undertakes, supervises or supports The third paragraph of this section reads as follows: Supervision for purposes of the directly attributable rules does not include the performance of managerial functions that relate to general administration. However, supervision could include some non-technological functions, e.g. long-term strategic planning, contract administration, etc., that directly relate to the prosecution of SR&ED. These functions would generally be performed in carrying out the other related duties of a technological supervisor of SR&ED (see section 9.0 Administrative salary or wages under the traditional method). KPMG submits that the specific roles within an organization that are outlined in this paragraph may not apply to all situations and could be misinterpreted. KPMG suggests removing the last sentence because the description technological supervisor may not be appropriate or may not exist in certain corporations. Section 8.1 Meaning of undertakes, supervises or supports The last paragraph in this section reads as follows: 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 3

6 Support work does not include the performance of clerical duties involved in carrying out SR&ED. Note that this is consistent with the position taken in paragraph 32 of IT-145R (Consolidated), Canadian Manufacturing and Processing Profits Reduced Rate of Corporate Tax, concerning clerical staff. Salary or wages relating to clerical or administrative support staff, could be included as SR&ED overhead expenditures (see section 9.5 Clerical and administrative staff providing a service to SR&ED employees). KPMG submits that that last sentence could be reworded to clarify how to deal with these types of expenditures. The draft version above may confuse a reader who may not know the difference between the terms support work and support salaries. To help clarify, we suggest a revision to the last sentence such as the following: Salary and wages relating to clerical or administrative support staff should be included as SR&ED overhead expenditures when directly related to SR&ED work. Section 8.2 Supporting documentation and other evidence Traditional Method A sentence in the middle of the second paragraph of this section reads as follows: When applying the expenditure allocation in a claim under the traditional method, the information system used by a claimant must capture directly engaged time, as well as directly related and incremental time. KPMG submits that this paragraph seems to establish an expectation of claimants information systems that seems to be contrary to CRA s previous positions that taxpayers can rely on documentation normally generated from systems presently used to run their operations and are not required to implement new systems solely for SR&ED purposes. Such information systems tend to track business costs rather than directly engaged employee time. As a result, many claimants normally generated information would need to be reviewed and filtered to arrive at SR&ED eligible expenditures. As such, KPMG suggests revising this paragraph along the following lines: When applying the expenditure allocation in a claim under the traditional method, the information system, along with other systems and forms of contemporaneous documentation used by a claimant, must capture directly engaged time, as well as directly related and incremental time. Section 9.2 Application of the rules The portion of salary or wages for hands-on work performed by administrative staff is an expenditure directly attributable to SR&ED and could qualify as salary or wages of an employee who directly undertakes, supervises or supports the prosecution of SR&ED. However, work performed by administrative staff with no technological background generally does not qualify as hands-on work. In this case, an analysis of the duties performed is required to determine the direct linkage to SR&ED work. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 4

7 KPMG submits that the last sentence could be expanded as follows to clarify how these expenditures qualify: In this case, an analysis of the duties performed is required to determine the direct linkage to SR&ED work and include the expenditures as an SR&ED overhead expense or other expenditures. Section 9.3 Examples of tasks directly related to the prosecution of SR&ED KPMG submits that the examples of tasks directly related to the prosecution of SR&ED in section 9.3 should include clerical and administrative tasks as per section 9.5. We suggest that the CRA could include in the list the examples provided in section 9.5 of clerical and administrative staff providing a service to SR&ED employees that is in support of SR&ED related activities. Section 9.3 Examples of tasks directly related to the prosecution of SR&ED Tasks/departments that are generally not directly related to SR&ED work: Bidding costs Purchasing (other than direct purchasing of material/sr&ed equipment) KPMG suggests expanding the purchasing exclusion to include those individuals responsible for the contracts with suppliers or R&D subcontractors. As such, we suggest revising the second bullet above as follows: Purchasing (other than direct purchasing of material/sr&ed equipment or subcontracts) Section 9.4 Incremental test Further, an expenditure for administrative salary or wages must also meet the incremental test (would not have been incurred had it not been for the prosecution of SR&ED) to be deductible as SR&ED expenditure. The claimant must demonstrate that the expenditure is incremental: if the SR&ED work were not carried out, would the expense still have been incurred? If yes, the expense would not meet the test and would therefore not be allowable as SR&ED expenditure. KPMG believes that the omission of the words or a portion thereof when referring to expenses in this paragraph could lead to confusion and inconsistency with other sections. As such, we suggest the CRA consider revising this paragraph by adding the underlined words: Further, an expenditure for administrative salary or wages must also meet the incremental test (would not have been incurred had it not been for the prosecution of SR&ED) to be deductible as SR&ED expenditure. The claimant must demonstrate that the expenditure, or a portion thereof, is incremental: if the SR&ED work were not carried out, would the expense, 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 5

8 or a portion thereof, still have been incurred? If yes, the expense would not meet the test and would therefore not be allowable as SR&ED expenditure. Section 13.3 Support for labour allocation The labour allocation must be supported by evidence that: the allocation method is appropriate in the company's environment the allocation method is consistent with the legislation and the administrative practices of the CRA the allocation system is functional throughout the year KPMG submits that the wording in this section seems to indicate that one singular allocation system must be in place throughout the year. This is often not the case for first-time claimants or for taxpayers who may implement systems that are suited for a particular department or group, which may differ from a system that might be required of another group that captures information that is relevant for their business. Systems may also not be used at all times in environments where SR&ED is not predominate. We suggest the CRA consider revising the third bullet in this list along the following lines: Where applicable, the allocation system is functional throughout the periods of SR&ED activities taking place Section 13.6 When is a labour allocation method reasonable? The second sentence of the second paragraph in this section reads as follows: The CRA will advise a claimant either orally or in writing if there is a need for additional supporting information relating to a claim for SR&ED labour expenditures. If in writing, the letter will explain that proper supporting information will have to be kept for claim periods starting after the date of the letter. KPMG submits that this statement implies that the CRA will not discuss its suggestions prior to issuing a letter. Ideally, KPMG believes that the onus should be on the CRA to explain and detail why current systems were insufficient to show how the SR&ED expenditures were segregated from other expenditures that may be tracked for business purposes but do not qualify. A system may not always provide detailed low level (activity level) tracking as exhibited in the case study in this paper. As such, KPMG suggests the CRA consider revising this paragraph along the following lines: The CRA will advise a claimant either orally or in writing if there is a need for additional supporting information relating to a claim for SR&ED labour expenditures. The CRA will also work with the claimant to come up with a system that provides the information required by the CRA to support an SR&ED claim but does not require the taxpayer to track more information than would be required for that business. If in writing, and if agreed upon in collaboration with the taxpayer, the letter will explain that proper supporting information will have to be kept for claim periods starting after the date of the letter. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 6

9 2. Is the information well organized? Our overall impression of the document is that the information is well organized and useful. We did, however, note that the information on traditional and proxy method-related subjects could be better organized. Specifically, it is sometimes unclear which policy topic relates to which costing method. KPMG suggests having a separate section for each of the traditional and proxy methods. For example, section 7 could be placed under the Proxy Method heading and sections 8 and 9 could be placed under the Traditional Method heading. 3. Are there any gaps or omissions in the information? KPMG noted several places in the document where adding examples or data could help to state policy more clearly and make it easier for taxpayers to understand. Our comments address the following sections of the document. Section 2.3 Table outlining SR&ED salary or wages inclusions and exclusions Included in SR&ED salary or wages Salary or wages (section 2.0) KPMG believes that this table presents an opportunity to clearly outline the expenditures made for a benefit that would be taxable to the employee and generally included within the definition of salary or wages. As such, we suggest adding the following information: Included in SR&ED salary or wages Salary or wages (section 2.0) (including vacation pay, statutory holiday pay, sick leave pay, pay in lieu of termination notice, bonuses, tips and gratuities, honorariums, director s fees, management fees and commissions.) Section 3.0 Taxable benefits The second paragraph in this section states: As stated in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, salary or wages could relate to gross wages reported on a T4 slip for the calendar year if the tax year ends at the calendar year-end. KPMG believes that this statement presents an opportunity to provide a practical example of how a taxpayer would analyse the information reported on a T4 supplementary slip in order to calculate SR&ED salary and wage expenditures. KPMG suggests the statement be revised to provide a numeric example which extracts amounts reported in box 14 of the T4 supplementary slip and then apply an appropriate 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 7

10 SR&ED allocation, based on a fact pattern or case study that details the allocation, in order to calculate SR&ED salary and wage expenditures. Section Amounts that are not salary or wages Example Facts Employee X (a non-specified employee) receives salary of $10,000 per month. He earns 1 month of vacation and 1 month of sick leave each year. KPMG believes that examples throughout the document are an excellent method to illustrate and apply the information within the relevant section. However, the examples could be more detailed to help clarify any ambiguity or what if scenarios. As such, KPMG suggests adding to the example above as follows: Example Facts Employee X (a non-specified employee) receives salary of $10,000 per month. He earns 1 month of vacation and 1 month of sick leave each year. Earned vacation and sick leave are inherently accrued while working, along with the expenditure being incurred by the company at that same time. Section Portion of an expenditure for salary or wages The directly engaged salary or wages or portion thereof is calculated on the time spent directly engaged in SR&ED relative to the total time worked. For example, if a salaried employee earning $100,000 per year spends all of their 1,800 regular hours directly engaged in SR&ED KPMG believes that ambiguity surrounding the calculation of employee s time spent directly engaged in SR&ED, and in particular what constitutes regular hours, may lead to varying interpretations and results. The CRA may want to consider providing an example that illustrates how regular hours are determined as there appears to be some inconsistency in applying these rules. KPMG suggests adding an example such as the following: The directly engaged salary or wages or portion thereof is calculated on the time spent directly engaged in SR&ED relative to the total time worked. For example, if a salaried employee earning $100,000 per year spends all of his or her 1,800 regular hours (which is net of statutory holidays and vacation, specifically 52 weeks 40 hours per week = 2,080 hours, less 80 hours statutory holidays, less 200 hours vacation = 1,800 regular hours) directly engaged in Section Example Reasonably be considered to relate to SR&ED An employee who is directly engaged in the prosecution of SR&ED 60% of the time receives a regular salary of $100,000 and a commission of $15,000 on the sale of a product. The amount for the commission is not an 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 8

11 expenditure on SR&ED as it not directly linked to the SR&ED work being performed. KPMG is concerned that ambiguity surrounding the details of how the prosecution of SR&ED 60% of the time is calculated could lead to varying interpretations and results. KPMG suggests adding an example such as the following: An employee who is directly engaged in the prosecution of SR&ED 60% of the time, for example a total of 1,080 hours out of 1,800 regular hours (which is net of statutory holidays and vacation, specifically 52 weeks 40 hours per week = 2,080 hours, less 80 hours statutory holidays, less 200 hours vacation = 1,800 regular hours) receives a regular salary of $100,000 and a commission of $15,000 on the sale of a product. The amount for the commission is not an expenditure on SR&ED as it not directly linked to the SR&ED work being performed. Section All or substantially all When the portion of the expenditure represents all or substantially all (90% or more) of the time spent by the employee on SR&ED work, all of the expenditure is deemed to be on SR&ED. KPMG is concerned that ambiguity surrounding the details of how 90% is calculated could lead to varying interpretations and results. KPMG suggests the following revision: When the portion of the expenditure represents all or substantially all, commonly referred to as 90% or more, of the time spent by the employee on SR&ED work, all of the expenditure is deemed to be on SR&ED. For example, a total of 1,620 hours out of 1,800 regular hours has been spent on SR&ED, where 1,800 regular hours are net of statutory holidays and vacation. Specifically calculated as follows, 52 weeks x 40 hours per week = 2,080 hours, less 80 hours statutory, less 200 hours vacation = 1,800 regular hours. Section 12.2 Employees of a related corporation Legislative Reference Income Tax Act Subsection 37(13) Non-arm's length contract Linked work This legislative reference appears to be missing a citation to subsection 37(1.1), as follows: Subsection 37(1.1) Business of related corporations Section 13.7 Example of an allocation method The example provided is a very practical approach to preparing an SR&ED filing using an allocation method. In order to enhance the example, KPMG suggests providing more details and calculating actual amounts as they would be reported on the T661. In particular, specific details regarding expenditures incurred, T4 amounts, percentages translated to hours, application of percentages to expenditures incurred, etc., would help clarify the example. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 9

12 4. Is there any information that is not necessary? KPMG submits that several sections of the policy paper under the proxy method seem to define directly engaged in a more restrictive way than previous documents. These sections detail which hands-on work different roles can perform and also provide what could be interpreted as a restrictive list of tasks for each role (Paragraph 7.1). This approach seems to differ from the prior policy document AP96-06 which states, Whether an employee is directly engaged in SR&ED is a question of fact based on the duties performed and not on the job title. As such, the information in the policy paper seems less like a consolidation of previous papers and more like a policy change. If this consolidation is not meant to be a policy change, then it seems that the explanation of directly engaged in the policy paper could be misinterpreted by RTA and taxpayers. For example, many businesses may have managers/supervisors who, by the nature of their role and activity, have very few or no administrative tasks and therefore could be ASA directly engaged in SR&ED. As presented, the policy paper seems to imply that managers won t be able to do paragraph 248(1)(d) activities and could further be interpreted to indicate that taxpayers can not claim managers as directly supporting the SR&ED activities in this capacity. KPMG submits that the CRA may want to consider simply stating what directly engaged means and then perhaps give several examples that include situations where employees at various levels of an organization become directly engaged in SR&ED, including managers, employees and non-specialized employees. Our comments address the following sections of the document. Section 7.1 Meaning of directly engaged Generally, the CRA considers the time employees, including first-line supervisors and managers (see section 7.1.3), spend to perform the following tasks as time they are directly engaged in SR&ED: preparing equipment and materials for experiments, tests, and analyses (this does not include time spent maintaining equipment); experimenting, testing, and analyzing; collecting data for experimentation and analysis; and directing the course of the ongoing SR&ED work being claimed in the year. The CRA considers time spent performing the following tasks to be time during which employees are directly engaged in SR&ED (to the extent that the tasks are required as part of an SR&ED project): recording measurements, making calculations, and preparing charts and graphs; conducting statistical surveys and interviews; preparing computer programs; and working in engineering or design, operations research, mathematical analysis, computer programming, data collection, testing, or 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 10

13 psychological research that is commensurate with the needs and directly in support of eligible SR&ED work. The claimant should view its employees' tasks in terms of how they correlate to the primary reason for employment when determining whether the employee's salary or wages are directly engaged in SR&ED. [emphasis added] KPMG submits that the current structure in this section that provides distinct roles for supervisors/managers and employees and associated tasks for each role could be misinterpreted to mean that eligibility is determined by role, contrary to the rules in the ITA, which indicate that anything directly engaged is eligible. Specifically, KPMG recommends that last sentence underlined above be removed from the policy because it appears to conflict with AP96-06, which says, Whether an employee is directly engaged in SR&ED is a question of fact based on the duties performed and not on the job title. Further, KPMG suggests removing the first sentence of the second paragraph underlined above as well and combining the eight bullet points. Section Non-specialized employees who are directly engaged Tasks performed by non-specialized employees are generally not considered to be "directly engaged" in SR&ED. For example, any work related to equipment maintenance or repairs, materials-handling, and clerical and administrative support activities does not qualify under the proxy method (Refer to the Traditional and Proxy Methods Policy. This document is currently under development and a link will be provided once the project is complete.). KPMG recommends that the CRA consider removing this paragraph from the policy. We are concerned that taxpayers and RTAs could misinterpret this paragraph to mean that these tasks are always ineligible. This is not the case any task within an organization which can be shown to be directly engaged and commensurate is eligible under the ITA. Section Managers and supervisors who are directly engaged Managers and supervisors are also considered to be directly engaged in SR&ED when they are performing experimentation and analysis in the performance of basic research, applied research or experimental development and when they are carrying out technical activities in support of the research or development work. In addition, managers and supervisors who supervise the ongoing SR&ED work are also considered to be directly engaged in SR&ED when they are directing the course of the ongoing SR&ED work or when they are providing direct technical input into the SR&ED work. However, any time spent by a 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 11

14 manager or supervisor performing non-technological management activities or decision-making functions that do not directly influence the course of the SR&ED, even if it relates to the SR&ED, is not considered to be time the manager or supervisor is directly engaged in SR&ED. In most cases, work performed beyond the first-line level of supervision does not qualify as directly engaged in SR&ED. Where time is claimed for employees beyond the first-line level of supervision, the claimant will be asked to provide details of the duties the employees performed during the time they were directly engaged in SR&ED. The claimant will also have to demonstrate how these duties are "directly engaged," as described above. It is KPMG s suggestion that this section be revised to remove any implications that managers cannot perform specific types of directly engaged activities. We suggest this section be revised as follows to recognize that managers can perform directly engaged activities: Managers and supervisors are also considered to be directly engaged in SR&ED when they are performing SR&ED under subsections (a) through (d) of 248(1) of the ITA. In addition, managers and supervisors who supervise the ongoing SR&ED work are also considered to be directly engaged in SR&ED when they are directing the course of the ongoing SR&ED work or when they are providing direct technical input into the SR&ED work. However, any time spent by a manager or supervisor performing non-technological management activities or decision-making functions that do not directly influence the course of the SR&ED is not considered to be time the manager or supervisor is directly engaged in SR&ED. Where time is claimed for employees beyond the first-line level of supervision, the claimant will be asked to provide details of the duties the employees performed during the time they were directly engaged in SR&ED. The claimant will also have to demonstrate how these duties are "directly engaged," as described above. Section Meaning of solely in support The SR&ED work carried on outside Canada must be solely in support of SR&ED carried on in Canada by the claimant. Work carried on outside Canada that is basic research, applied research, experimental development or work described in paragraph (d) of the definition of SR&ED in subsection 248(1) of the ITA would qualify as "support work" provided the work is an integral part and is solely in support of the SR&ED work carried on in Canada by the claimant. The question whether an activity performed outside Canada is solely in support of the SR&ED work carried on in Canada is a question of fact to be determined on a case by case basis. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 12

15 - Where an activity is in support of both an SR&ED project carried on in Canada and another SR&ED project carried on outside Canada, that activity would not be considered to be solely in support of the SR&ED work carried on in Canada. - Where an activity performed outside Canada supports work that involves SR&ED carried on in Canada and at the same time supports non SR&ED work (dual purpose activity) performed in Canada, that activity would not be considered to be solely in support of the SR&ED work carried on in Canada. KPMG submits that the policy paper s current explanation of solely in support may not allow for situations where technical staff cannot control what other spinoff R&D occurs in other countries stemming from test results. Therefore, we recommend that section be revised to exclude solely in support such that the portions of time spent outside of Canada become ineligible when they no longer support Canadian R&D as it is often feasible to differentiate between eligible and ineligible portions of a trip. As such, KPMG suggests that the first two paragraphs of section be revised as follows: The work claimed for SR&ED that was carried on outside Canada must be in support of SR&ED carried on in Canada by the claimant. Work carried on outside Canada that is basic research, applied research, experimental development or work described in paragraph (d) of the definition of SR&ED in subsection 248(1) of the ITA would qualify as "support work" provided the work is an integral part and is in support of the SR&ED work carried on in Canada by the claimant. The question whether an activity performed outside Canada is in support of the SR&ED work carried on in Canada is a question of fact to be determined on a case by case basis. KPMG also suggests that the last bullet paragraph of section be revised as follows because Canadian technical staff cannot control what other spinoff R&D occurs in other countries stemming from testing: Where an activity performed outside Canada supports work that involves SR&ED carried on in Canada and at the same time supports non SR&ED work (dual purpose trip) performed in Canada or elsewhere, that portion of the trip which was not considered to be in support of the SR&ED work carried on in Canada would be ineligible. 5. What are the best features of the document? KPMG believes that the legislative references within the document are well positioned and presented as footnotes which allows an interested reader to quickly refer to additional information should it be required to understand their specific case. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 13

16 The hyperlinks in the policy paper to related sections are extremely beneficial, although the CRA may want to consider also distributing PDFs of these files with active HTML links. Access to PDFs would benefit users because these files tend to be easier to print and distribute than websites. 6. Do you have any other comments or suggestions to improve the document? The CRA may want to consider an overall objective of providing more practical examples throughout the paper. This approach will provide consistency in the document and help enhance the reader s understanding. Conclusion KPMG welcomes the opportunity to contribute to the consultation on this important issue for Canadian corporations. We look forward to answering any questions from the CRA about this submission and to providing further comments when new proposals are released. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 14

17 Appendix: CRA Policy Document SR&ED Salary or Wages Policy Draft Table of Contents 1.0 Purposes 2.0 Definition of "salary or wages" o 2.1 Legislation o 2.2 Expenditures incurred Examples of expenditures not incurred o 2.3 Table outlining SR&ED salary or wages inclusions and exclusions 3.0 Taxable benefits o 3.1 Expenditure incurred vs. Value of taxable benefits Example: Automobile and motor vehicle benefits o 3.2 GST/HST or PST considerations o 3.3 Value of taxable benefits T4 slips 4.0 Bonuses, remuneration based on profits and other types of remuneration o 4.1 Meaning of "remuneration based on profits" o 4.2 Meaning of "bonuses" o 4.3 Inducement payments and non-competition payments to employees o 4.4 Expenditure on or in respect of SR&ED 5.0 Amounts that are not salary or wages o 5.1 Related benefits o 5.2 Expenditures for extended vacation or sick leave Example o 5.3 Stock option benefits Options granted or shares issued on or after November 17, Background Stock option benefits Treatment of stock option benefits o 5.4 Retiring allowances Accumulated vacation and sick leave credits upon retirement 6.0 Specified employees o 6.1 Bonuses or remuneration based on profits for specified employees Limitation regarding specified employees Rules for associated corporations 7.0 Salary or wages of employees directly engaged in SR&ED Proxy method o 7.1 Meaning of "directly engaged" Employees who are directly engaged Non-specialized employees who are directly engaged Managers and supervisors who are directly engaged o 7.2 Supporting documentation and other evidence Proxy method o 7.3 Calculating the amount of the expenditures Portion of an expenditure for salary or wages Only the portion of the salary or wages that can reasonably be considered to relate to SR&ED can be included Example Reasonably be considered to relate to SR&ED All or substantially all (ASA) Example All or substantially all 8.0 Undertakes, supervises, supports Traditional method o 8.1 Meaning of "undertakes, supervises or supports" 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 15

18 o 8.2 Supporting documentation and other evidence Traditional method o 8.3 Calculating the amount of the expenditures Portion of an expenditure for salary or wages Only the portion of the salary or wages that can reasonably be considered to relate to SR&ED can be included All or substantially all (ASA) o 8.4 Salary or wages under the traditional method and Form T Administrative salary or wages Traditional method o 9.1 "Directly attributable" tests "Directly related" and "incremental" salary or wages o 9.2 Application of the rules o 9.3 Examples of tasks directly related to the prosecution of SR&ED o 9.4 "Incremental test" o 9.5 Clerical and administrative staff providing a service to SR&ED employees 10.0 Salary or wages of employees carrying on SR&ED outside Canada o 10.1 Calculation of permissible salary or wages for SR&ED work carried on outside Canada Example o 10.2 Applying the rules Meaning of "solely in support" Salary or wages paid were not subject to income or profits tax from another country Determining amount B - Limit o 10.3 How to calculate permissible salary or wages for work carried on outside Canada for Form T Unpaid salary or wages o 11.1 Identification of unpaid salary or wages on Form T661 o 11.2 Evidence of payment Unpaid amounts vs. Reserve 12.0 Other issues related to salary or wages o 12.1 Employee vs. Self-employed o 12.2 Employees of a related corporation 13.0 Allocation of labour expenditures for SR&ED o 13.1 Cost allocation methods o 13.2 Research and development (R&D) environment o 13.3 Support for labour allocation High-level information Medium-level information Low-level information o 13.4 Sources of supporting information Development plans Supervisors' summaries Time sheets Naturally generated information o 13.5 R&D environment Distinct well-defined R&D projects Dedicated R&D environments Early stage or start-up business Shop floor SR&ED o 13.6 When is a labour allocation method reasonable? o 13.7 Example of an allocation method The approach Appendix A - References o A.1 Legislative references o A.2 Jurisprudence 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 16

19 o A.3 CRA publications 1.0 Purposes This draft policy document consolidates the content of Canada Revenue Agency's (CRA) publications that deal with salary or wages for scientific research and experimental development (SR&ED) claims. The purpose of this document is to clarify the position of the CRA regarding salary or wages when administering the SR&ED legislation under the federal Income Tax Act (ITA) and the Income Tax Regulations (Regulations). In particular, its purpose is: to explain what may be included in salary or wages for SR&ED purposes; to highlight the differences between directly undertaking, supervising or supporting salary or wages under the directly attributable rules when using the traditional method and directly engaged salary or wages when using the proxy method; and to clarify the CRA's position with respect to a number of issues that are common to both the traditional method and the proxy method. 2.0 Definition of "salary or wages" The expression "salary or wages" is defined in the Income Tax Act (ITA) (section 2.1) and means income from an office or employment. Salary or wages generally includes any expenditure made in respect of a benefit that would be taxable to the employee under section 6 of the ITA (section 3.0) as well as vacation pay, statutory holiday pay, sick leave pay, pay in lieu of termination notice, bonuses (section 4.0), tips and gratuities, honorariums, director's fees, management fees and commissions. These amounts must be paid to or incurred for the employees in the year (section 2.2). Salary or wages do not include amounts in respect of the employer's shares of the related benefits (section 5.1), amounts for extended vacation or sick leave (section 5.2), stock options benefits (section 5.3) and retiring allowances (section 5.4). There is also a general rule that applies to exclude unpaid salary or wages (section 11.0). The general rules described in the sections referred to above also apply for SR&ED purposes. However, there are specific rules that apply in order for salary or wages to be an allowable SR&ED expenditure. These rules are discussed in section 7.0 for a claimant using the proxy method (Please refer to the Traditional and Proxy Methods Policy. This document is currently under development and a link will be provided once the project is complete.) and in section 8.0 for claimants using the traditional method (Refer to the Traditional and Proxy Methods Policy. This document is currently under development and a link will be provided once the project is complete.). Other specific rules apply to salary or wages for SR&ED purposes. There are rules for: specified employees (section 6.0), administrative salary or wages under the traditional method (section 9.0) and for salary or wages of employees performing SR&ED outside Canada (section 10.0). 2.1 Legislation The definition of salary or wages in the Income Tax Act (ITA) is as follows: 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 17

20 "salary or wages", except in sections 5 and 63 and the definition "death benefit" in this subsection, means the income of a taxpayer from an office or employment as computed under subdivision a of Division B of Part I and includes all fees received for services not rendered in the course of the taxpayer's business but does not include superannuation or pension benefits or retiring allowances. Legislative Reference Income Tax Act Subsection 248(1) Definition of "salary or wages" 2.2 Expenditures incurred To be included in the pool of deductible expenditures for SR&ED carried on in Canada, an expenditure must be an expenditure "on or in respect of SR&ED". One of the requirements to meet this condition is that the expenditure must be incurred. Legislative Reference Income Tax Act Subsection 37(8) SR&ED expenditures Examples of expenditures not incurred In certain cases, expenditures are considered not to be incurred. Some examples are: employee remuneration that is not paid within180 days from the end of the tax year in which the expense was incurred (see section 11.0 unpaid salary or wages) the value of a taxable benefit (see section 3.1) stock option benefits (see section 5.3) Legislative Reference Income Tax Act Subsection 78(4) Unpaid remuneration and other amounts 2.3 Table outlining SR&ED salary or wages inclusions and exclusions Included in SR&ED salary or wages Salary or wages (section 2.0) If it is incurred on or in respect of SR&ED If electing the proxy method, salary or wages for employees directly engaged in SR&ED in Canada may be included (section 7.0) If using the traditional method, salary or wages for employees directly undertaking, supervising, or supporting SR&ED may be included (section 8.0) Administrative salary or wages for employees directly attributable may be included as SR&ED overhead expenditures provided the traditional method is used (section 9.0) Permissible salary or wages for SR&ED work performed outside Canada may be included (section 10.0) 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 18

21 Taxable benefits (section 3.0) - Cash benefit May be included in SR&ED salary or wages - Non-cash benefit (the value of the benefit) May be included in SR&ED salary or wages, if: - the value is a reasonable estimate of actual costs - the value of the benefit does not include any GST/HST or PST, unless no input tax credit was claimed - the actual costs to which the non-cash benefit relates are not claimed as a business expense Bonuses [Footnote 1] (section 4.2) Remuneration based on profits (section 4.1) Inducements, non-competition payments (section 4.3) For employees other than specified employees For employees other than specified employees Considered to be remuneration for services rendered during employment (exceptions may apply) Excluded from SR&ED Salary or Wages Related benefits (section 5.1) Extended vacation or sick leave (section 5.2) Stock option benefits (section 5.3) Retiring allowance (section 5.4) Could be considered as overhead under the traditional method Considered not directly undertaking, supporting or supervising; considered not directly engaged Considered not to be an expenditure for SR&ED Could be considered part of overhead under the traditional method [Footnote 1] The rules discussed are only for bonuses with respect to expenditures for salary or wages. Rules concerning bonuses affecting the prescribed proxy amount are discussed in the Policy on the prescribed proxy amount. 3.0 Taxable benefits Taxable benefits are benefits or allowances an employer provides to its employees that are taxable under the ITA. For example: automobile benefits; housing, board, and meals; gifts and awards; interest-free or low-interest loans; group term life insurance policies; or tuition fees. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 19

22 As stated in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, salary or wages could relate to gross wages reported on a T4 slip for the calendar year if the tax year ends at the calendar year-end. However, when using the T4 slips as a basis for determining the allowable salary or wages, certain adjustments may be required to be made as discussed in sections 3.1 to 3.3 below. Legislative Reference Income Tax Act Section 6 Taxable benefits 3.1 Expenditure incurred vs. Value of taxable benefits Where an employee receives a non-cash benefit, the employer must determine the value of the benefit and include that value in the employee's income. A list of all non-cash benefits is provided in Guide T4130, Employer's Guide Taxable Benefits. For the employer, however, the value of a benefit is not an expenditure incurred and, therefore, is not an allowable SR&ED expenditure. In certain cases, the actual costs incurred by the company may have no relation to the value of the benefits otherwise determined. In determining the allowable amount of a taxable benefit, only the actual costs incurred in respect of the taxable benefits should be included in the allowable salary or wages. This is consistent with the existing practice applicable to the automobile standby charge (see section 3.1.1). The value of a benefit to the claimant will be allowed as an SR&ED expenditure if all the following conditions are met: it represents a reasonable estimate of the actual cost incurred (the onus is on the claimant to demonstrate the reasonableness); the amount of the benefit claimed does not include any GST/HST or PST (unless no input tax credit refund was claimed) (see section 3.2); and the actual costs, including capital cost allowance (CCA), to which the value of the benefits relates are not claimed as business expenses under section 9 of the ITA Example: Automobile and motor vehicle benefits The benefit for an automobile provided by the employer for the year includes a standby charge for the year and an operating expense benefit for the year (minus any reimbursements by the employee). The value of the benefit, including the GST/HST or PST that applies, is included in box 14 of the T4 slip as "Employment income," and in the "Other information" area under code 34. Although automobile taxable benefits, including standby charges, may not involve an expenditure incurred in the year, in practice an amount in respect of such benefits can be included as salary or wages if the amount represents a reasonable estimate of the actual costs incurred and does not include any GST/HST or PST (unless no input tax credit refund was claimed) and the automobile expenses and CCA to which the standby charge relates are not included in calculating business income. 3.2 GST/HST or PST considerations Some taxable benefits (like non-cash benefits) included on the employee's T4 slip may include a GST/HST or PST component. The employer may claim an input tax credit for the GST/HST that applies on the taxable benefits (or a similar provincial credit for PST on taxable benefits). The amount of input tax credit claimed is deemed to be government assistance. 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 20

23 Therefore, no GST/HST or PST amount should be included in the allowable SR&ED salary or wages where an input tax credit (or a similar provincial credit) is claimed in respect of these amounts. Legislative Reference Income Tax Act Subsection 248(16) GST Input tax credit and rebate 3.3 Value of taxable benefits T4 slips Other taxable non-cash benefits are based on the value of the benefits (for example, value of parking). A list of all non-cash benefits are provided in Guide T4130, Employer's Guide Taxable Benefits and Allowances. Other than specific codes for certain non-cash benefits, it should be noted that code 40 could include the value of certain non-cash benefits as well as GST/HST or PST, depending of the type of benefits. Claimants also have to ensure that no amounts are claimed as salary or wages for the following benefits: Interest-free and low-interest loan (box 14 of the T4 slip and code 36 and 37 in the "Other information" of the T4) is not an expenditure incurred and does not qualify as SR&ED salary or wages. Security options benefits (box 14 of the T4 slip and code 38 in the "Other information" of the T4) are not allowable expenditures (see section 5.3). In certain situations, placement agency workers (box 14 of the T4 slip and code 81 in the "Other information" of the T4) are not employees of the claimant, yet the claimant pays the salary and has to prepare the T4 slip for the workers. In these situations, the salary or wages of the placement agency workers do not qualify as salary or wages expenditures for the claimant but could qualify as a contract expenditure for SR&ED performed on the claimant's behalf (Please refer to the Contract Expenditures for SR&ED Performed on Claimant's Behalf Policy. This document is currently under development and a link will be provided once the project is complete.). 4.0 Bonuses, remuneration based on profits and other types of remuneration Restrictions apply to bonuses and remuneration based on profits in respect of specified employees (see section 6.0). When calculating the prescribed proxy amount, all bonuses and remuneration based on profits (both to specified and non-specified employees) are excluded from the salary base of employees directly engaged in SR&ED in Canada. (Please refer to the Prescribed Proxy Amount Policy. This document is currently under development and a link will be provided once the project is complete.) "Bonus" and "remuneration based on profits" are not defined in the ITA or the Regulations. Therefore, the ordinary dictionary definitions of the terms apply. Legislative Reference Income Tax Act Subsection 37(9) Remuneration based on profits or bonus for specified employees Legislative Reference Income Tax Regulation Subsection 2900(9) Exclusions to salary base 4.1 Meaning of "remuneration based on profits" 30 April 2011 SR&ED Salary or Wages Policy (Draft) Paper 21

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