Materials Consumed in SR&ED
Prior to February 24, 1998 proxy based filers (filers claiming the 65% overhead factor) could only claim the cost of material consumed in SR&ED. Traditional based filers could claim all material costs that were incremental to the SR&ED activity.
This was confirmed in the Consoletex case. In this Tax Court case the definition of the word “consumed” was discussed by Judge Bowman. He considered whether experimental production of yarn that was later sold was consumed in SR&ED. He found that “it would put a strained interpretation on the word consumed to say that … yarn which is turned into product that is sold was consumed”. He did however, find that the yarn was an eligible expenditure in that it was an incremental cost. As Consoltex was not a proxy filer, Judge Bowman directed Revenue Canada to allow the claim for material that was sold, as an eligible SR&ED expenditure.
This gave an opening for companies to elected to not use the proxy method, and claim material sold to customers as SR&ED, where it improved their tax credit position. The department of Finance disliked this decision and moved in the February 1998 budget to block it for expenditures made after February 24, 1998. All materials consumed or transformed into another product during the course of an SR&ED project, are eligible for SR&ED tax credits. However, where the product is sold or later converted to commercial use, companies are required to repay the tax credit previously claimed. The amount of the repayment is based on the lesser of, the proceeds of disposition of the property, or the cost of SR&ED materials included in the property.
The Strategy
Companies will want to consider making a claim for experimental production materials, particularly when something goes wrong and the company cannot bill for the product. Also, there will be a cash flow advantage under this formula, in that the credit comes as the material is used, and is paid back after the product is sold. This advantage will occur when those two events take place sequentially, but in two different taxation years.
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