What is a Contract Payment?
When a taxpayer contracts with another party to perform SR&ED on its behalf, the taxpayer can generally claim tax credits on the amount of payments made under that contract. The recipient of the payment can also claim tax credits, however, in calculating the amount of tax credit that it can claim, the recipient must first reduce the cost of its SR&ED by the amount of the contract payment received.
The Income Tax Act generally defines a contract payment to mean an amount paid or payable to a taxpayer, by a taxable supplier, a Canadian government, municipality or other Canadian public authority or a tax exempt person, in respect of the amount, for SR&ED, to the extent that it is performed for or on behalf of the payer.
Note that a contract payment must be made by a taxable supplier or a government unit within Canada. With some exceptions, a taxable supplier is defined to be an entity that is subject to taxation in Canada. A payment received from a foreign corporation that does not have a permanent establishment in Canada, or a foreign government, would not be considered a contract payment.
Note that non-arms length payments from taxable suppliers are not contract payments. They are subject to a whole different set of rules. (See Non-Arm’s Length Contract Payments)
Where a payment is received from a taxable supplier, it is often difficult to determine whether that payment is for SR&ED. A contract may be a simple one line purchase order, or even a handshake.
Revenue Canada’s position (Application Policy SR&ED 94-04) is that “the key element for determining an amount as a contract payment is whether the payer requested the contractor to perform SR&ED on behalf of the payer under the terms of the contract.” In looking for this key element, a number of factors are considered.
What are the contractor performance requirements?
Is the contractor required to do specific SR&ED work? Does the contract use terminology like design, integrate, test, verify performance? Were there certain specifications to which the contractor had to comply in performing their tasks?
If the answer is yes to any of those questions, Revenue Canada takes that as an indication that a contract payment was made.
Is there a ceiling price beyond which the contractor would not have been paid?
Or would the contractor have been entitled to payments only if the work had met the requirements of the contract, as to the work that was being performed? If the answer is yes to either of those questions, Revenue Canada takes that as an indication that a contract payment has not been made.
Does the payer own the exclusive right to the intellectual property (IP) at the end of the contract?
If the IP belongs exclusively to the person making the payment, then there is evidence that the payer is making a contract payment. Note that Revenue Canada discounts this test where the payer is the Crown, in that the Crown often does not take title to the intellectual property.
Is the contract a contract for services or a contract for goods?
If the three tests described above do not provide strong evidence for or against a contract payment, Revenue Canada then looks to the nature of the contract. A contract for services provides evidence that a contract payment has been received. A contract for the sale of goods provides evidence to the contrary.
The Strategy
Many taxpayers do not make SR&ED tax credit claims where they have been paid for work that they have done. Other taxpayers do not claim tax credits on work done for them by another party. These two factors are largely irrelevant in determining claim eligibility. Where SR&ED activities are performed, review payments received and made, to determine whether they are contract payments.
