Water and Energy Sources as Materials

Addendum to Application Policy SR&ED 2000-01

Issue

Generally water and energy sources used to carry out SR&ED are not considered to be materials. Their costs are treated as overhead expenses and could be allowable SR&ED expenditures only in the traditional method of calculating the investment tax credit (ITC).

However, there are circumstances where water and energy sources used in performing SR&ED could be considered materials consumed, based on the definitions of "materials" and "consumed" in Application Policy 2000-01.

This Interim Instructional Sheet is aimed at clarifying how water and energy sources should be treated for SR&ED purposes.

CCRA's Policy

Application Policy 2000-01 describes "materials consumed" with respect to SR&ED claims, defines "cost", "materials", "consumed" and "transformed" and gives examples from various industries.

As used in subclause 37(8)(a)(ii)(B)(V) of the Income Tax Act and paragraph 2900(2)(a) of the Income Tax Regulations, the word "materials" is defined as: "all the raw materials, substances, or other items that compose the body of a thing at a given moment in the SR&ED process".

The policy also states "energy sources directly related to the prosecution of SR&ED (fuel, electricity oil, etc.) are generally not materials," and that "costs related to these energy sources are overhead expenditures".

According to the application policy, "consumed" means that the material was "destroyed or rendered virtually valueless as a result of the SR&ED". Cost of consumed materials can be claimed both in the traditional and proxy methods of ITC calculations. Whereas materials "transformed" are described as being incorporated into a product that has some value either to the claimant or to another party. Cost of transformed materials is an allowable SR&ED expenditure only in the traditional method.

Water and Energy Sources as Consumed Materials

In most industries, specifically in the chemical, petrochemical, minerals, pulp and paper and textile industries, water consumed is usually separated into several streams. One is the utility water used throughout the plant, another stream is the boiler feed water, which is used to generate steam on site, and the third is the process water stream which, like any other feed material, enters the process and becomes part of intermediate and/or final product(s), as governed by the chemical equation(s) on which the process is based.

This process water stream is often pre-treated or conforms to specifications unique to the process. Once water enters the process, for all practical purposes, it is rendered useless - as process water feed - even if it is recovered.

Such process water streams meet the definition of "materials" and "consumed". The problem, however, is the identification of the costs and the quantity consumed in SR&ED. See "Financial and Technical Review Issues" below.

With respect to energy use, a similar argument could be made that some of the energy sources used in the plant can be part of the chemical/physical process - i.e. it is part of the conversion/production process and is integral to the chemical reaction on which the process is based.

All endothermic reactions in the chemicals, petrochemicals, pharmaceutical and biotechnology industries, most metallurgical refining processes, production of cement, glass, ceramics and other industrial raw materials, as well as most forming operations in the plastics industry, require significant energy input directly into the process. In physical terms, the intermediate and final products of these processes may retain this energy in their new form, but often the energy must be removed (sometimes dissipated).

The cost of such energy sources used in a process, that is part of SR&ED, could be included in the cost of materials consumed. However, the problem is to clearly identify its cost and quantity, apart from the portion used for lighting, space heating and running the machinery and equipment. See below.

Financial and Technical Review Issues Related to Water and Energy Use

Although it is theoretically possible to calculate the energy and water consumed in a particular physical/chemical process, or to measure such consumption precisely in an operating plant, or in an experiment or trial run, often this data is not readily available to the claimant or the technical reviewers. Where some data may be available, it is often hard to clearly identify the portion of consumed water and energy sources directly related to the project.

Where expenditures on portion of water and energy sources that might qualify as "materials consumed" are expected to be significant, the claimant has the choice of the traditional method of calculating ITCs, where cost of all water and energy sources directly attributable to the SR&ED are allowable overhead expenditures.

A claimant can also choose the proxy method of calculating ITCs and claim water and energy sources as consumed materials. In the case of proxy, claimants will have to identify and document clearly the portion of the water and energy sources "consumed" in the process.

Where expenditures on water and energy sources that might qualify as "materials consumed" are expected to be insignificant, the choice of the proxy method has no substantial impact on the cost of materials consumed allowable for SR&ED purposes.

Application policy SR&ED 2000-01 will be revised to reflect this position and to clarify other issues.

Any comments or questions regarding this matter should be referred by e-mail to the Manager, Research and Technology Section, or to the Manager of the Financial Legislative Application Section.
Original Signed by

Mel Machado
Manager
Financial Legislative Application Section

Mark Bobra
Acting Manager
Research and Technology Section