Application Policy

The purpose of this paper is:

1. To highlight the differences between directly undertaking, supporting or supervising salary and wages under the directly attributable rules when using the traditional method and directly engaged salary and wages when using the proxy method, and
2. to clarify the Department's position with respect to a number of issues which are common to both.

Traditional method

Expenditures for salary and wages that are either all or substantially all attributable to the prosecution of SR&ED pursuant to subclause 37(8)(a)(ii)(A)(I) of the Income Tax Act (the Act) or directly attributable to the prosecution of SR&ED by virtue of subclause 37(8)(a)(ii)(A)(II) can be claimed under the traditional method.

Paragraph 2900(2)(b) of the Income Tax Regulations (Regulations) describes salary and wages for undertaking, supervising or supporting SR&ED that are directly attributable. Where an employee directly undertakes, supervises or supports the prosecution of SR&ED, paragraph 2900(2)(b) of the Regulations captures the portion of the amount incurred for salary and wages of that employee that can reasonably be considered to be in respect of such prosecution.

1. "Undertakes" means performing experimentation, analysis and other related activities in the prosecution of SR&ED work described in paragraphs 2900(1)(a) to (d) of the Regulations.
2. "Supervises" refers to the day-to-day management of work described in paragraphs 2900(1)(a) to (d) by an employee, not merely the supervision of employees who undertake or support SR&ED work. It is expected that the performance of such work would require a significant technological background based on the employee's academic or work experience, or both.

Supervision for purposes of paragraph 2900(2)(b) of the Regulations 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.

3. The word "supports" describes the performance of any of the work described in paragraph 2900(1)(d) of the Regulations and other technical support which relates to the prosecution of SR&ED.

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 34 of IT-145R concerning persons directly engaged in qualifying M&P activities. Salary and wages relating to clerical support, along with other administrative support, are included under paragraph 2900(2)(c) to the extent such costs are incremental to the prosecution of SR&ED.

The portion of salary or wages referred to in paragraph 2900(2)(b) of the Regulations is generally calculated on the time spent undertaking, supporting and supervising the prosecution of SR&ED compared to the total time worked.

Proxy method

Subclause 37(8)(a)(ii)(B)(IV) provides for the deduction of directly engaged salary and wages when using the proxy method. Subsection 2900(4) of the Regulations provides for the directly engaged salary and wages base for purposes of calculating the prescribed proxy amount.

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. Directly engaged refers to "hands-on" work which would be included in paragraphs 2900(1)(a) to (d) of the Regulations. "Hands-on" work performed by an employee includes:

1. preparing equipment and materials for experiments and analysis, but not maintaining equipment;
2. experimentation and analysis;
3. recording measurements, making calculations, and preparing charts and graphs; and
4. performing work with respect to engineering or design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research that is commensurate with the needs and directly in support of eligible SR&ED work.

The claimant must identify all employees directly engaged in SR&ED and outline the tasks the employees performed in respect of the time claimed as being directly engaged in SR&ED. Generally, technological work performed by the first-line supervisor and the technological employees under his/her supervision will be directly engaged in the SR&ED. Normally, work performed beyond the first-line supervision level will not be considered directly engaged. If time is claimed for employees beyond the first-line supervision level, the claimant should be requested to provide details of the duties performed in respect of the time claimed as directly engaged in SR&ED and to demonstrate how these duties are directly engaged as described above.

Where it is not clear as to whether or not the duties being claimed are directly engaged the following steps should be taken:

1. the claimant should be requested to explain how the duties in question relate to the SR&ED activities being claimed;
2. the auditor and the science advisor should work together in establishing the reasonableness of the wages and salary claimed and requesting any additional information; and
3. the science advisor should make the final determination regarding any remaining contentious issues based on an analysis of the duties performed.

The directly engaged salary and 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/her 1,800 regular hours directly engaged in SR&ED and works an additional 600 hours of unpaid overtime performing general administrative duties, the directly engaged salary and wages are $75,000 (i.e., 1,800/2,400 x $100,000). See Example for further deals.

Pursuant to subsection 2900(5) of the Regulations, where an employee spends all or substantially of his/her time directly engaged in SR&ED, all of his/her time will be considered directly engaged in SR&ED. All or substantially all means at least 90%. For instance, if $100,000 of wages is incurred in respect of an employee who spent 90% of his/her time directly engaged in SR&ED, $100,000 is considered to be the directly engaged wages for that employee.

An employee performs a series of tasks in carrying out his/her duties of employment. These tasks should be viewed in terms of how they correlate to the primary reason the employee is employed by the claimant when determining if the employee's salary and wages are directly attributable to the prosecution of SR&ED or directly engaged in SR&ED. The following chart is designed to assist in determining how the salary and wages relating to the performance of various tasks and duties should be handled under the traditional and the proxy method. The eligibility of the salary and wages is subject to meeting all the relevant conditions set out in section 37 of the Act and section 2900 of the Regulations and may vary depending on the facts of each case.

Common Issues

1. Meaning of salary or wages

"Salary or wages" is defined in subsection 248(1) and generally means the income of a taxpayer from an office or employment as computed under subdivision a of Division B of Part I, e.g. vacation pay, statutory holiday pay, sick leave pay, etc. Since section 37 of the Act is based on expenditures incurred, taxable amounts which do not relate to amounts expended by the employer are not included in directly attributable or directly engaged salary and wages. Examples of taxable amounts for which an expenditure would not normally be incurred include most stock options benefits (section 7) and interest-free loans (subsection 6(9)).

Although automobile taxable benefits including standby charges may not involve an expenditure in the year, an amount in respect of such benefits can be included in section 37 as directly engaged salary and wages on an administrative basis. This concession will only be made to the extent that the automobile expenses and CCA to which the standby relates are not included in calculating business income under section 9 of the Act.

2. Related Benefits

Prior to the introduction of the proxy method, paragraph 2900(2)(b) of the Regulations included salary and wages and related benefits. With the introduction of the proxy method the words "related benefits" were deleted from paragraph 2900(2)(b). The cost of such employment benefits are now captured under paragraph 2900(2)(c) as an SR & ED cost.

Related benefits include the employer's share of CPP, QPP, and UIC and the employer's contributions to WCB, approved employee pension plans and employee medical, dental or optical insurance plans. The following expenditures can also be considered related benefits provided such expenditures do not constitute a taxable benefit under section 6 or 7 of Act:

• supplementary sick benefits;
• an employer's contributions in relation to an employee savings plan where, for instance, for every three dollars that an employee uses to purchase shares in the parent company the employer undertakes to pay one dollar, up to a given ceiling.

The employer's contributions to the Quebec and Ontario Health Insurance Plans are not "related benefits" since it is not necessary to be an employee to be able to benefit from these plans. Consequently, such contributions are general business expenses which can only be SR&ED expenditures if directly related and incremental to the prosecution of SR&ED.

Amounts included in income under sections 6 and 7 cannot be considered related benefits since such amounts are elements of an employee's salary or wages. However, for purposes of calculating the prescribed proxy amount , these amounts are not included in the salary base pursuant to paragraph 2900(9)(a) of the Regulations.

3. Meaning of bonuses and remuneration based on profits

Restrictions apply to bonuses and remuneration based on profits in respect of specified employees for purposes of section 37 of the Act. When calculating the prescribed proxy amount , all bonuses and remuneration based on profits (both to specified and non-specified employees) are excluded from the directly engaged wage and salary base in accordance with subsection 2900(9) of the Regulations.

"Bonus" refers a payment that is not earned and is a gratuity to an employee beyond his/her normal pay. For this purpose, the extent to which a bonus payment is based on an employee's performance is immaterial. Whether or not an amount was paid to an employee in recognition of his/her performance, the amount would be considered to be a bonus if it was not paid pursuant to the employee's terms of employment and the employer was under no obligation to make the payment. The number of times in the year that a bonus is paid does not, by itself, affect the meaning of the term "bonus".

"Remuneration based on profit" means every remuneration to an employee that is conditional on the profit of the business or that is a portion of the profit of the business.

Where an employee performs duties that are considered to be directly undertaking, supervising or supporting the prosecution of SR&ED under the traditional method or directly engaged under the proxy method and the only remuneration in respect of performing those duties was bonuses or remuneration based on profits, the Department will consider an amount thereof that is commensurate with the performance of those duties to be directly attributable to, or directly engaged, in SR&ED on an administrative basis. The determination of what is commensurate is a question of fact and may require the utilization of industrial standards published by various technological or professional associations.

4. Impact of vacation and sick leave

Wages and salary relating to extended vacation or sick leave are not considered directly undertaking, supporting or supervising or directly engaged since the employee would not be performing any duties during the leave period. Extended leave is considered to be leave in excess of the normal annual leave earned.

See Example for further details.

5. Unpaid wages and salaries

Accrued salaries and wages are used to calculate the portion that is directly attributable or directly engaged. If the remuneration remains unpaid 180 days after the end of the year in which the expense was incurred, subsection 78(4) applies. It deems the expense not to have been incurred in the year but rather in the year in which the amount is paid. Where the proxy method is being used, amounts deemed to be incurred by virtue of subsection 78(4) are excluded from the directly engaged wages and salary base in accordance with subsection 2900(9) of the Regulations. This eliminates the possibility of SR&ED "overheads" being approximated in respect of salary and wages relating to another year.

Marcel Clément
Interim Director
Specialized Compliance Enhancement Division

Issued by: Tax Incentive Audit Section and Scientific Research Section

Facts

Employee X ( a non-specified employee) receives $10,000 per month. He earns 1 month of vacation and 1 month of sick leave each year.

1994

He was directly engaged in SR&ED for 6 months. The other 6 months he performed duties which were totally unrelated to SR&ED. He did not take vacation or sick leave in 1994.

1994 Directly Engaged Salary

Directly Engaged Portion: 6/12 x $130,000 = $65,000

1995

He was directly engaged in SR&ED for 8 months. The other 2 months he worked he performed duties which were totally unrelated to SR&ED. He took 2 months of accrued vacation in 1995. He did not take any sick leave in 1995.

1995 Directly Engaged Salary

Directly Engaged Portion: 8/10 x $110,000 = $88,000

1996

He was directly engaged in SR&ED for 2 months. The other 4 months he worked he performed duties which were totally unrelated to SR&ED. He took 6 months of sick leave in 1996. He did not take any vacation in 1996.

1996 Directly Engaged Salary

Directly Engaged Portion: 2/6 x $75,000* = $25,000

*Salary Expense $60,000 + Sick Leave Expense Attributable to normal annual leave $10,000 + Accrued Vacation Expense $5,000