Administrative Guidelines for Software Development

NO: 97-1

DATE: February 28, 1997

At the time of printing, the proposed amendment has not been enacted to place the definition of SR&ED in subsection 248(1) of the Act, replacing the definition given by subsection 2900(1) of the Income Tax Regulations. The present guidelines are subject to the effective statutory definition of SR&ED.

1 Introduction

1.1 Document purpose

This document is intended to assist taxpayers and Canada Customs and Revenue Agency (CCRA) staff in interpreting how the scientific research and experimental development (SR&ED) tax incentives apply to software development. It provides interpretation of the definition of scientific research and experimental development in subsection 248(1) of the Income Tax Act (the Act) and expands on Information Circular 86-4, Scientific Research and Experimental Development. It is directed towards software specialists involved in the management of research and development who are responsible for providing technical descriptions to the CCRA as part of claims for SR&ED expenditures.

The discussions in this document concern only technical issues involved in determining the eligibility
of work as SR&ED. Questions relating to allowable expenditures are covered in Interpretation
Bulletin IT-151, Scientific Research and Experimental Development Expenditures.

1.2 Definitions

The words taxpayer and company are used interchangeably in this document since most SR&ED claimants are corporations. Taxpayer has the meaning defined in the Act and does not imply a liability to pay tax.

Software refers to the encoded instructions executed by electronic devices, including computers, for performing operations or functions. Science and technology relating to software are subfields of computer science and information technology.

Computer science is the study of the theoretical and applied disciplines in the development and use of computers for information storage and processing, mathematics, logic, and many other areas. Information technology is the body of technical knowledge associated with collecting, storing, manipulating, and communicating information using computers and communications systems. The fields of computer science and information technology can be considered to overlap, and for the purpose of these guidelines it is not necessary to differentiate between them.

SR&ED is defined for income tax purposes in subsection 248(1) of the Act, as follows:

"scientific research and experimental development" means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is

(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or

(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,

and, in applying this definition to a taxpayer, includes

(d) work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing or psychological research, where the work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b) or (c) that is undertaken in Canada by or on behalf of the taxpayer,

but does not include work with respect to

(e) market research or sales promotion,

(f) quality control or routine testing of materials, devices, products or processes,

(g) research in the social sciences or the humanities,

(h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas,

(i) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,

(j) style changes, or

(k) routine data collection.

1.3 General comments on interpretation and evaluation of SR&ED

This document must be read and contemplated in its entirety to understand its meaning and intent. This is because many concepts in the characterization of SR&ED are interrelated and cannot be applied in isolation. Quoting extracts out of context is often inconsistent with a holistic interpretation.

Examples are provided to illustrate important concepts. All examples are placed in boxes labelled as exhibits and are referenced in the text. They are intended to illustrate only the specific points referenced. Reading them in isolation or out of context can lead to erroneous interpretation. All examples are hypothetical but are representative of actual claims. Revenue Canada does not expect taxpayers to force their claims to fit any of the situations included for illustrative purposes in this document. By the nature of SR&ED, every claim is unique and is examined on its merits.

No set of strictly factual tests can be sufficient to determine whether work is eligible as SR&ED. Hence, the opinions of individuals expert in the area in question will be required. Opinions must be based on the facts of each case.

The SR&ED tax incentives are intended to encourage the performance of SR&ED in Canada. The eligibility of work as SR&ED is evaluated in terms of the process of performing SR&ED for the purpose of scientific or technological advancement in the categories of basic research, applied research, or experimental development as defined in subsection 248(1) of the Act, quoted above. SR&ED eligibility is not evaluated based on outputs, such as software products or information systems, which may or may not arise through a process that includes SR&ED.

The success, failure, marketability, or commercial significance of work is not relevant to determining its eligibility as SR&ED. Work is not made ineligible because it is performed for an ultimate commercial purpose and, in fact, section 37 of the Income Tax Act requires that SR&ED expenditures be related to the business of the taxpayer.

Software development can be eligible as SR&ED on the basis that it aims to advance computer science or information technology. In addition, computer programming that is commensurate with the needs, and directly in support, of an SR&ED project in any field of science or technology is a qualifying SR&ED support activity. The present document deals only with SR&ED projects that are intended to advance computer science or information technology through, or in relation to, the development of software.

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