SR&ED and outsourcing - Kanada

In today’s business environment, it is common for companies to hire personnel through specialized placement agencies or to outsource certain functions to third parties. Companies are looking for placement agencies that can offer personnel with certain skill sets that the company needs only on a temporary basis, or only for staffing for specific projects. Alternatively, they are looking to outsource certain functions to third-party consulting firms. These types of arrangements are common both in the information technology sector and among firms undertaking large engineering projects.

At an SR&ED conference organized by the Association de planification fiscale et financière (APFF) in Montreal on March 16, representatives of the Canada Revenue Agency (CRA) set out an administrative policy on SR&ED as it pertains to contracts with placement agencies or similar organizations. Companies need to understand the CRA’s policy to assess the potential impact on their SR&ED claim and whether they need to develop different strategies related to outsourced personnel.

The issue is whether companies using placement-agency workers in their SR&ED projects can include the costs of these employees in their SR&ED claims. The answer is complex and depends on the facts and circumstances. One of the factors relates to the method of claiming overhead: the traditional or the proxy method. If the taxpayer uses the traditional method, then the cost of placement-agency personnel who perform qualifying SR&ED activities can be claimed either as expenditures which are “all or substantially all” attributable to SR&ED or as overhead.

Under the proxy method, there are a limited number of types of expenditures that can be claimed. Contracts for SR&ED may be claimed, while contracts for services may not. The CRA considers that a standard contract between a taxpayer and a placement agency is not for SR&ED, but for the supply of services and therefore not claimable.

However, the CRA’s administrative policy is that, in such circumstances, they will look at the amount of time spent on SR&ED by each contracted individual. The CRA is prepared to allow payments to third parties for individuals — provided that the person spends all or substantially all of his or her time in qualifying SR&ED activities during the fiscal year. The CRA’s policy is to interpret “all or substantially all” to mean more than 90 percent of the time, although there are court cases which set a lower threshold.

The CRA provided two examples at the conference. One was that of a placement agency that provided 25 individuals who spent all or substantially all of their time on SR&ED. In this case, all of the costs will be treated as a contract for SR&ED. In the other example, a taxpayer using the proxy method outsourced IT work to a consulting firm. The contract was for 50 named individuals. Thirty of these individuals spent all or substantially all of their time on SR&ED and hence their costs are considered eligible. The other 20 individuals spent 60 percent of their time on SR&ED and hence their costs are considered not eligible as SR&ED under the proxy method. However, the cost related to 60 percent of their time would be eligible under the traditional method.

The CRA’s announcement provides three important lessons. The first is that, although the intention of the legislation is to provide incentives to Canadian taxpayers who perform SR&ED, it is not sufficient by itself that the work undertaken by the individual be eligible. It is also important that the contractual agreement related to the individual fit within the parameters of the legislation. The second is the importance for taxpayers of choosing which method of overhead to use: the traditional or the proxy method. The third is the importance of ensuring that SR&ED contracts are worded properly to show that taxpayers are contracting for SR&ED and not services when using the proxy method.

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Source: Deloitte & Touche LLP - Canada (English)