Pool of Deductible SR&ED Expenditures Policy

Date: March 30, 2022

Table of contents

• 1.0 Purpose
• 2.0 Overview
• 3.0 The Pool of deductible SR&ED expenditures
  • 3.1 Increases to the Pool
  • 3.2 Decreases to the Pool
• 4.0 No deduction is allowed for an expenditure made to acquire rights in, or arising out of SR&ED
• 5.0 Negative pool balance
• 6.0 Deduction claimed in the year
• 7.0 Carry forward
• 8.0 Impact of loss restriction event
• 9.0 Donations as SR&ED
• Appendix A - References
  • A.1 Legislative references
  • A.2 Jurisprudence
• Appendix B – Revisions
  • B.1 Explanation of changes

1.0 Purpose

The purpose of this document is to clarify the position of the Canada Revenue Agency (CRA) regarding the pool of deductible scientific research and experimental development (SR&ED) expenditures when administering the SR&ED legislation under the federal Income Tax Act and the Income Tax Regulations.

2.0 Overview

A taxpayer carrying on a business in Canada in a tax year may deduct, in calculating income from the business for the year, expenditures for SR&ED carried on in Canada that relate to a business of the taxpayer [note 1]. The taxpayer may also earn an SR&ED investment tax credit (ITC) on all or part of such expenditures incurred in the year. Amounts in the pool of deductible SR&ED expenditures can generally be deducted in the year or in any subsequent year. However, certain restrictions may apply to a taxpayer whose control has been acquired (see section 8.0).

Whether a taxpayer is carrying on a business is a question of fact that must be determined on a case-by-case basis. When a corporate claimant performs SR&ED that is related to a business actively engaged in by a related corporation, the SR&ED can be considered to be related to a business of the claimant at that time. For example, if the claimant performing SR&ED is a wholly owned subsidiary of another corporation, the subsidiary's SR&ED will be considered to be related to a business of the claimant if the SR&ED is related to a business carried on by the parent. The parent must be actively engaged in the business at the time the subsidiary makes the expenditure, or payment for SR&ED. In determining whether two corporations are related, the determination is to be made without reference to a right (control by right) referred to in the Income Tax Act. For more information on related corporations, refer to Income Tax Folio S1-F5-C1, Related Persons and Dealing at Arm's Length.

No amount can be deducted in respect of an expenditure to acquire rights in or arising out of SR&ED (see section 4.0).

The expenditures for SR&ED performed in Canada must be identified by the taxpayer on Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, which has to be filed with the taxpayer's return of income for the year. For more information on filing requirements, refer to the SR&ED Filing Requirements Policy.

For the purpose of this paper, a claimant is a taxpayer who claims SR&ED expenditures.

Expenditures incurred by a claimant for SR&ED carried on in Canada are accumulated in a "pool" of deductible SR&ED expenditures (see section 3.0).

Note 1

Special rules allow claimants to include a portion of permissible salary or wages for SR&ED work carried on outside Canada. For more information on salary or wages, refer to the SR&ED Salary or Wages Policy.

When calculating net income or loss for income tax purposes, a taxpayer may deduct an expenditure of a current nature incurred in the year in carrying on SR&ED outside Canada. Except for the special rules for permissible salary or wages, expenditures for SR&ED performed outside Canada, cannot be claimed on Form T661, and such expenditures do not earn ITC.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Subsection 37(1.1) SR&ED related to a business of a related corporation
Subsection 37(1.3) SR&ED in the exclusive economic zone
Subsection 37(1.5) Salary or wages outside Canada – limit determined
Subsection 37(2) Research outside Canada
Subsection 248(1) Definition of "business"
Subsection 248(1) Definition of "SR&ED"
Subsection 248(1) Definition of "taxpayer"

3.0 The Pool of deductible SR&ED expenditures

The pool of deductible SR&ED expenditures is determined in Section C of Part 3 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim. The legislation regarding the pool of deductible SR&ED expenditures is found in subsection 37(1) of the Income Tax Act. Form T661 and the Act are not structured the same but the end result is the same. Form T661 adds and deducts amounts from the prior-year ending pool balance to arrive at the current year amount available for deduction. The legislation is structured to provide for a pool that accumulates amounts over time, and is recalculated taking into consideration all relevant transactions and adjustments that occur over that time.

The pool concept allows a claimant the option of deducting the entire amount of SR&ED expenditures available for the year or any portion thereof after certain adjustments (see section 3.1 and section 3.2). Any unclaimed balance may be carried forward to be claimed (deducted in calculating the claimant's income from business) in future years (see section 7.0).

Legislative Reference Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures

3.1 Increases to the Pool

In general, the pool of deductible SR&ED expenditures is increased by the following:

• the amount of expenditures of a current nature incurred on SR&ED carried on in Canada, including:
  • the portion of salary or wages of employees directly engaged in the SR&ED . For more information, refer to the SR&ED Salary or Wages Policy;
  • the cost of materials consumed or materials transformed in the prosecution of SR&ED. For more information, refer to the Materials for SR&ED Policy;
  • lease costs of equipment used for SR&ED for costs incurred prior to 2014;
  • contract expenditures for SR&ED performed on behalf of the claimant. For more information, refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy;
  • certain payments to corporations and approved entities for SR&ED. For more information, refer to the Third-Party Payments Policy; and
  • overhead expenditures when the traditional method is used. For more information, refer to the SR&ED Overhead and Other Expenditures Policy;
• the amount of expenditures of a capital nature incurred on SR&ED carried on in Canada for capital acquired prior to 2014;
• the amount of repayments of government assistance or non-government assistance that had previously reduced the pool of deductible SR&ED expenditures. For more information, refer to the Assistance and Contract Payments Policy. Repayments of assistance are expenditures pursuant to the Income Tax Act;
• the amounts that have been included in income in a previous tax year under paragraph 12(1)(v) of the Act (see section 5.0);
• the pool of deductible SR&ED expenditures transferred on an amalgamation or wind-up (see section 8.0); and
• the amount of SR&ED investment tax credit (ITC) recaptured in the prior year. For more information, refer to the Recapture of SR&ED Investment Tax Credit Policy.

Legislative References Income Tax Act
Paragraph 12(1)(v) Income inclusion – research and development deductions
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – current expenditures
Paragraph 37(1)(b) Pool of deductible SR&ED expenditures – capital expenditures [Repealed]
Paragraph 37(1)(c) Pool of deductible SR&ED expenditures – repayment of government or non-government assistance
Paragraph 37(1)(c.1) Pool of deductible SR&ED expenditures – amounts included in income because of paragraph 12(1)(v)
Paragraph 37(1)(c.2) Pool of deductible SR&ED expenditures – amounts added because of an ITC recapture
Paragraph 37(1)(c.3) Pool of deductible SR&ED expenditures – amounts added because of partnership ITC recapture excess amount

3.2 Decreases to the Pool

Generally, the pool of deductible SR&ED expenditures is decreased by the following:

• the amount of government assistance or non-government assistance that the claimant has received, is entitled to receive, or can reasonably be expected to receive, for SR&ED expenditures included in the pool. For more information, refer to the Assistance and Contract Payments Policy;
• a "super-allowance benefit amount" for the year or for preceding taxation years in respect of a province. For more information, refer to the Assistance and Contract Payments Policy;
• ITCs applied and / or refunded in a preceding year. For more information, refer to the SR&ED Investment Tax Credit Policy;
• amounts deducted from the pool of deductible SR&ED expenditures in previous years; and
• amounts the claimant has deducted with respect to insolvency in preceding years, to the extent these amounts did not exceed the balance of the pool of deductible SR&ED expenditures in the year in which the amount was claimed.

A corporation's pool of deductible SR&ED expenditures is reduced to nil at the time when control of the corporation is acquired (see section 8.0). Similarly, a trust’s pool of deductible SR&ED expenditures is reduced to nil at the time there is a new majority-interest beneficiary. In either case the pool of deductible SR&ED expenditures may be reinstated in a subsequent tax year (see section 8.0).

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(d) Pool of deductible SR&ED expenditures - government or non-government assistance
Paragraph 37(1)(d.1) Pool of deductible SR&ED expenditures - super-allowance benefit
Paragraph 37(1)(e) Reduction of the pool of deductible SR&ED expenditures
Paragraph 37(1)(f) Amounts deducted under subsection 37(1) in preceding years
Paragraph 37(1)(f.1) Amounts the taxpayer has deducted under section 61.3 in preceding years
Paragraph 37(1)(h) Amount determined under subsection 37(6.1) due to a loss restriction event
Section 61.3 Deduction for insolvency

4.0 No deduction is allowed for an expenditure made to acquire rights in, or arising out of SR&ED

SR&ED investment tax credits are granted to Canadian companies that bring their technology base to a higher level through work, which meets the requirements of SR&ED. If a company's technology base is raised by acquiring third-party know-how, then the expenditure related to this purchase is not allowable for SR&ED purposes.

The underlying reasons for not allowing expenditures involving the acquisition of rights in, or arising out of SR&ED to be included in the pool of deductible SR&ED expenditures is twofold:

• Only one claimant should receive SR&ED tax incentives on the SR&ED work. Since the performer is entitled to the SR&ED tax incentive, allowing the incentive to the purchaser of the rights would effectively result in duplication.
• The aim of the SR&ED tax incentive is to encourage research and development in Canada. If the SR&ED, from which the rights resulted, was performed outside Canada, allowing the SR&ED tax incentive to the purchaser of the rights would be contrary to this goal.

As an expenditure made to acquire rights, in or arising out of, SR&ED is excluded from being deducted as an SR&ED expenditure, no investment tax credit (ITC) will be allowed for these expenditures. It does not matter if SR&ED expenditures have not been claimed for such work in the past, or if it was done by a non-resident entity that cannot claim for SR&ED tax incentives.

Legislative References Income Tax Act

Subsection 37(1) Pool of deductible SR&ED expenditures
Subsection 37(4) Acquisition of rights
Subsection 248(1) Definition of "SR&ED"

Legislative Reference Income Tax Regulations
Paragraph 2902(c) Prescribed expenditures – acquisition of rights

5.0 Negative pool balance

A negative balance in the pool at the end of a tax year must be brought into net income for tax purposes, in the year.

The pool of deductible SR&ED expenditures at the beginning of a tax year cannot be a negative amount. When a claimant is required to report an amount in income due to a negative pool balance at the end of the tax year, the amount is also technically added to the pool to remove the negative amount resulting in an opening balance of nil (zero) for the subsequent tax year. Thus no amount would be reported on line 450 of the subsequent tax year Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim.

The use of an amount from the pool of deductible SR&ED expenditures is not subject to the SR&ED reporting deadline since the SR&ED expenditures comprising the pool were identified on time on Form T661.

Legislative References Income Tax Act
Paragraph 12(1)(v) Income inclusion – research and development deductions
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(c.1) Pool of deductible SR&ED expenditures – amounts included in income because of paragraph 12(1)(v)

6.0 Deduction claimed in the year

In determining net (loss) income for income tax purposes (form T2SCH1) for a particular year, a claimant cannot deduct an amount that is greater than the available balance in the pool of deductible SR&ED expenditures at the end of the tax year.

A claimant can deduct all or a portion of their pool of deductible SR&ED expenditures, or they can accumulate their SR&ED expenditures and carry them forward to deduct them in future years (see section 7.0). The deduction is optional, and can be any amount up to the current year's amount available for deduction, subject to the following restrictions:

• If the claimant is a corporation or trust and there was a loss restriction event, the total amount of the pool may not be deducted in the year or in a subsequent year. Special rules apply to determine the amount that can be deducted (see section 8.0).
• A partnership cannot carry forward an amount in the pool of deductible SR&ED expenditures to a subsequent year. Therefore, the pool of deductible SR&ED expenditures at the end of the year of the partnership must be fully deducted in calculating the partnership's net income for tax purposes in the year. For more information on partnerships, refer to the SR&ED Claims for Partnerships Policy.

The use of an amount from the pool of deductible SR&ED expenditures is not subject to the SR&ED reporting deadline since the SR&ED expenditures comprising the pool were identified on time on Form T661.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(h) Amount determined under subsection 37(6.1) due to a loss restriction event
Subsection 37(6.1) Loss restriction event
Subsection 37(11) Filing requirement
Paragraph 96(1)(e.1) Partnership and the pool of deductible SR&ED expenditures

7.0 Carry forward

A positive balance in the pool of deductible SR&ED expenditures does not expire. It may be carried forward indefinitely and deducted in a subsequent tax year against any business income.

The CRA treats the pool of deductible SR&ED expenditures as a running balance; only the total balance carried forward is identified. The year to which each expenditure amount relates is not recorded or tracked. Since amounts in the pool can be carried forward indefinitely, it is not necessary to know the year to which an expenditure relates.

There are some restrictions on the carry forward of the pool after a loss restriction event (see section 8.0).

Legislative Reference Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures

8.0 Impact of loss restriction event

When there is an acquisition of control, there is a deemed year-end immediately before the acquisition of control and the corporation's pool of deductible SR&ED expenditures is reduced to nil. Similarly, a trust’s pool of deductible SR&ED expenditures is reduced to nil at the time there is a new majority-interest beneficiary. In the subsequent tax year, the pool of deductible SR&ED expenditures may be reinstated in cases when the business to which the expenditures relate is carried on for profit or with a reasonable expectation of profit.

In general terms, the undeducted portion of the pool, before control of a corporation is acquired (or in the case of trusts, before there is a new majority-interest beneficiary), may be carried forward and deducted in calculating income for tax purposes for a subsequent tax year only:

• when the business to which the expenditure related is continued for profit, or with a reasonable expectation of profit; and
• to the extent that its income for the tax year (before making any deduction from the pool of deductible SR&ED expenditures) is from that same business or a similar business.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Paragraph 37(1)(h) Amount determined under subsection 37(6.1) due to a loss restriction event
Subsection 37(6.1) Loss restriction event

9.0 Donations as SR&ED

When an expenditure in respect of SR&ED could be deductible as an SR&ED expenditure or a charitable donation, the amount must be deducted as an SR&ED expenditure and not as a donation.

Legislative References Income Tax Act
Subsection 37(5) Where no deduction allowed under sections 110.1 and 118.1
Section 110.1 Gifts – computation of taxable income
Section 118.1 Charitable gifts – computation of tax

Appendix A - References

A.1 Legislative references

A.2 Jurisprudence

Appendix B – Revisions

B.1 Explanation of changes

The following are the explanation of changes to the Pool of Deductible SR&ED Expenditures Policy as part of the revision of March 30, 2022:

Section 2.0 has been revised to remove discussions on expenditures of a capital nature or expenditures for the right to use capital property (lease) if the expenditure was incurred after 2013, as such expenditures do not qualify for SR&ED tax incentives. New wording has been provided for clarity, to explain that expenditures for SR&ED performed in Canada may result in the earning of ITC. If the expenditures that form the pool of deductible SR&ED expenditures are not deducted in the year, they may be deducted in a subsequent year. Additional wording was provided to explain that the SR&ED performed can be related to the business of a related corporation. In Note 1, new wording was provided to explain that, except for the special rules for permissible salary or wages for SR&ED work carried on outside Canada, expenditures for SR&ED performed outside Canada cannot be claimed on Form T661 and do not result in ITC.

Sections 3.1 and 4.0 have been revised to remove discussions on expenditures of a capital nature or expenditures for the right to use capital property (lease) if the expenditure was incurred after 2013, as such expenditures do not qualify for SR&ED tax incentives. Any discussions that remain on expenditures of a capital nature relate to capital expenditures incurred prior to 2014, which are still included in the determination of the pool of deductible SR&ED expenditures.

Section 6.0 has been revised to include wording such that the use of an amount from the pool of deductible SR&ED expenditures is not subject to the SR&ED reporting deadline since the SR&ED expenditures comprising the pool were identified on time on Form T661.

Other minor formatting and editing corrections were made throughout the document.