Prescribed Proxy Amount Policy

Date: December 18, 2014

Changes to the Prescribed Proxy Amount Policy

Reasons for revision

This revision accommodates the legislative changes that have been announced.

Revision overview

Instead of scientific research and experimental development (SR&ED) overhead and other expenditures, a claimant can include as a qualified SR&ED expenditure an amount referred to as the prescribed proxy amount (PPA). The PPA is a percentage of the salary base.

The percentage at which SR&ED overhead and other expenditures are accounted for under the proxy method is reduced from 65% to 55% over a two year period. The percentage for the 2012 and earlier calendar years is 65%. The percentage is reduced to 60% for the 2013 calendar year and 55% for the 2014 and later calendar years. The proxy calculation is prorated based on the number of days in the tax year that straddle January 1, 2013 or January 1, 2014.

The text of this document has been revised to reflect these changes, see Appendix 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 prescribed proxy amount (PPA) when administering the SR&ED legislation under the federal Income Tax Act and the Income Tax Regulations. The PPA is only determined under the proxy method for calculating SR&ED expenditures.

2.0 Overview

Claimants have two ways to calculate their SR&ED expenditures. They can elect to use the proxy method or choose to use the traditional method. Claimants that elect to use the proxy method to determine their expenditures on, or in respect of, SR&ED cannot treat any portion of SR&ED overhead and other expenditures as qualified SR&ED expenditures because these expenses are not one of the three (six, prior to 2014) specific types of expenditures that may be included in the pool of deductible SR&ED expenditures. However, in lieu of these SR&ED overhead and other expenditures, these claimants can include as a qualified expenditure an amount referred to as the prescribed proxy amount (PPA). The PPA is a notional amount calculated under the Regulations. For more information on the traditional and proxy methods, please refer to the Traditional and Proxy Methods Policy, and for more information on overhead and other expenditures, please refer to the SR&ED Overhead and Other Expenditures Policy.

About the PPA

  • The PPA represents the amount of SR&ED overhead and other expenditures, and it is used only to determine the claimant's qualified SR&ED expenditures for calculating the investment tax credit (ITC).
  • A claimant does not include the PPA in the pool of deductible SR&ED expenditures and does not deduct it when calculating income for income tax purposes.
  • The PPA is calculated (see section 3.0) as a percentage of the salary base (see sections 4.0 to 4.2).
  • The actual overhead and other expenditures that the PPA represents are ordinary business expenses that may be deducted in the year.

The calculation of the PPA is made in Part 5 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim.

Legislative references Income Tax Act
Subsection 9(1) Income from a business or property
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – current expenditures
Subclauses 37(8)(a)(ii)(B)(I) to (VI) SR&ED expenditures in Canada under the proxy method
Subsection 127(9) Definition of “qualified expenditure” – includes the prescribed proxy amount

Legislative reference Income Tax Regulations
Subsection 2900(4) Calculation of the prescribed proxy amount

3.0 Calculation of prescribed proxy amount

The prescribed proxy amount (PPA) for a tax year is a percentage of the salary base (see sections 4.0 to 4.2 ), subject to the overall PPA cap (see section 5.0 ).

The percentage used to calculate the PPA is 65% of the salary base for calendar years prior to 2013. The percentage is reduced by 5% of the salary base (to 60%) for the 2013 calendar year, and by 10% of the salary base (to 55%) for 2014 and later calendar years. The proxy calculation is prorated based on the number of days in the tax year that straddle January 1, 2013 or January 1, 2014. The following formula calculates the PPA and accounts for this proration of days.

PPA = [A × 65%] – [A × 5% × B/D] – [A × 10% × C/D]

Where:

A = Salary base

B = Number of 2013 calendar days in the tax year

C = Number of days after 2013 in the tax year

D = Number of days in the tax year

Legislative reference Income Tax Regulations
Subsection 2900(4) Calculation of the prescribed proxy amount

4.0 Salary base

The salary base is an amount used to calculate the prescribed proxy amount (PPA).

The salary base is composed of salaries or wages of the claimant's employees for work performed in Canada and outside Canada (in certain cases) who are directly engaged in SR&ED . For more information on the salary or wages of employees directly engaged in SR&ED, please refer to section 7.0 of the SR&ED Salary or Wages Policy.

Table 1 illustrates the differences between the expenditures for salary or wages that can be included in the pool of deductible SR&ED expenditures and those that can be included in the salary base.

Table 1 Inclusion of amounts in the pool of deductible scientific research and experimental development expenditures vs. the salary base

Pool of deductible SR&ED expenditures Salary base for PPA
For employees other than specified employees - directly engaged salary or wages incurred and paid in the tax year or paid within 180 days of the tax year-end, including bonuses, remuneration based on profits, taxable benefits, and prior years' unpaid salary or wages paid in the year. For employees other than specified employees - directly engaged salary or wages incurred and paid in the tax year or paid within 180 days of the tax year-end, excluding bonuses, remuneration based on profits, taxable benefits, and prior years’ unpaid salary or wages paid in the year.
For specified employees – directly engaged salary or wages incurred and paid in the tax year or paid within 180 days of the tax year-end, including taxable benefits and prior years' unpaid salary or wages paid in the year, excluding bonuses and remuneration based on profits, to a maximum of 5 x year’s maximum pensionable earnings (YMPE). For specified employees – total salary or wages incurred and paid in the tax year or paid within 180 days of the tax year-end, excluding bonuses, remuneration based on profits, and taxable benefits, multiplied by the percentage of time spent on SR&ED, to a maximum of 75%. This amount is limited to 2.5 x year's maximum pensionable earnings (YMPE).
Related benefits (employer's contributions) are not included in the pool of deductible SR&ED expenditures. Related benefits (employer's contributions) are not included in the salary base for PPA.

In certain cases, claimants can earn SR&ED investment tax credits (ITCs) on permissible salary or wages for SR&ED work performed outside Canada after February 25, 2008. For more information on permissible salary, please refer to section 10.0 of the SR&ED Salary or Wages Policy. When the expenditures, or portion of the expenditures, for the salary or wages of employees performing SR&ED work outside Canada are deemed to be expenditures incurred in Canada, such salary or wages will be part of the salary base.

In summary, for any employee, whether a specified employee or not, the amount of an employee's salary or wages that the claimant can use in calculating the salary base cannot include any of the following amounts:

  • a taxable benefit;
  • an unpaid amount from a prior year and paid in the current tax year that is deemed to be an expenditure incurred in the year (amount identified on line 310 of Form T661);
  • remuneration based on profits; and
  • bonuses.

For more information on the above amounts, please refer to the SR&ED Salary or Wages Policy.

The Regulations may further restrict the amount of salary or wages that the claimant can take into account for a specified employee. For more information on the restrictions for specified employees, please refer to section 4.1.

Legislative references Income Tax Act
Section 6 Taxable benefits
Section 7 Stock options
Subsection 78 Unpaid remuneration and other amounts

Legislative references Income Tax Regulations
Subsection 2900(4) Calculation of the prescribed proxy amount
Subsection 2900(5) ASA salary or wages – proxy method
Subsection 2900(9) Exclusions to salary base

4.1 Restrictions for specified employees

The Regulations restricts the amount that a claimant can include in the salary base for a specified employee to the lesser of the following amounts:

  • 75% of the specified employee's total salary or wages, SR&ED and other (excluding bonuses, remuneration based on profits, taxable benefits, and prior year's unpaid salary or wages paid in the year); or
  • 2.5 times the year's maximum pensionable earnings ( YMPE *) for the calendar year in which the claimant's tax year ends, prorated for the number of days of employment in the year. There is no proration for the time during the year that the employee is not a specified employee.

* The YMPE is determined for purposes of the Canada Pension Plan. To obtain the YMPE for each year, use the Rates for Money Purchase limits, RRSP limits, YMPE, DPSP limits and Defined Benefits limits.

The formula to determine the maximum amount that a claimant can include in the salary base for a specified employee for the year, in other words for the second limit mentioned above, is:

2.5 × A × (B ÷ 365)

In this formula:

A is the YMPE for the calendar year in which the tax year ends.

B is the number of days in the tax year that the claimant employed the individual.

Other rules apply if a specified employee of a corporation is also an employee of an associated corporation (see section 4.2).

For information on the rules that apply to the salaries or wages of specified employees, please refer to section 6.0 of the SR&ED Salary or Wages Policy.

Legislative references Income Tax Regulations
Subsection 2900(7) Restrictions for specified employees
Subsection 2900(9) Exclusions to salary base

4.2 Specified employees of associated corporations

In addition to the restrictions discussed in section 4.1, the amount of salaries or wages that a corporate claimant can include in its salary base for an individual who is a specified employee of the corporation is restricted further. This is the case if, in the corporation's tax year ending in a particular calendar year, the corporation is associated with another corporation that has employed the same individual in its tax year ending in that particular calendar year.

The total amount of salaries or wages that the corporate claimant can include in its salary base in respect of the specified employee cannot be more than 2.5 times the  YMPE and must be shared between the associated corporations. In other words, the maximum salary or wages a claimant can include for a specified employee in calculating its salary base cannot be more than 2.5 times the YMPE, minus the amount the associated corporation has included in its salary base for its tax year ending in the same calendar year for the specified employee.

For the purposes of the above rule, the following individuals or partnerships are deemed to be corporations associated with a particular corporation for the purposes of the salary base:

  • individuals related to the particular corporation;
  • partnerships that have a partner that is an individual related to the particular corporation;
  • partnerships that have a partner that is a corporation associated with the particular corporation.

Legislative references Income Tax Regulations
Subsection 2900(8) Specified employee employed by an associated corporation
Subsection 2900(10) Deemed to be a corporation and associated

Other reference
Canada Pension Plan section 18, Year's maximum pensionable earnings (YMPE)

5.0 Overall cap on prescribed proxy amount

For most claimants, the prescribed proxy amount (PPA) is a percentage of the salary base as calculated in section 3.0. However, in certain situations, an overall cap on the PPA may limit the PPA that the claimant has otherwise determined.

The objective of the overall cap is to ensure that the total qualified SR&ED expenditures and PPA and other deductions specifically allowed under the Regulations are not greater than the total business expenditures made in the year. Generally, the overall cap on the PPA should not apply to claimants carrying on a diversified business (that includes, for example, production, marketing, and research and development). The overall cap will usually not restrict the calculated PPA if the claimant has deducted more than $55 (or between $55 and $65 for years before 2014) of non-SR&ED expenses (excluding the deductions specifically identified by the Regulations as mentioned below) for each $100 of eligible salary included in the salary base.

The overall cap is calculated based on the total expenditures for tax purposes minus certain deductions allowed under other sections of the Income Tax Act. These latter deductions are specifically identified by the Regulations, for example capital cost allowance (CCA), SR&ED deduction as per line 411 of Schedule T2SCh1, building rent, interest, etc.

The following items are the components of the calculation of the overall cap on the PPA:

  1. The total amounts deducted when calculating the net income for tax purposes from the business for the year (including the cost of goods sold).
  2. The deductions claimed in the year under sections 20 (for example, capital cost allowance, interest, bad debts), 24 (if you cease to carry on a business), 26 (for a bank), 30 (improving land for farming), 32 (if your business is that of an insurance agent or broker), 37 (for SR&ED expenditures), 66 to 66.8 (for example, exploration and development expenses), and 104 (for a trust) of the Act.
  3. The amount of expenditures incurred for the use of, or the right to use, a building (other than a prescribed special-purpose building, for years before calendar year 2014).

The calculation of the amount of the overall cap on the PPA is: A - B - C.

If a claimant carries on more than one business, the claimant should add the amounts specified under the Regulations that were deducted when calculating the claimant's income for the year from all businesses.

For an example of the overall cap calculation, please refer to Part 5, Section B – Prescribed proxy amount (PPA) of the T4088, Guide to Form T661 – Scientific Research and Experimental Development (SR&ED) Expenditures Claim.

Legislative reference Income Tax Regulations
Subsection 2900(6) Overall cap on the prescribed proxy amount

Appendix A – References

A.1 Legislative references

List of provisions
Income Tax Act Description
Section 6 Taxable benefits
Section 7 Stock options
Subsection 9(1) Income from a business or property
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – current expenditures
Subclauses 37(8)(a)(ii)(B) (I) to (VI) SR&ED expenditures in Canada under the proxy method
Subsection 78(4) Unpaid remuneration and other amounts
Subsection 127(9) Definition of “qualified expenditures” – includes the prescribed proxy amount
List of regulations
Income Tax Regulations Description
Subsection 2900(4) Calculation of the prescribed proxy amount
Subsection 2900(5) ASA salary or wages – proxy method
Subsection 2900(6) Overall cap on the prescribed proxy amount
Subsection 2900(7) Restrictions for specified employees
Subsection 2900(8) Specified employee employed by an associated corporation
Subsection 2900(9) Exclusions to salary base
Subsection 2900(10) Deemed to be a corporation and associated

A.2 Other reference

Canada Pension Plan section 18, Year's maximum pensionable earnings (YMPE)

Appendix B – Revisions

B.1 Explanation of changes

The following are the explanation of changes to the Prescribed Proxy Amount Policy as part of the revision of December 18, 2014.

Section 1.0 has been revised to delete the first sentence of the previous policy which mentioned that this policy document was a consolidation of the CRA publications that deal with the PPA for SR&ED claims.

Section 3.0 has been added to reflect the legislative changes resulting from the 2012 federal budget measures with respect to the reduction of the rate used to calculate the PPA. Section 3.0 contains a formula to calculate the PPA and accounts for a proration of the rate for the 2013 and 2014 calendar years.

As a consequence of new section 3.0 being added to discuss the calculation of the PPA, previous sections 3.0, 3.1, 3.2 and 4.0 have been renumbered as sections 4.0, 4.1, 4.2 and 5.0 respectively. Cross-referencing has been revised to reflect the above re-numbering. Table 1 found in section 4.0 was reformatted. There are no other changes to sections 4.0, 4.1 and 4.2.

Section 5.0 (previously 4.0) has been revised to reflect the reduction of the rate used to calculate the PPA for the 2013 and 2014 calendar years. Table 2 in the previous policy was reformatted into text and illustrates the calculation of the overall cap on the PPA. Consequential to the repeal of section 2903 of the Regulations after 2013, the reference to a prescribed special-purpose building has been limited to years before 2014.

Appendix A.2 "CRA publications" has been removed.

Appendix A.3 "Other references" has been renumbered Appendix A.2.

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

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