SR & ED Performed Under Contract: Whose SR & ED Is It?

Where one party performs SR & ED under contract with another party, the tax authorities have an interest in ensuring that both parties do not make SR & ED claims for the same work. Where the amount paid fits the definition of a contract payment (which is similar under both Quebec tax legislation and the Income Tax Act), only the payer can make the claim. In MDA Systems Ltd. (2020 QCCQ 4190; under appeal), the Court of Quebec ruled that the funding party’s payment to the taxpayer fit this definition, significantly reducing the amount of the SR & ED tax credit for salaries and wages the taxpayer could claim. This is a landmark decision on a rarely litigated but crucial question that is highly relevant to the pricing of SR & ED projects to be done under contract.

The case concerned a project involving different phases of satellite design, manufacture, and delivery funded by the Canadian Space Agency and contracted out to the taxpayer. The issue was whether all or part of the amount paid was a contract payment. In both Quebec and Canadian tax legislation, a “contract payment” is defined as an amount paid to a taxpayer for SR & ED to be performed for or on behalf of a taxable supplier. Generally, the application of this concept reduces the amount used as the basis for calculating SR & ED tax incentives.

To determine the nature of the payments received by the taxpayer, the court analyzed the four criteria set out in section 5.5 of the CRA’s “Assistance and Contract Payments Policy.” Despite the fact that these criteria are not in the law itself, the court relied strictly on them and on tax practitioner Lucie Bélanger’s comments about them. The court also affirmed that this issue was a question of mixed fact and law and noted that none of these criteria are, in themselves, conclusive. The court’s analysis of the four criteria was as follows:

  • Contractor performance requirements. The project contracts did not contain any explicit requirement that the taxpayer perform SR & ED. However, the court considered that, given the sophisticated and novel nature of the deliverables, the parties knew that this would be necessary. The court used this interpretation to conclude that SR & ED was an implied requirement of the contracts, rather than conducting an analysis of the parties’ common intent—a crucial point of analysis in Quebec civil litigation. This interpretation was a key element favouring the Crown, so it is expected to be central to the taxpayer’s planned appeal.
  • Pricing versus risks assumed. The court conducted an overall analysis of the contractual agreements to determine that the funding party was assuming the majority of the financial risks should the project fail. Again, this supported the Crown. However, the court did not analyze each of the project phases separately, even though the phases had different terms.
  • Intellectual property. The court found that this criterion supported the Crown because the intellectual property ultimately belonged to the funding party—even though the taxpayer had obtained perpetual, irrevocable, and royalty-free licences to use the intellectual property resulting from the SR & ED.
  • Contract for services. The project contracts were held to be service contracts (not contracts for the sale of goods) within the meaning of article 2103 of the Civil Code of Québec, because SR & ED was crucial (not incidental) to the project and there was an implied obligation to perform SR & ED. This again supported the Crown, so all four criteria were held to support the Crown’s case.

Another notable aspect of the judgment is the brief and enigmatic comment in paragraphs 87 and 88 on the current model of burden of proof in tax appeals. These paragraphs are not completely consistent with recent FCA decisions (notably Sarmadi v. Canada, 2017 FCA 131 and, more recently, Eisbrenner v. Canada, 2020 FCA 93).

Marie-France Dompierre
Davies Ward Phillips & Vineberg LLP, Montreal

Etienne C. Laplante
Lavery de Billy LLP, Montreal

Canadian Tax Focus
Volume 11, Number 1, February 2021
©2021, Canadian Tax Foundation