CRA Application Policy 2000-04R2: Recapture of Investment Tax Credit

Application Policy SR&ED 2000-04R2 (June 18, 2002) is CRA’s administrative guidance on the investment tax credit recapture rules in subsections 127(27) to (35), which require credits earned on SR&ED property to be repaid when the property is sold or converted to commercial use. Its most useful guidance: all four statutory conditions must be present, recapture applies to purchased property rather than labour or overhead, and materials incorporated into a product that is later sold are the usual trigger. Read it together with the statutory text of subsection 127(27).

Key Excerpts from the Policy

Issue. The purpose of this application policy is to outline the position of the Canada Customs and Revenue Agency (the CCRA) with respect to the Investment Tax Credit (ITC) recapture rules when administering the Scientific Research and Experimental Development (SR&ED) legislation under the Income Tax Act (Act) and the Income Tax Regulations (Regulations).

Legislation. The ITC recapture rules were introduced in the February 23, 1998 federal Budget. Bill C-72, which included the provisions for the recapture of SR&ED ITC, received Royal Assent on June 17, 1999. The ITC recapture rules are contained in subsections 127(27) to (35) of the Act.

Conditions to apply ITC recapture rules. Paragraphs 127(27)(a) to (d) of the Act describe the conditions in which there will be recapture of ITC in a taxation year. This applies to corporations and individuals. However, in the case of a transfer of qualified expenditures under subsection 127(13), the circumstances are described in paragraphs 127(29)(a) to (d) (see “Recapture of ITC of allocating taxpayer” below). In the case of partnerships, the circumstances are described in paragraphs 127(28)(a) to (d) (see “Partnerships” below).

The conditions described in paragraphs 127(27)(a) to (d) are:

(a) the taxpayer acquired a particular property from a person or partnership in a taxation year of the taxpayer or in any of the 10 preceding taxation years,

(b) the cost of the particular property was a qualified expenditure to the taxpayer,

(c) the cost of the particular property is included in an amount, a percentage of which can reasonably be considered to be included in computing the taxpayer’s ITC at the end of the taxation year, and

(d) in the year and after February 23, 1998, the taxpayer converts to commercial use or disposes of the particular property or another property that incorporates the particular property.

Note: All four conditions have to be present to create a recapture of ITC.

When are the rules applicable? The ITC recapture rules apply to dispositions and conversions of property that occur after February 23, 1998. Note that ITCs earned on expenditures incurred before February 24, 1998 are subject to recapture provided that the disposition of the property or its conversion to commercial use takes place after February 23, 1998 and the above conditions are met.

Tax policy intent: reflecting the net cost of performing SR&ED. At the outset of an SR&ED project, a claimant may not know whether the materials used in the project will be consumed or will result in a product that has some value. For equipment used in SR&ED a claimant may intend to use the property in SR&ED throughout its useful life, but subsequently changes its use or disposes of it. The recapture rules are intended to reflect the net cost of performing SR&ED. Since this net cost cannot be determined at the outset, the recapture rules will reverse all or a portion of the ITC when the sale of the SR&ED property takes place or when it is converted to commercial use.

No recapture on SR&ED salaries and SR&ED overhead. It is not intended that the rules be applied to recapture ITC in respect of SR&ED labour costs or overhead expenditures. There will be no ITC recapture in respect of any property that is constructed or produced by the claimant, apart from the cost of purchased components or materials (such as a motor in a machine). The first condition in paragraph 127(27)(a) requires that the property subject to recapture must be acquired from a third party. Further, subsection 127(32) of the Act specifies that for the purposes of subsections (27), (28) and (29), the “cost of the particular property” to a taxpayer shall not exceed the amount paid by the taxpayer to acquire the property from a transferor of the property and does not include amounts paid by the taxpayer to maintain, modify, or transform the property.

… [the remainder of the policy, including worked Examples 1 to 7 and the sections on partnerships and allocating taxpayers, is omitted here but appears in the PDF] …

Source: Canada Customs and Revenue Agency, Application Policy SR&ED 2000-04R2, Recapture of Investment Tax Credit, June 18, 2002 (historical administrative guidance; CRA’s current position appears in its SR&ED policy documents). See also the companion page reproducing subsection 127(27) of the Act.