Government Assistance or Loan?

Reproduced from the August 2013 edition of the Canadian Tax Highlights, a Canadian Tax Foundation publication

SR&ED activities are often funded by governmental programs such as the federal Industrial Assistance Research Program (IRAP). A successful SR&ED claim cannot be based on funds that were extended as government assistance and those funds cannot generate refundable investment tax credits. “Government assistance” is defined to mean assistance from a government, municipality or other public authority whether as a grant, subsidy, forgivable loan, deduction from tax, investment allowance or any other form of assistance other than” the federal investment tax credit (subsection 127(9)). A loan is government assistance only if it is a forgivable loan. The difference is considered by the TCC in Immunovaccine Technologies Inc. (2013 TCC 103), which concluded that funds extended by the Atlantic Canada Opportunities Agency (ACOA), a federal agency, constituted government assistance and not a bona fide loan. An appeal to the FCA was filed on May 10, 2013.

The decision sets out the contribution agreement between ACOA and the taxpayer on December 31, 2004, which specifies that the taxpayer must repay the ACOA contribution in annual installments calculated as a percentage of all gross revenues from any source. The first repayment was due on December 1, 2008 and repayment was to continue until the contribution was repaid in full. Each repayment was 2 percent if annual gross revenue in the immediately preceding year was less than $5,000,000 and 10 percent if gross revenue was more. No security was provided to ACOA if the contribution could not be repaid; no interest was charged. The agreement also further provided that if the taxpayer did not generate gross revenue, the agreement terminated upon the ACOA’s consent without any further repercussions to the taxpayer. The taxpayer acknowledged that it did not receive any other federal, provincial, or municipal financial assistance other from the ACOA. On numerous occasions, the agreement referred to the ACOA funding as a contribution.

The taxpayer said that the agreement’s reference to its termination if the taxpayer did not generate gross revenues merely reflected the business reality for all start-ups and business ventures: a loan or investment was not recoverable if the company was not successful. The taxpayer also argued that the contribution was a loan. Furthermore, the taxpayer said that the phrase “any other form of assistance” at the end of the government assistance definition should be read ejusdem generis with the preceding examples enumerated: the catch-all phrase only encompassed the extension of funds for which there was no expectation of repayment. Because on the facts the agreement provided for the funding’s repayment, it was not caught in the catch-all phrase “any other form of assistance” in the definition of government assistance.

The TCC disagreed, saying that the addition of the term “forgivable loan” in the enumerated items made it clear that the definition of government assistance extended beyond government acts that were purely gratuitous and unilateral. According to the court, the real test was set out in CCLC Technologies ([1996] FCJ No. 1226) in which the FCA focused on whether the contribution made by the government body was made “in exactly the same way for exactly the same reasons as payments made by private business, that is, for the purpose of advancing the interests of the payor”. In CCLC  the government of Alberta contributed funds in return for equity in the taxpayer`s technology development project.  The province agreed that if the technology became commercially successful, the province would sell back its equity for a price equal to the funds contributed plus interest. The FCA concluded that the funds extended by Alberta were government assistance: the agreement between the taxpayer and the province did not give the province any lasting property rights in the technology if the venture became commercially valuable. That was an arrangement, the court said, that an entity would not enter into to advance its business interests. On the facts in Immunovaccine Technologies, the TCC concluded that the fact that ACOA could not receive any net profit on the money invested in the appellant's ventures, combined with ACOA's objectives under the ACOA Act, made it clear that ACOA was not dealing with the taxpayer on basic commercial terms and was not acting in its own business interests. 

The TCC looked to the statutory context relating to the deductibility of SR&ED expenses and the related ITCs, under which the deductions and credits are deferred until the government assistance is repaid, This scheme, said the court, “reflect[s] Parliament's intention to restrict access to tax relief for SRED expenditures and to refundable investment tax credits (ITCs) where relief was provided in some other form. In other words, if another party has borne the economic cost of a taxpayer's participation in scientific research and experimental development, there is no need to allow deductions or credits as an incentive for that taxpayer to engage in SRED activities.” The scheme could only buttress the court’s conclusion that the funding was government assistance, because the rules outlined only operate in respect of government assistance.

The court also reviewed the ACOA legislation and concluded that although the ACOA was given a broad array of powers to enable it to achieve its objectives, it was not authorized to carry on business. ACOA’s  main objective was to strengthen the local economy in Atlantic Canada by “supporting the development of knowledge-based industry” and “help[ing to] increase the region’s capacity to carry out leading-edge research and development.” The court concluded that ACOA was not acting in its own business interest, a fact underscored because it could not receive any net profit on the contribution to the taxpayer’s ventures and also by the ACOA objectives as set out in the governing legislation.

Government assistance that is used in SR&ED activities and not repaid in the year of a SR&ED claim does not qualify as deductible SR&ED expenses or as refundable ITCs. However, if the assistance is repaid by the claimant, paragraph 37(1)(c) provides that the deductible expenditure pool for SR&ED activities in the year of repayment is increased by the amount by which the pool was previously reduced. Similarly paragraphs 127(9)(e.1) and (e.2) of the ITC definition allow the claimant to include an amount repaid in the year of repayment in order to calculate his ITC.

On the advice of its auditors and accountants the taxpayer sought unsuccessfully from ACOA an amendment to the agreement to require repayment on a fixed monthly repayment schedule instead of repayment based upon a percentage of gross revenues. The fixed monthly repayment amount would have been added under paragraph 37(1)(c) to the deductible expenditure pool for SR&ED activities and included in the ITC calculation under paragraph 127(9)(e.1) and (e.2).

Sunita Doobay

TaxChambers, Toronto