Tax Design and Legislation Branch
Tax Legislation Bulletin Number 98-12, October 1998
INTRODUCTION
In the 1997 Budget, Ontario announced the Ontario New Technology Tax Incentive (the "ONTTI") to encourage the development and transfer of new technology. The rules discussed in this bulletin are contained in sections 11.1 and 13.1 of the Corporations Tax Act (CTA) and in section 203 of Regulation 183 under the CTA. This bulletin is provided as a guide for taxpayers. It is not intended as a substitute for the legislation or the regulations. For precise details, the reader should consult the CTA and the regulations.
1. General
Prior to the May 6, 1997 Ontario Budget, taxpayers were generally entitled only to a gradual deduction of the costs of intellectual property acquired for use in their businesses. For example, corporations could claim 25% of the capital cost of patents (Class 44) on a declining balance basis, subject to the "half-year rule". The capital cost of class 14 properties such as franchises or licences could be claimed on a straight line basis over the life of the particular contract. The portion of eligible capital expenditures for other intangible properties that is included in cumulative eligible capital could be deducted on a 7% declining balance basis.
As announced in the 1997 Budget, the ONTTI allows taxpayers a 100% immediate write-off of the eligible cost of qualifying intellectual properties acquired in the course of an intellectual property transfer. Where a corporation uses the qualifying property exclusively in Ontario and allocates part of its taxable income to other jurisdictions, the eligible costs can be grossed-up by the Ontario allocation factor to ensure that the full value of the deduction is realized for Ontario income tax purposes.
2. Eligible Costs
The eligible cost of a qualifying intellectual property of a taxpayer is the taxpayer's capital cost of the property that is included by the taxpayer for the purposes of the Income Tax Act (Canada) (ITA):
- in the undepreciated capital cost of Class 14 or Class
44 of Schedule II to the ITA; or
- in computing its eligible capital expenditures ( Reg.183 subsection 203(1)).
3. Intellectual Property Transfer
An intellectual property transfer is an acquisition of qualifying intellectual property by a corporation from an unrelated person for the purpose of implementing an innovation or an invention in the corporation's business that is carried on in Ontario ( Reg.183 subsection 203(1)).
4. Qualifying Intellectual Property
A qualifying intellectual property is a patent (whether domestic or foreign), a licence, a permit, know-how, a commercial secret, a process, a formula or other similar property constituting knowledge that is acquired in the course of an intellectual property transfer, but it does not include:
- a property that is used primarily to earn rent or
royalties; or
- a trademark, an industrial design, a copyright, or other similar property constituting the expression of knowledge ( Reg.183 subsection 203(1)).
5. Ontario New Technology Tax Incentive
The eligible costs of qualifying intellectual properties are included in a Class 12 capital cost allowance ("CCA") pool and allowed as a 100% deduction from income in the year of acquisition (Reg.183 subsection 203(2)).
To claim the ONTTI, a taxpayer must meet the following criteria:
- the taxpayer acquired the qualifying intellectual
property after August 31, 1997 in an intellectual property transfer under a
contract entered into after May 6, 1997;
- the property is first used by the taxpayer in carrying
on its business in Ontario within a reasonable time following acquisition and
continues to be used during the entire period in which the innovation or
invention is being implemented;
- for federal income tax purposes, the eligible cost of
the qualifying intellectual property is included by the taxpayer in the
undepreciated capital cost of its Class 14 or Class 44 assets or is included in
computing its eligible capital expenditures;
- for Ontario tax purposes, the eligible cost of the
qualifying intellectual property is included by the taxpayer in the
undepreciated capital cost of its Class 12 assets and a separate class is
established for each property.
- the total of all eligible costs included in Class 12 assets for ONTTI purposes for a year must not exceed the taxpayer's expenditure limit for that year.
A taxpayer's total ONTTI deduction for a taxation year is equal to the total amount of CCA allowed in respect of each ONTTI property. Neither the "half-year" rule nor the "available for use" rule applies for ONTTI purposes (Reg.183 subsection 203(10)).
6. Ontario New Technology Tax Incentive Gross-up
The ONTTI is a deduction in computing income for Ontario tax purposes. Taxpayers that use a qualifying intellectual property exclusively in Ontario are entitled to a special gross-up in order to reflect the value of the ONTTI that would otherwise be reduced to the extent that the taxpayer earns income outside Ontario (section 13.1). The gross-up is calculated according to the following formula:
A = B/C - B, where
"A" is the taxpayer's ONTTI gross-up for
the year;
"B" is the amount of ONTTI for the year before
applying the gross-up; and
"C" is the taxpayer's Ontario
allocation factor for the year.
Example:
A taxpayer spends $100 on acquiring a patent in the taxation year. The taxpayer's Ontario source income is 30% (the Ontario allocation factor). Its ONTTI gross-up will be $233 ( $100/.3 - $100 = $233).
Without the gross-up the taxpayer would only have a $30 ($100 × .3) reduction in its income allocated to Ontario. The ONTTI gross-up allows the taxpayer to claim a deduction of $333 ($100 of eligible cost + $233 of gross-up) in computing its income before allocation to Ontario. As a result, the taxpayer will have a full $100 ($333 × .3) deduction from income allocated to Ontario.
The ONTTI gross-up is based on CCA claimed in respect of qualifying intellectual property. If a taxpayer only claims a portion of the CCA available for a qualifying intellectual property in computing income for the taxation year, the gross-up will only be available for that portion of the CCA. Using the example above, if the taxpayer decides to claim $50 of the deduction in a taxation year instead of the $100 allowed, only $117 ($50/.3 - $50) of the gross-up would be allowed in the taxation year. The total ONTTI deduction of the taxpayer in computing its income before allocation to Ontario would be $167 ($50 + $117). The taxpayer would be able to deduct $50 ($167 × .3) from its income allocated to Ontario.
When the taxpayer claims the remaining $50 in a subsequent taxation year, the amount will generate a further gross-up based on the Ontario allocation factor of that year.
7. Ontario New Technology Tax Incentive Gross-up Recapture
Where a taxpayer sells a qualifying intellectual property in a taxation year, all or part of the ONTTI deduction may be recaptured under the regular CCA rules since each qualifying intellectual property is in a separate class (section 11.1). To ensure that the appropriate benefit of the ONTTI deduction is recaptured, the taxpayer is also required to include an ONTTI gross-up recapture in computing income for the taxation year. The ONTTI gross-up recapture is calculated in accordance with the following formula:
A = B/C - B, where
"A" is the taxpayer's ONTTI gross-up
recapture for the taxation year;
"B" is the amount of ONTTI
recapture for the taxation year before the gross-up; and
"C" is
the taxpayer's Ontario allocation factor for the taxation year in which
the property is sold.
8. Reduction of Non-Capital Loss
Where a taxpayer's ONTTI gross-up creates a non-capital loss which is then applied to reduce the income of other taxation years, the amount of the non-capital loss may be subject to a reduction. Under section 35 of the CTA, the minister may reduce the non- capital loss applied if the Ontario allocation factor for the taxation year to which the loss is being applied exceeds 120% of the Ontario allocation factor for the taxation year in which the loss is incurred. This reduction is to prevent the application of artificially increased losses to other taxation years.
9. Expenditure Limit
The expenditure limit of a taxpayer for a taxation year is the maximum amount of eligible costs that the taxpayer may add to the undepreciated capital cost of Class 12 assets for the taxation year in respect of qualifying intellectual properties (Reg.183 subsections 302(6) to (9)).
- The expenditure limit for a taxation year is $20
million.
- Where a taxpayer is associated with one or more other
taxpayers in a taxation year, the associated group shares the $20 million
limit. The expenditure limit of each associated member for the taxation year is
determined by the following rules:
- If all associated taxpayers have filed with the
Minister an agreement in a form acceptable to Minister allocating the $20
million limit between them and the total of all amounts allocated does not
exceed $20 million, the expenditure limit for the taxation for each taxpayer is
the amount allocated to it.
An agreement will be considered acceptable to the Minister if the agreement contains the following information for each taxpayer in the associated group:
- legal name
- Ontario corporate tax account number (not applicable for partnerships)
- head office address
- taxation year-end (fiscal year-end for partnerships)
- expenditure limit for the taxation year
- name and position (or office) of authorized officer
- signature of authorized officer
- If the Minister notifies in writing any taxpayer in
an associated group to file an allocation agreement for a year and no agreement
is filed within 30 days after the notice, the Minister may allocate the $20
million limit between one or more members of the group. The amount so allocated
will be the respective taxpayer's expenditure limit for the year.
- Where no allocation agreement is filed by the
associated taxpayers and no allocation is made by the Minister, the expenditure
limit for each taxpayer for the taxation year will be nil.
- Where a taxpayer has more than one taxation year
ending in a calendar year in which it is associated with another taxpayer, the
expenditure limit of the taxpayer for the second or subsequent taxation year
that ends in the calendar year is equal to the lesser of:
- Its expenditure limit determined under (I),
(ii) or (iii) for its first taxation year ending in the calendar year, prorated
by the ratio of the number of days in the taxation year to 365; and
- its expenditure limit determined under (I), (ii) or (iii) for its second or subsequent taxation year ending in the calendar, prorated by the ratio of the number of days in the taxation year to 365.
- Its expenditure limit determined under (I),
(ii) or (iii) for its first taxation year ending in the calendar year, prorated
by the ratio of the number of days in the taxation year to 365; and
Example:
X Co. and Y Co. are associated and both have a taxation year ending June 30. X Co. and Y Co. choose to allocate $10 million each as their expenditure limit for the first taxation year.
On July 1, Z Co. becomes associated with X Co. and Y Co. Z Co.'s taxation year end is September 30. X Co. and Y Co. change their taxation year end to September 30. The associated group allocates the $20 million for the second taxation year as follows:
- $5 million to X Co.;
- $5 million to Y Co.; and
- $10 million to Z Co.
Since the period July 1 to September 30 is the second taxation year of X Co. and Y Co. that ends in the calendar year, the expenditure limit for X Co. or Y Co. for the second taxation year is $1.12 million, which is the lesser of:
- $10 million × 82/365 = $2.24 million; and
- $5 million × 82/365 = $1.12 million.
- If all associated taxpayers have filed with the
Minister an agreement in a form acceptable to Minister allocating the $20
million limit between them and the total of all amounts allocated does not
exceed $20 million, the expenditure limit for the taxation for each taxpayer is
the amount allocated to it.
- For taxpayers whose taxation year is less than 51 weeks
(except in the case where (b)(iv) applies) the expenditure limit for the
taxation year must be prorated by the ratio of the number of days in the
taxation year to 365.
- For taxpayers whose taxation year straddled May 7, 1997, the expenditure limit for the taxation year must be prorated by the ratio of the number of days in the taxation year ending after May 6, 1997 to the number of days in the taxation year.
For all circumstances, the unused expenditure limit in a taxation year may not be carried forward to subsequent years or carried back to prior years.
10. Associated Corporations
For the purpose of determining a taxpayer's expenditure limit, corporations are associated with each other if they are associated in the taxation year under section 256 of the ITA (Reg. 183 subsection 203(10)). A partnership and a corporation or two or more partnerships are deemed to be associated with each other in a taxation year if on the application of the following rules they would be associated under section 256 of the ITA:
- A partnership is deemed to be a corporation with one
class of issued shares that have full voting rights and each partner is deemed
to own a proportionate number of the shares based on its percentage share of
the income or loss of the partnership.
- Two partnerships are deemed to be associated if each
member of one partnership is also a member of the other partnership or is
related to at least one member of the other partnership.
- A taxpayer that is deemed to be associated with another taxpayer will be deemed to be associated with every corporation and partnership that is deemed to be associated with the other taxpayer.
11. Partnerships
A partnership, other than a limited partnership, may claim the ONTTI in computing the partnership's income prior to allocating the income to its corporate partners (Reg. 183 subsection 203(1)). However, only corporate partners are eligible for the ONTTI and their share of the ONTTI in the partnership is based on their percentage of income or loss in the partnership. The ONTTI gross-up is applied at the level of the partner using the partner's Ontario allocation factor.
12. Non-arm's Length Transfer
Where an ONTTI property is transferred by a taxpayer to a related person, the regular rules in respect of a disposition of a capital property to a related person apply. As long as the property is acquired by the transferee for the purpose of gaining or producing income, the property will be deemed to be in the same class as the class in which it was last included by the transferor (ITA regulation subsection 1102(14)). Hence, the ONTTI including the gross-up previously available to the transferor, will be available to the transferee if the transferred property continues to be used within a reasonable time after the acquisition and is used during the entire period when the innovation or invention is being implemented (Reg. 183 subsection 203(15)).
When the transferred property is subsequently disposed of by the transferee to an unrelated party, the transferee is required to include, in computing its income, the recapture of CCA as well as the ONTTI gross-up recapture if applicable.
13. Failure to Use Qualifying Intellectual Property as Required
If a taxpayer fails to use the qualifying intellectual property continuously throughout the implementation period of the innovation or invention or uses the property to earn rent or royalties, the taxpayer will be reassessed as follows:
- The ONTTI claim will be disallowed.
- The property will be deemed never to have been a qualifying intellectual property and will be included in the appropriate CCA class or in the eligible capital expenditure pool, so that the regular CCA or eligible capital expenditure may be claimed (Reg. 183 subsection 203(15)).
For further information please contact:
Ministry of Revenue
Corporations Tax Branch
Tax
Advisory
33 King Street West
Oshawa, Ontario L1H 8H5
Tel. (905)
433-6513 Fax 905 433-6747
