AG Shield Ltd. v. R. - TCC: Salary paid to main shareholders was SRED expense

AG Shield Ltd. v. R. - TCC:  Salary paid to main shareholders was SRED expense

AG Shield Ltd. v. The Queen (April 27, 2017 – 2017 TCC 68, D’Arcy J.).

Précis:  Tom and Gary McCrae each owned 50% of the shares of the taxpayer.  The taxpayer paid each of them salary of $30 per hour based on the number of hours they spend in SRED activities.  They did not receive salary for the time they spent in other corporate activities but did receive equal amounts of dividends each year.  CRA pro-rated the SRED treatment based on total hours spend by each of them and the taxpayer appealed to the Tax Court.  The Tax Court found that the amounts of salary claimed by the taxpayer fell within the definition of SRED and did not have to be pro-rated between SRED and non-SRED activities.  The appeal was therefore allowed with costs.

Decision:  At issue was a portion of the salaries paid to Tom and Gary McCrae, the shareholders of the taxpayer:

[8]             Tom McCrea was directly engaged in SR&ED activities for 1094.5 hours and in non-SR&ED activities for 1,905.5 hours. Gary McCrea was directly engaged in SR&ED activities for 201.5 hours and in non-SR&ED activities for 2,798.5 hours.

[9]             In summary, the parties agree that Tom McCrea worked 3,000 hours in 2010, of which 1094.5 were spent on SR&ED activities, and Gary McCrea worked 3,000 hours, of which 201.5 were spent on SR&ED activities.

[10]        The Appellant paid Tom McCrea wages of $26,940 and Gary McCrea wages of $11,940.

The underlying law was not complex:

[24]        Paragraph 11 of the PASF states: The Appellant used the proxy method of claiming overhead costs for its SR&ED claim in the 2010 Taxation Year. Counsel for the Appellant confirmed that the parties are referring to the election that is made under clause 37(8)(a)(ii)(B) and subsection 37(10) of the Act.

[25]        With respect to salary and wages, since the Appellant made the so-called proxy election, it was only entitled, under subclause 37(8)(a)(ii)(B)(IV), to include as an expenditure on or in respect of scientific research and experimental development that portion of an expenditure made in respect of an expense incurred in the year for salary or wages of an employee who is directly engaged in scientific research and experimental development in Canada that can reasonably be considered to relate to such work having regard to the time spent by the employee thereon . . . ”.

The Crown’s contention was that the salaries paid to the McCrea brothers had to be pro-rated in relation to both their SRED activities and their other work for the corporation:

[26]        The Respondent does not accept that the $38,880 of wages that the Appellant paid Tom McCrea and Gary McCrea was only paid for the time those two individuals spent performing SR&ED. As discussed previously, it is the Respondent’s position that the salary and wages relate to all of the work that Tom McCrea and Gary McCrea performed for the Appellant. This would include the 1,905.5 hours Tom McCrea spent and the 2,798.5 hours Gary McCrea spent performing director or management activitiesfor the Appellant.

The Court rejected the Respondent’s submission on the basis that the non-SRED work performed by the brothers was compensated by the payment of dividends:

[32]        Counsel for the Respondent argued that, if I accept that the Appellant paid the $38,880 of wages solely for SR&ED, then Gary McCrea and Tom McCrea did not receive any compensation for the significant time they spent performing director or management activities for the Appellant.

[33]        I do not accept this conclusion. The evidence before me was that Gary McCrea and Tom McCrea received compensation for such work in the form of dividends. As the controlling shareholders of the Appellant, Gary McCrea and Tom McCrea could cause the Appellant to pay them dividends, or remuneration in the form of salary and/or bonuses, for their contributions with respect to directing and managing the Appellant. As the controlling shareholders and managing directors of the Appellant, they chose to receive dividends in lieu of salary and/or bonuses. This was their choice and did not require a formal agreement.

Thus the appeal was allowed with costs.