Mr. A owns all the common shares of ABC Limited, a Canadian-controlled private corporation. ABC Limited incurred certain costs in the development of a new process that qualifies for SR&ED expenditures treatment.

Of the indirect costs, Mr. A believes that approximately 20% is applicable to the development of the new process, but the corporation’s accounting system is not sophisticated enough to identify the direct overhead costs.

Included in the direct labour costs is a salary of $50,000 paid to Mr. A’s daughter, a professional engineer who spent 90% of her time on SR&ED activities.

ABC Limited has not had any SR&ED expenditures in the past and had taxable income for the preceding year of $135,000. Taxable capital in the preceding taxation year was $800,000. ABC Limited is not associated with any other corporation. The corporation does not anticipate that it will have any taxable income for this taxation year.

REQUIRED

Describe the tax treatment of the direct and indirect development costs of the new process on the assumption that the new process meets the requirements as SR&ED expenditures for the taxation year ending December 31, 2016.

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Direct material Direct labour Indirect costs overhead $250,000 200,000 150,000