Is the SR&ED program the right one for your business to apply for tax incentives?
What is SR&ED?
The SR&ED program is a Federal program that offers tax incentives to Canadian businesses in different sectors and of different sizes to encourage them to conduct research and development in Canada. The tax incentives can be in three different forms including a tax deduction, a tax credit, or in some cases a refund.
It is clearly the largest and most well-known program that supports research and development in Canada. The businesses that are offered tax incentives are corporations, trusts, and partnerships. Tax incentives are provided to businesses to foster innovation, technological advancements, discoveries, and creativity. These will in turn lead to economic growth and the creation of jobs. Ultimately, they make Canada more competitive on a global scale.
Tax incentives under the SR&ED program are not restricted only to technology companies. Research and development can take place in any industry and in businesses of all sizes.
How much a business can claim in tax incentives?
The amount of tax credit that a Canadian-controlled private corporation can claim is 35% up to a maximum of $3 million of expenditures. This amount is refundable rather than simply a reduction of corporate taxes payable. The research and development expenses that are covered are wages, salaries, machinery, and equipment.
R&D expenses exceeding $3 million may qualify for a non-refundable tax credit of 15% although a portion of this may also be refundable given certain eligibility requirements. 40% of the income tax credit can be refunded.
What is the timeframe to apply for the tax incentives and use them?
With CCPCs, non-refundable tax credits for R&D expenses can be carried back 3 years or carried forward up to 20 years. If your company had paid taxes in any of the three previous years, you are eligible to apply for a refund against those taxes paid or simply apply the tax credits against taxes payable in future years. There is a deadline to apply for a tax credit, and that is 18 months after the financial year.
Corporations that are not CCPC, individuals (sole proprietors), and trusts can also claim SR&ED tax credits, usually at a reduced rate of 15%. However, for individuals and trusts, you first must apply the ITC against tax payable before the CRA can refund 40% of the unclaimed balance of ITCs earned in the year.
What are the expenses that can be claimed in the SR&ED program?
Wages and salaries of full-time employees can be claimed at 100%. However, if an employee works only part-time on a research project, only salaries incurred on that project can be claimed. The wages of the employee will have to be pro-rated. Detailed time-sheets related to hours spent on specific projects will have to be kept in order to back up the claims.
Expenses incurred on independent contractors can be claimed at 80% as long as the work was performed in Canada. Payments made in advance to contractors cannot be claimed until the work is performed by them. Contractors sometimes require a down-payment in order to work on projects because of the expenses they incur at the beginning of a project. The ownership of the project rests with the business and not the contractor.
Raw materials, substances, and other items that are directly used to conduct research and development can also be claimed. Overhead expenses that can be directly attributed to the research ad development can also be claimed. Third-party payments which are payments made for research and development carried on in Canada can also be claimed by the business conducting the research.
How do you know you qualify for the SR&ED program?
One way to know whether your business can qualify for a claim is to put in a pre-claim consultation request. If you prefer, you can hire an SR&ED consultant who can help you determine whether you are eligible. In fact, it is highly recommended to hire a consultant in SR&ED if you are not too familiar with the specialized nature of scientific research and development. However, if you are going the pre-claim route, you can only apply for a maximum of 3 projects per year and the claim must be filed with your tax returns at year-end. There are additional schedules to be completed that describe the SR&ED.
What determines if your SR&ED project is eligible or not?
A business can apply for SR&ED tax incentives only if it meets the stringent criteria set out by Canada Revenue Agency. The following five criteria determine whether it is SR&ED for a business to apply for tax incentives.
1. There must be a scientific or technological uncertainty
That means there is no obvious or apparent solution to a problem. Due to the limitations of current scientific, technological knowledge, and experience, there is no certainty to achieve a given result or outcome. Research and development have to be performed in order to advance the current state of technology and reduce the limitations. One example in 2020 would be to send astronauts to planet Mars and bring them back, given that we do not have the technology.
2. Were hypotheses involved to reduce the uncertainty?
Hypotheses in the context of SD&ER simply means an idea which is the starting point for further investigation to prove or disprove an idea. What kind of space vehicle we would need to send the astronauts to Mars and what kind of power-generating technologies we would need to cover such great distance in space?
3. There must be systematic investigation or search
This is simply the method by which hypotheses reduce or eliminate the uncertainties, including the testing of the hypotheses through experiment or analysis and developing conclusions from the results of the findings. That means having a systematic plan in place and using an iteration process based on test results. What are the new power-generating technologies that would need to be developed to accomplish our mission to Mars, if the current technologies do not exist?
4. There must be technological advancement
This is simply the development of new knowledge or new information to advance the understanding of scientific relationships. A project may not reach its ultimate objectives, but technological advancement may help to explain the reason for the failure by rejecting a hypothesis. Our astronauts may not end up on Mars but we may develop significant technological advancement in terms of developing new power generating technologies for long-distance travel in space than currently possible.
5. Record of the hypotheses tested and results kept for the SR&ED program
This is keeping a record of the hypotheses, tests, and results as the work progresses. For example to explain how the distinct elements of the project fit together and why they are required. Project designs, project plans, prototypes, pictures, videos, test results, timesheets, and progress reports have to be kept. In our example, that would relate to a new space vehicle powered by new power generating technologies.
If the answer to all the above questions is yes, then there is likely SR&ED and a business can put in a claim for tax incentives.
Given the complex nature of SR&ED, we recommend you consult with an expert in that area to help you determine whether you are eligible to apply for tax incentives. Proper bookkeeping of SR&ED expenses has also to be done in order to separate eligible and non-eligible deductions. As we have seen, some expenses may not qualify. To learn more about eligible business expenses, check out our blog on the top business deductions. If you do get audited a few years down the road, you want to make sure that you have your books in order and have all the supporting documents for the claims.
For more information on the SR&ED program, please check out the following CRA website.
The information in this blog is not intended to provide legal, accounting, or tax advice. It is intended for informational purposes only. You should obtain professional advice from your accountant or lawyer before acting on any information in this blog.