By Earl Forman, CPA, CA, Partner and Mitchell Weiss, Senior Manager, Tax, Richter Montreal
Too often companies don’t know that they perform scientific research and experimental development (SR&ED) through their daily activities. Consider these questions:
- Are you in a start-up or growth phase?
- Have you developed some form of customized equipment or machinery?
- Have you created or modified a process or product?
- Are you planning to change an existing process or develop a new product in the near future?
- Have you tried to create a new product, process, or technology but failed in the attempt?
Hurray! If you answered yes to one or more of these questions, your company could be eligible to federal and provincial SR&ED tax credits!
What are SR&ED tax credits?
SR&ED tax credits are fiscal measures through which the federal and provincial governments reimburse investments in innovation. Millions of dollars are allocated annually to these programs to foster innovation. Each year, nearly 25,000 companies in Canada claim such tax credits, among which almost 75 per cent are SMEs.
Six common myths debunked
Many companies perform research and development without claiming the credits they are entitled to. Why is that? It’s time to debunk some of those myths:
1. “Just part of my business”
In order to be eligible, SR&ED expenses do not need to be part of a specific or special research and development program. If you have developed any new product, process, or technology as part of your normal activities, you may be entitled to tax credits.
2. “Secrets will be revealed”
SR&ED claims do not require that you reveal industrial secrets but only that you demonstrate the scientific value of your activities. The documentation will be shared with the Canada Revenue Agency (CRA) exclusively, which is bound by strict confidentiality rules.
3. “Lab coats and PhD are required”
You do not have to fit the mold of traditional research to be eligible to SR&ED claims. The lack of a dedicated laboratory or professional researchers is not an obstacle.
4. “It will trigger a full-blown audit by the CRA”
This common fear is unfounded. In the many years working on SR&ED claims for a number of clients at Richter, I have never encountered a case where such a file triggered a complete audit by the CRA.
5. “We didn’t achieve results”
SR&ED credits regulation specifically states that research and development activities do not need to succeed for expenses to be eligible. As explained in this article, the process and the methodology used are what matters.
6. “SR&ED claim is an onerous process”
SR&ED claims should not be viewed as an expense. In reality, it is an investment that could provide you with a significant return.
How does it work?
SR&ED tax credit programs simply reimburse a part of the expenses incurred by companies with non-refundable tax credits (lowering your income tax payable) or refundable tax credits (cash).
|Eligible Expenses||Reimbursement Rate|
• Sub-contractors (80%)
|15% or 35%|
• Sub-contractors (50% in Quebec)
• Overhead salaries
|14% to 30%|
How much can you get? The ABC example
The amount of tax credits you can get depends on the expenses incurred for the development (or failure ) of your new process, product, or technology. The Quebec credits feature an exclusion threshold. The first $50,000 of eligible expenses is automatically excluded and up to $225,000 can be excluded, depending on the company’s assets.
Let’s look at the fictitious case of ABC Company Inc., who worked on developing a new artificial intelligence tool. ABC’s expenditures are as follows:
- Salaries: $100,000
- Sub-contractors: $10,000
- Material: $1,000
As shown in the table below, ABC’s $111,000 in SR&ED expenditures could translate into $68,125 for the company in net cash refund.
|Example SR&ED Credit Calculation (with Quebec Exclusions)|
|Expenses|| Federal Rate
| Provincial Rate
Overhead Proxy (55%)
$5,000[Not eligible] [Not eligible]
|Less Provincial Tax Credit||($16,500)|
|Eligible Expenses for Tax Credit||$147,500||$55,000|
|Total Tax Credit||$68,125|
Do you qualify?
To assess your SR&ED tax credits claim and determine its eligibility, the CRA uses five questions:
- Was there a scientific or a technological uncertainty?
- Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
- Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
- Was the overall approach undertaken for the purpose of achieving a scientific or technological advancement?
- Was a record of the hypotheses tested and the results kept as the work progressed?
If the answers to these questions are positive, you are ready to file a claim!
What do you need to file a claim?
The key to file a successful claim for SR&ED is to provide comprehensive and relevant information clearly stating the expenses incurred and the scientific value of the activities. This documentation can include:
- project planning documents;
- timesheets (or equivalent);
- design of experiments;
- project records, lab notebooks;
- design, system architecture, source code;
- records of trial runs;
- progress reports;
- test protocols, test data, analysis of test results;
- photos, videos;
- samples, prototypes, scrap;
- contracts; and
- meeting notes.
It is of the utmost importance that the documentation submitted shows that it is contemporaneous to the activities.
How to maximize your SR&ED claim
There are many factors to consider when preparing or filing a claim in order to maximize your return. Here are a few things to consider.
A timely claim
You have up to 6 months after the end of the fiscal year to file a claim as part of your original annual income tax return. You can also file a claim or amend an already filed tax return up to 18 months after the end of the fiscal year. No claims can be submitted or adjusted thereafter.
Plan your expenses to maximize your return
Some expenses are fully eligible, while others are only partially eligible. Therefore, you should plan expenses in order to maximize reimbursement. For example, expenses related to employees will provide you with greater returns than those incurred by sub-contractors.
The amount of SR&ED credits available is directly related to the expenses incurred for a given project. Maximizing shareholder/employee remuneration will enhance the value of the claim and the credits to which you are entitled.
Consider tax implications on the following year’s income
Don’t forget that SR&ED tax credits are considered taxable income the year they are received. Robust tax planning is needed in order to minimize the fiscal impact of this added income.
Is SR&ED the best program?
Some projects may have components that qualify for multiple tax credits: the E-Commerce tax credit (Crédit d’impôt pour le développement des affaires électroniques), the tax credit for the production of multimedia titles, or the Design tax credit (Crédit d’impôt pour la réalisation d’une activité de design à l’interne). The Ontario government also offers specific tax credits for digital media and innovation. While you are allowed to claim different tax credits for the same project, all claims must be related to different elements of the project. Since you cannot claim multiple credits for a single expense, you should take time to determine which fiscal program will generate the most beneficial return.
Stay focused on your business
While it is possible to manage the filing of a SR&ED tax credit claim internally, we strongly recommend using the help of seasoned professionals for this process. Professionals will accelerate the CRA approval process and significantly increase your claims’ success rate. Fiscal planning and administrative paperwork will be taken care of, meaning you can stay focused on what matters most: your business.