The following list represents answers to some frequently asked questions about the Scientific Research and Experimental Development (SR&ED) tax credit program. To understand how SRE&ED tax credits apply to your company's unique circumstances, or for details on other tax credit programs, speak with a TSI SR&ED professional and learn what our team of SR&ED experts can do for your bottom line.
SR&ED stands for Scientific Research and Experimental Development. The SR&ED tax credit program is a tax incentive program to encourage innovation in Canada. The Canada Customs and Revenue Agency (CRA) administers the program, and claims are made through income tax returns. While most claims are made by corporations through their corporate income tax return, the SR&ED tax credit program is also available to partnerships and sole proprietorships.
Most SR&ED claims are made on the basis of experimental development by businesses in virtually all industry sectors, ranging from those in manufacturing, information technology, and software development, to companies in chemical processing, medical, and food science industries. In fact, any time a company in one of these industries is creating or improving a new product or process, it is highly likely that they will be eligible for SR&ED tax credits. In many cases the tax credits result in a cash refund to the company of up to 73% of their SR&ED expenditures for both federal and provincial programs combined.
The amount of money that can be recovered from a SR&ED claim depends on a number of factors, including the type of expenditure, the province of activity, the structure of the company, and certain financial factors such as profitability and taxable capital.
Investment tax credits are contributed by the Federal government, and in most cases are coupled with Provincial credits.
For Canadian Controlled Private Corporations operating in Ontario, for example, a company could be eligible to receive up to 73% on qualifying labour expenditures, and up to 44% on qualifying materials and contractor expenditures.
In all cases, taxes owing are paid first. For Canadian Controlled Private Corporations, the remainder is refunded in cash. For other company structures, none or only a portion of the expenditures may be refundable, and may instead be available as tax credits. These credits may be carried back three years to apply against taxes which were paid or are payable, and may be carried forward for up to 20 years to apply against future taxes payable.
Learn more about how much money you can recover from a SR&ED funds claim and see an example of the calculations involved.
What expenditures are eligible for SR&ED tax credits?
There are two methods by which you can claim SR&ED expenditures - the proxy method or the traditional method.
Proxy method. Most companies claiming SR&ED tax credits claim under the proxy method. The proxy method is a simple approach to claiming SR&ED expenditures. Under this method the following expenditures may be claimed:
Wages for staff doing hands-on work on SR&ED activities
Materials used up or consumed in performing SR&ED (Note: materials which ultimately go into commercial production or are sold need special consideration and analysis in order to determine if they may be claimed).
Payments made to contractors to carry out SR&ED on behalf of the company
Leased equipment to the extent that 90% of the lease relates to SR&ED (A portion of SR&ED tax credits claimed to the extent that 50% of the lease relates to SR&ED)
Capital equipment to the extent that it is new and used 90% or more in SR&ED (Partial tax credits are available if the capital equipment is used 50% or more in SR&ED)
In addition to the above, overhead may be claimed based on a factor of 65% of direct SR&ED salaries. The 65% factor only applies to salaries (amounts reported on T4 slips, for employees on the company's payroll). Note, contract payments, management fees, or shareholder draws do not apply to this calculation. Generally, where SR&ED is labour-intensive, most companies select the proxy method since 65% of directly engaged SR&ED salaries and wages far exceed actual overhead.
Traditional method. The second method is known as the traditional method, which includes all of the above costs as well as:
Actual overhead to the extent that it relates to SR&ED activities (rather than a proxy estimation)
Administrative salaries and wages to the extent that they relate to SR&ED
Capital equipment or leased equipment to the extent that it relates to SR&ED
Typically, we find companies that do not pay salaries or wages, or have a high degree of overhead, will claim under the traditional method. Our experience is that more than 90% of companies claim under the proxy method, but we will be able to advise you of the optimal method for your particular environment.
Will the work my company is doing qualify for SR&ED tax credits?
If you are a Canadian-controlled private corporation (CCPC), a publicly traded Canadian corporation, a foreign held corporation, a partnership, or a sole proprietorship that develops new or improved materials, products or processes in Canada, you may be eligible to receive SR&ED tax credits if:
Your work plan, if completed successfully, will result in a technological advance in your industry or field (even if your attempts prove unsuccessful, you may still qualify)
You have overcome one or more new or unexpected technological problems or uncertainties
You carry out the development in a systematic manner, such as conducting trials, experiments or analyses in order to solve these problems
You require experienced and trained specialists to complete the development of your SR&ED project
It also helps if you can demonstrate that the work was done with supporting evidence such as reports, models, prototypes, test results, logbooks, or photographs.
Our accountants prepare our taxes. Can't they prepare these SR&ED claims for us?
Preparing a successful SR&ED claim requires both technical and financial expertise. Most accounting firms don't support in-house technical experts. Our accountants work hand in hand with your accountant to ensure the filing is done correctly. In fact, many accounting firms seek our expertise and services in order to ensure that their clients receive the best advice and processes when it comes to maximizing their SR&ED tax credit.
If you are a Canadian Controlled Private Corporation, you should ideally submit your SR&ED claim with your T2 Corporate Income Tax Return within six months of your fiscal year-end. However, you must file your SR&ED claims within 18 months of the end of the taxation year in which you are making a claim. If you wait longer than 18 months, the SR&ED tax credits are permanently lost.
The implication of the 18 month filing duration is that you may be eligible to file a SR&ED claim for not only your most recently completed fiscal period, but potentially the year before as well. Using an example, if your fiscal year end is December 31, and the current date is March 2009, you would be eligible to file a SR&ED claim for fiscal years 2008 and 2007 as long as you file before June 30, 2009. The financial benefits of being able to claim multiple years are substantial, providing you take advantage before the deadline expires.
Is the process completely confidential or will my competitors find out about my SR&ED claim?
The Canada Revenue Agency must maintain the confidentiality of all files and information they gather. At TSI, your privacy is of the utmost importance to us, and we maintain strict confidentiality with all client information. Our documentation systems are SSL secured and backed up regularly on secure servers.
What is the general process when applying for SR&ED tax credit?
There are essentially two components to consider when making a SR&ED claim.
The first is to identify one or more SR&ED projects and write a project description. Within this project description, you must identify the technological advances, articulate the uncertainties and problems encountered, and describe the systematic experimental approach utilized to resolve the problems. These three criteria must be discussed in the context of technology and not product development or business and marketing applications.
The second component is to identify the eligible expenditures that qualify as SR&ED and give rise to SR&ED tax credits. Once these are completed, federal forms T661 and Schedule 31 must be completed and filed on time. Appropriate provincial SR&ED forms may need to be completed as well.
While it can be a complicated process, the rewards are well worth it. To ensure your SR&ED claim meets strict CRA guidelines, contact TSI and get the SR&ED specialists on your side.
TSI’s expertise not only covers preparing professional and credible SR&ED claims, but also in providing coaching and guidance for clients so as to maximize the size of their SR&ED claim. TSI has several proprietary techniques that are available through consultation that, via pre-planning, enable clients to legally increase their claim values. Commonly known tips include the following:
Consider your compensation structure, because bonuses, dividends, or stock options not eligible to claim as SR&ED expenses for specified employees (who own more than 10% of the company). If you are a company owner who elects to minimize personal taxes by paying yourself a combination of salary and dividends, it is worthwhile to discuss options with your accountant and consultant to minimize your aggregate taxes. Paying a higher base salary can increase your SR&ED claim size substantially but is offset by higher personal taxes. Striking the appropriate balance that is right for you is key.
Consider your organization structure in terms of the use of employee versus contractors. Although contractors offer flexibility and other non-financial benefits to a company, they are refunded at almost half the value of a salaried employee. Weighing the pros and cons of utilizing contractors versus employees represents and important decision as it can substantially impact your SR&ED claim size.
Used capital equipment is not eligible to claim. If you are purchasing capital equipment that is to be utilized 90% or more for SR&ED purposes, consider that you may end up saving more by buying new and claiming the expenditure versus obtaining a lower price by purchasing the equipment used.
Equipment that can be used for production or non-SR&ED purposes is not eligible to claim. Consider renting or leasing equipment that is exclusively required for testing, and returning the equipment when testing is complete.
Recall that work done outside Canada and by non-resident contractors is mainly ineligible (with the exception of 10% of eligible Canadian labour costs starting in February 2008). Although you may find lower cost labour rates offshore, when comparing that utilizing Canadian labour may be refunded at up to 73% in Ontario, the comparison may become more evenly weighted from a financial perspective.
CRA first validates that your SR&ED claim is complete, and then ensures it is eligible from both a technical and financial perspective. If you are claiming for the first time, a Financial Reviewer and/or Technical Reviewer assigned by CRA may visit your location to meet with you and examine your documents or information regarding the claim. TSI will assist you in these reviews. If you establish a good track record of having eligible projects and supporting documentation, a review might be carried out only every few years thereafter.
All claims are reviewed by CRA to determine if a SR&ED claim can be processed as filed, or requires further review. For refundable SR&ED claims, if your SR&ED claim is filed within six months of your taxation year-end, CRA has committed to reviewing and processing your claim within 120 days of receiving your complete claim.
Alternatively, if your SR&ED claim is filed within 18 months of your taxation year-end as an adjustment to your income tax return that has been previously filed, CRA will complete the review process within 240 days of receiving your complete SR&ED claim. For non-refundable claims, if your claim is filed within six months of your taxation year-end, CRA will advise you within 120 days as to whether your claim will be processed as filed or if further review is required.
If further review is required, CRA will complete the review process within one year of receiving a complete SR&ED claim. Alternatively, if your claim is filed within 18 months of your taxation year-end as an adjustment to your income tax return that has been previously filed, CRA will complete the review process within 180 days or 360 days of receiving your complete SR&ED claim depending on the amount of review required.