SR&ED Tax Incentives

There are tax planning opportunities to maximize the use of SR&ED Tax incentives discussed HERE.

What is the SR&ED Program?

The Scientific Research and Experimental Development (SR&ED) program is a federal tax incentive program to encourage Canadian businesses of all sizes and in all sectors to conduct research and development (R&D) in Canada that will lead to new, improved, or technologically advanced products or processes. The SR&ED program is the largest single source of federal government support for industrial research and development. Claimants can apply for SR&ED investment tax credits for expenditures such as wages, materials, machinery, equipment, some overhead, and SR&ED contracts. It should be noted that the CRA is responsible for administering the SR&ED program, while the Department of Finance is responsible for the legislation that governs it.

Who qualifies?

Generally, Canadian-controlled private corporations with taxable income less than the small business deduction limit can receive a refundable investment tax credit (ITC) of 35% of qualifying SR&ED expenditures, to a maximum of $2 million of expenditures. The amount is refundable which means that even though the corporation has no taxable income, they are still entitled to a cash refund of the SR&ED expenditures.

Most other Canadian corporations, proprietorships, partnerships, and trusts can receive an investment tax credit of 20% of qualifying SR&ED expenditures. This tax credit is applied to taxes otherwise owing and is not refundable. To the extend the ITC’s cannot be used (for example, taxes owing are less than the ITC’s), they can be carried back 3 taxation years to reduce taxes otherwise owing in those years and forward 10 taxation years. After 10 years, any unused ITC’s will expire.

ITC's only apply to Federal income tax not Provincial income tax.

What kind of projects qualify?

To qualify for the SR&ED program, scientific or technological work must advance the understanding of scientific relations or technologies, address scientific or technological uncertainty, and incorporate a systematic investigation by means of experiment or analysis by qualified personnel. Work that qualifies for SR&ED tax credits includes: 

1. Experimental Development to achieve technological advancement to create new materials, devices, products, or processes, or improve existing ones; 

2. Applied Research to advance scientific knowledge with a specific practical application in view; 

3. Basic Research to advance scientific knowledge without a specific practical application in view; and 

4. Support Work in engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, or psychological research, but only if the work is commensurate with, and directly supports, the eligible experimental development, or applied or basic research.

    

The following activities are not eligible for benefits under the program:

1. social science and humanities research;

2. commercial production of a new or improved material, device, or product, or the commercial use of a new or improved process;

3. style changes;

4. market research or sales promotion;

5. quality control or routine testing of materials, devices, products, or processes;

6. routine data collection;

7. prospecting, exploring, or drilling for or producing minerals, petroleum, or natural gas; and

8. development based solely on design or routine engineering practice.

SR&ED Eligible Expenditures 

For SR&ED carried on In Canada, eligible expenditures include current as well as capital expenditures used all or substantially all in SR&ED activities are included in a special SR&ED expenditure pool. Specifically excluded are cost of buildings and rent for buildings. Employee's who have 10% or more of the shares of a corporation cannot include salary which exceeds 5 times the CPP limits. Current expenditures are expenditures directly undertaken by or on behalf of the taxpayer and expenditures which are payments to Canadian resident corporations provided the taxpayer is entitled to exploit the results of the SR&ED. Capital expenditures are also included in the pool and are normally depreciable property. Certain amounts are deducted from the pool. Deductions include government or non-government assistance received or receivable in respect of the expenditures (unless the assistance is repaid - the repayment increases the pool) and ITC's deducted in preceding years from corporate tax.

For SR&ED carried on outside of Canada, only current, not capital expenditures are included in the SR&ED pool. In this case, the SR&ED has to be undertaken directly by the taxpayer and must relate to the taxpayer's business. Payments to CRA approved organizations can also be included if the taxpayer is entitled to exploit the results of the SR&ED and the SR&ED relates to the taxpayer's business.

To make an SR&ED Claim

1. The taxpayer must carry on a business in Canada;

2. The prescribed tax forms must be filed within the prescribed time (typically 18 months from the tax year-end);

3. The expenditures must relate to a business carried on by the taxpayer; and

4. The deduction may be made only from the income of the "Business".

Prescribed Tax Forms

There are two basic sets of forms:

1. T661/Schedule 31 for corporations. This schedule details out the expenditures and other required information. A copy of a blank form can be found HERE. For individuals, Form T2038 must be completed.

2. Detailed Project Description. For each of the projects you are claiming and for each taxation year, identify the project and complete questions A to E below :

   A. Scientific or Technological Objectives – What is the technological or scientific objective of your project? Does this project involve scientific research or experimental development? What field of science or technology does the project involve?

   B. Technology or Knowledge Base Level – Before you started your project, what were the technological limitations of your products or processes to be overcome, or if your project work was predominantly scientific research, give a perspective in terms of the scientific knowledge that you were seeking before you started your work? You can use the information you provided last year if your project is

   C. Scientific or Technological Advancement – What advancement in technology is being sought, what were the problems or challenges that you could not solve using commonly available experience and required you to seek an advance in the underlying technology to achieve the objective in A above, or what was the new scientific knowledge sought in your work?

   D. Description of Work in this Taxation Year – Describe the work, including experiments and analyses, that you did in this taxation year to achieve the above technological or scientific objectives.

   E. Supporting Information – What technical records or documents such as records of trials, test results, progress and final reports, meeting minutes, employee activity records, prototypes, new products, generated over the course of the work are available to support your work?

Tax Planning Opportunities

1. Startup corporations or corporations which do a lot of development work, typically have little or no cash to continue to fund ongoing operations. To the extent that the expenditures of the corporation relate to SR&ED and if the corporation is eligible for the refund of 35% of these expenditures, cash flow can be improved by making SR&ED claims and getting government refunds of cash already spent. 

2. Capital expenditures for SR&ED activities, which normally can only be written off over time, are added to a separate pool of deductible expenditures. This pool can be fully deductible at any time by the corporation. This allows a fast write off of capital expenditures and consequently the company can enjoy lower taxes sooner.

3. Startup corporations or corporations which do a lot of development work, typically have little or no taxable income in early years of operations, but may have indications of profitability in the future. However under income tax law,  corporations with taxable losses can only carry over unused taxable losses 7 years. After 7 years they expire and any benefit for the use of these losses is lost. To assist these corporations, expenditures that qualify for SR&ED can accumulate these costs in a separate pool which can be carried forward indefinitely to offset taxable income in any future year.

SR&ED Tax Incentives are a complicated area and a Chartered Accountant should be consulted. Contact Keith Anderson CA at (780) 447-5830 if you need advice. 

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