Undertaking in the journey of leveraging the Scientific Research and Experimental Development (SR&ED) tax incentive program in Canada often comes with a myriad of questions and uncertainties.
From eligibility criteria to claim preparation, navigating the complexities of SR&ED can be a daunting task for businesses and researchers alike. In this post, we aim to demystify the most common SR&ED questions, providing clarity and insight to empower you on your innovation journey. Whether you're a seasoned claimant or new to the program, understanding these key aspects will streamline your SR&ED experience and maximize your potential for success. Let's unravel some of the more common questions and contradictions surrounding SR&ED and unlock the opportunities it holds for claimants.
Answering Common SR&ED Questions:
How does SR&ED work, and who can claim?
The SR&ED program along with tag-along provincial R&D programs are administered by the Canada Revenue Agency (CRA). Claims are filed through a claimants Canadian tax filing requirement by completing and integrating specific forms. Claims can be filed on an annual basis by corporations (T2), individuals (T1) and partnerships.
To qualify for SR&ED, eligible activities must meet certain criteria, both technical and financial, as set out by the CRA (see below for additional details). The program is industry agnostic and covers a wide range of industries and technologies, including but not limited to engineering, software development, biotechnology, and manufacturing.
How do you file SR&ED?
For corporations, SR&ED claims are submitted using Forms ‘T661 SR&ED Expenditures Claim’ and ‘S60 Part 2 SR&ED Project Information’, along with integration with other T2 Corporate Income Tax Forms (e.g. S1, S5, S31, S49, provincial R&D forms, etc.) and must be filed within 18 months of the corporations year-end date. These forms require claimants to provide detailed information about their R&D projects, including project descriptions, objectives, methodologies used, and outcomes achieved. Additionally, businesses must report their eligible expenditures, broken down by category (e.g., salaries and wages, materials, contractor payments, overhead, etc.) along with other relevant information.
What qualifies for SR&ED?
To qualify for SR&ED, the activities undertaken must meet specific criteria set by the CRA. Eligible SR&ED activity streams include:
Basic Research: Systematic investigation or search that is conducted for the advancement of scientific knowledge without any specific practical application in view.
Applied Research: Systematic investigation or search that is conducted with the specific practical application in view.
Experimental Development: Systematic work, using experiment or analysis, that is undertaken for the purpose of achieving technological advancement for creating new, or improving existing, materials, devices, products, or processes.
Additionally, the following criteria must be met for an activity to qualify for SR&ED:
The work must be systematic or investigative, meaning it involves a systematic approach to solving a problem or testing a hypothesis.
The work must involve a technological advancement, meaning it seeks to create new knowledge or improve existing technology.
The work must involve uncertainty, meaning there is scientific or technological uncertainty about whether the desired outcome can be achieved or how to achieve it using existing knowledge or technology.
The attempt to overcome the uncertainty must involve a systematic investigation or search.
The work must be carried out in Canada.
Under the SR&ED program, Canadian claimants can earn investment tax credits (ITCs) for eligible expenditures related to SR&ED and can include: wages, materials consumed or transformed, overhead, capital (Manitoba), contractors and third-party payments directly related to the SR&ED activities.
Canadian claimants can earn ITCs for eligible expenditures related to SR&ED. These expenditures can include wages, materials, overhead, contractors and certain third-party payments directly related to eligible R&D projects.
Are SR&ED credits taxable?
Yes, SR&ED Investment Tax Credits (ITCs) are considered income earned the year after they are received. SR&ED ITCs are effectively included in a corporation’s taxable income via the SR&ED expenditure pool. For tax purposes, provincial ITCs are considered taxable in the year in which they are claimed, whereas federal ITCs are considered taxable in the subsequent taxation period.
A provision does exist within the Income Tax Act which enables claimants to defer provincial ITCs related to the SR&ED prescribed proxy amount. This proportion of ITCs can be deferred until the following taxation period.
Recognizing that SR&ED ITCs received/receivable are often included in a company’s net income per financial statements, we highly recommend and suggest the use of a knowledgeable SR&ED preparer to ensure proper taxation of SR&ED ITCs, and to validate SR&ED ITCs are not being taxed twice, once through net income, and again via the SR&ED pool.
Demystifying Common SR&ED Misnomers:
A belief that only "white coat” laboratory work or high-tech industries qualify:
One common misconception is that SR&ED is only applicable to traditional scientific or laboratory research. In reality, eligible activities can include a wide range of work, including experimental development, systematic investigation, and even certain support work.
While the program is often associated with high-tech industries, SR&ED is available to businesses across various sectors. Any industry that engages in qualifying R&D activities may be eligible.
Thinking only successful projects qualify:
Some businesses wrongly assume that only successful projects or those resulting in a marketable product qualify for SR&ED. The program is designed to support the learning and experimentation process, and even failed projects or experiments may be eligible.
Thinking only development or technology efforts that are “new to the world” qualify:
A competitor could be developing and/or have developed the same technology you are attempting to develop, which doesn’t necessarily disqualify you from SR&ED. So long that the knowledge of ‘how they did it’ is not readily available to you in the public domain, your work could qualify.
Thinking that projects in common-place development areas (e.g. engineering, manufacturing, computer application development) are routine and do not qualify:
In certain cases, a form of SR&ED eligibility exists called system uncertainty which can arise from or during the integration of technologies, the components of which are generally well known. This is due to unpredictable interactions between the individual components or sub-systems.
This type of uncertainty can often be overlooked by claimants in identifying eligible SR&ED projects or activities. System uncertainty can arise in various situations (e.g. manufacturing, software development) and can be commonly overlooked as ‘routine engineering’ and/or ineligible for SR&ED. However, prudence should be given in these situations where overlapping system modules and/or system constraints result in technological challenges resulting from the uncertainty of achieving a specific set of overlapping performance requirements.
Not documenting activities and expenditures properly:
Proper documentation is crucial for a successful SR&ED claim. Some businesses may overlook the importance of maintaining detailed records of their R&D activities, which could result in headaches during a review/audit situation and/or in the denial or reduction of their claim. For example, the use of detailed and contemporaneous activity-based time logs to accurately carve out and pro-rate SR&ED eligible direct labour is one of many types of documentation that can alleviate CRA filing concerns.
A belief that filing SR&ED requires an over-abundance of internal resources and dedication in order to submit a claim:
Although corporate buy-in must be apparent throughout the entirety of the claim process including providing the necessary resource and time allocations, the SR&ED claim process does not and should not deter claimants from filing. Engaging a SR&ED consultant can ease this burden and allow claimants to focus on what they should be focused on... their business!
Unraveling the mysteries surrounding the SR&ED program through addressing common questions is essential for businesses and researchers to fully harness its benefits. By providing clarity on eligibility criteria, claim preparation, and other frequently asked topics, we aim to empower you to navigate the SR&ED process with confidence and efficiency. Remember, SR&ED is not just a tax incentive; it's a catalyst for innovation and growth. As you continue on your innovation journey, armed with a deeper understanding of SR&ED, seize the opportunities it offers to propel your organization towards greater success and competitiveness. If you have further questions or need assistance, don't hesitate to reach out—we're here to support you every step of the way.