SR&ED Tax Credits are part of the Scientific Research and Experimental Development (SR&ED, SRED, pronounced “SHRED”) program provides compensation to offset eligible expenses incurred by businesses in Canada. The program is administered by the Canada Revenue Agency (CRA) and is the largest tax credit program in Canada. $3 Billion is distributed to 20,000 companies annually through the SR&ED program.
The Scientific Research and Experimental Development (SR&ED, SRED, pronounced “SHRED”) program rewards companies for conducting research and development work (R&D) in Canada. A company does not need scientists, lab workers in white coats, PhDs, or P.Eng’s to qualify for R&D tax credits. Federal government statistics show that over 95% of credits are awarded for experimental development work (ie not classic R&D work). If you design new products or processes, carry out IT projects, or invest to build your stock of proprietary knowledge and best practices, you may qualify for SR&ED tax credits. Custom IT work qualifies. Failed and abandoned projects also qualify.
As long as the following criteria are satisfied, any business is eligible to apply for and receive SR&ED credits.
Not all R&D work is SRED qualifying work. For a SRED claim to be valid, you must demonstrate that you have carried out “qualifying work”. The definition changes and can get convoluted, but essentially you must have performed experimentation, prototyping, even trial and error to attempt to resolve a “technological uncertainty”. In other words, your project must have faced risk that you could not complete it satisfactorily due to technical obstacles or unknowns. There it is. The heart of the matter.
There are secondary requirements. Your efforts should be systematic. You have some record of your work. But striving to resolve a technological uncertainty is the meat.
An important note on qualifying work. If you have a project which has failed for technical reasons, this likely is SRED qualifying work and it can be fully claimed for payroll, materials, and any subcontract work.
The government updated a document in 2015 called Eligibility of Work for SR&ED Investment Tax Credits Policy. This piece is a bit of a deep dive, but it covers the concept of qualifying work for SRED in great detail.
To better illustrate what qualifying SRED work is, let’s take an example. Say you are a software developer. What types of software development work might qualify? Here are a couple tests/examples.
– If your software project lead could go to a technical conference related to your project’s subject matter (Blockchain, computer security, node.js, hybrid cloud architectures, etc.) and present a talk or paper on lessons learned, problems solved, new developments in the space, etc. chances are he is describing SRED qualifying work.
– Another test is risk of project failure for technical reasons. Say you are attempting to integrate two different platforms, environments, or architectures to produce a new, third environment with novel/unique/hybrid properties. You are unable to hire this expertise, so you carry out the work in-house. If there is uncertainty regarding the successful technological completion of your project, this points to qualifying work.
– Three. Tools development is often qualifying work. Say you repeatedly do projects for customers that involves similar steps. Security scans, porting code from environment A to B, etc. If you undertake a project to build a tool to automate a set of tasks or jobs, it is often likely that this tools development represents qualifying work.
– Fourth, and last software test/example. Say you are developing new code which must operate within a technological constraint that involves scaling. This could be response time under load. Ability to develop code with X functionality that will fit within a given memory or disk constraint. You must build a minimum viable feature set of the app to test it to see if it meets the technological constraint(s). This would probably represent qualifying work.
Qualifying work is often easier to spot in physical projects carried out in manufacturing, engineering, or product development firms. If you are carrying out prototyping work so that you can test an MVP (minimum viable product) against technical requirements or objectives, that is probably SRED. “Shop Floor SRED” is qualifying work. This is when you are engaged in normal production and you encounter a technical problem. This might be as simple as a printing company or a coatings company experiencing quality or adhesion changes in different seasons. If you undertake systematic testing/investigation/work to overcome the technical problem, that is likely SRED qualifying work.
If you are unsure if work that you are performing is SRED qualifying work or not, you can speak to an expert consultant free of charge. G6 Consulting offers this service. Many businesses decide to outsource the entirety of the SRED process to an expert consultant. G6 Consulting handles this process on a contingency basis. In other words you only pay a percentage of the credits you receive after you get your direct deposit from the government. More on this service.
SRED Credits are based on expenditures incurred while doing SRED qualifying work. Three types of expenses can be claimed for SRED; salaries, subcontractors, and materials. G6 has a tool to calculate the size of your potential SRED claim.
The first and largest SRED expense bucket is payroll. You must enumerate the hours spent by each company staff member as they are performing qualifying work. Next, you calculate employees’ hourly rate by dividing annual salary by hours of work in the year. The government allows a 1.5 times uplift factor to this hourly rate to account for overhead costs to support the employee in his work. This overhead factor is called proxy.
The second claimable expense is materials. Allowable material expenses are comprised of scrap and prototype costs. If your experiments generate scrap material, this expense can be claimed. If your experiments require a prototype to be built, the material costs in that prototype are claimable. A software claim or a process improvement SRED claim will generally not generate material costs.
The last claimable SRED expense is subcontracts. Subcontracts are payments made to people outside your organization who are performing qualifying work on your project. These subcontract payments may be for a company performing specialized testing on your prototype, or it might be hiring a subject matter expert in computer security for a software SRED claim. Allowable subcontracts for SRED must be to Canadian individuals and Canadian companies.
Now that we have all the allowable expenses assembled for our SRED project, we are ready for the final step. We need to multiply the SRED expenses by a SRED credit percentage to determine the amount we can claim. For a small business corporation, called a CCPC, the SRED credit percentages are 66, 42 and 34% respectively for payroll, materials, and subcontracts. That’s it, you’ve gone through all the steps to determine what you can claim for your SR&ED project.
Three types of entities can receive SR&ED credits. Individuals, CCPC’s (small business corporations) and large and/or foreign corporations.
Individuals and large corporations receive non-refundable credits. Non-refundable means you need a tax balance to turn the credits into cash. The credits can be carried back three years or saved on account for 20 years until you can cash them, but these non-refundable credits are restrictive. Especially if your firm has limited, highly variable or no profitability.
This is in contrast to CCPC’s. Are you a CCPC? Great news. SRED is tailor-made for you. You get (almost all) refundable credits. Refundable credits are cash! Start-up, no profits? No problem. Cash SRED. Perennially unprofitable manufacturing company attempting a turnaround? The Government of Canada has you covered. Cash SRED.
A last piece of good SRED news for CCPCs. Your credit percentages are much larger than those for large corporations. Let us take payroll expenses, which are the bulk of most companies’ claims. You receive over 65 cents of SRED credits for each dollar of qualifying payroll. Cash. What about Cisco or Shopify? Those guys have to make-do with less than 28 cents of SRED credits per dollar of qualifying payroll.
Every SRED claim in Ontario has at least a small component which is non-refundable. This is due to a 3.5% credit called the Ontario Research and Development tax credit, the ORDTC. Back in 2010, the SRED program was standardized between the feds and each of the piggyback r&d programs delivered by the provinces. This was called harmonization and it was rolled out in each province except Quebec. In Ontario, the provincial credits were degraded slightly when all the SR&ED definitions were aligned between the CRA and Ontario programs. To compensate for this, the ORDTC credit was introduced. For some reason, and I have never seen an explanation, the ORDTC was made a non-refundable credit, even though the main Ontario SRED credit, the OITC has always been refundable.
So, the bottom line for a CCPC is that over 92% of the credits you receive for SR&ED will be fully refundable.
The SRED program has been around since the mid 1980’s. Right from the beginning, there have been payments and government benefits which have reduced the SRED credits a company receives. These benefits are labelled, for purposes of SRED, government assistance and non-government assistance.
We speak of these benefits “grinding down” a company’s SRED credits. Why? All the assistance payments reduce the expenditures upon which SRED credits can be claimed. Specifically, assistance received reduces salary expenditures which may be claimed for SRED purposes. $1 of assistance reduces salary SRED expenditures by $1. Now, we earn SRED credits as a percentage of eligible SRED expenditures. Therefore, a CCPC that has SRED expenditures reduced by $1 will lose 35 cents of ITC credits. A public company in the same circumstance loses 15% of its ITC credits. This shows the grinding effect of assistance payments. The assistance payment reduces your (CCPC) SRED credit received to $0.65 from $1. That is bad. But overall, the company is still ahead, $1.65 vs $1, because they had already received the $1 assistance payment.
Here’s an SR&ED tax credit example to show the steps involved in claiming an SR&ED tax credit. While self-filing SR&ED is possible, it is wise to have a SR&ED expert consultant, such as G6, handle your SRED. SR&ED consultants do not get paid until you receive your direct deposit from the government. The business is done on a contingency basis
The first step is seeing whether your business might qualify for SR&ED money. Calling a consultant to schedule an introductory call can often shed clarity on this. There is no obligation to you or charge for this call. The first requirement for SRED is that you are engaged in a technical line of business. Businesses engaged primarily in retail, legal, marketing, sales, or distribution activities most likely have no ability to make a claim. The verticals that may have SRED-claimable work are broad. Software, manufacturing and process companies, start-ups, wineries, and green firms all widely claim SRED credits. There are several technical verticals where the firms in those lines of business in my experience under-claim SRED. These industries include agriculture, food production and engineering service companies.
If you are in a technical line of business, You likely have performed some SRED qualifying work. Have you developed any new products, or developed enhanced features to existing products? Have you built any prototypes? Have you developed any technology to increase productivity or efficiency in your business? These types of activities are all hallmarks of SRED-claimable work.
SRED credits are claimed for work you have already performed. This makes SRED the opposite of traditional R&D funding mechanisms like IRAP, where researchers write proposals for work they will undertake if they receive funding. A big advantage of SRED is that its provisions are built right into the Income Tax Act. This means that if you meet the requirements for funding, you will receive your credits. There is no competition for available funding between firms, nor is there a pot of money that may or may not have funding after you have qualified. The amount of SRED funding available to you is unlimited.
Your ability to claim SRED credits is time limited. Your SRED claim must be filed within 18 months of the end of the fiscal year during which the SRED work was performed. If you think you may have a claim, do not wait until the end of June to explore your options. With a December 31st year end, you could lose a year’s worth of SRED credits if your claim is not submitted before the June 30th deadline. This could be a loss to you of tens or hundreds of thousands of dollars!
Once qualifying work is identified within the proper time frame, details about your work need to be gathered and work needs to be separated into projects by fiscal year. A write-up of your work which lays out how your work meets the technical requirements for SRED qualifying work, all in less than 1400 words per project is required. One of the final steps of preparing a claim is assigning allowable payroll, material, and subcontract expenses to your project.
Next the SRED projects are transferred onto the proper CRA claiming forms, organized by fiscal year. If claiming SRED for a fiscal year where you have already filed your business taxes, you or your SRED consultant will file the SRED claim as an amendment to your previously filed taxes. Ideally your consultant will co-ordinate with your accountant so that the SRED is filed as part of your annual T2 filing.
For first time claimants, the government schedules a review at your site, typically a month or two after your claim is submitted. The government sends a technical and financial reviewer to learn about your business, educate you about SRED and review your claim to ensure it meets SRED standards. Your consultant is with you during this review, which typically takes a half day to a day to complete. Ideally your first claim is assigned FTCAS status, where the above review takes place, but it is less in depth because your claim has already been pre-approved prior to the review. After a successful review, your SRED credits will be direct deposited into your business bank account within about a month. At that time, your consultant will bill you a contingency fee based on a percentage of the cash you received.
Many companies who get SRED money successfully from the government find that they are doing qualifying work annually. G6 Consulting works with you to make documenting your SRED activities part of your regular workflow. You will file SRED annually as part of your T2 tax return. Processing times for repeat filers are often accelerated with turnaround times of a few weeks rather than months as in the above example. G6 will then work with you to strategize how SRED can be a key component in funding your business success and growth by incenting you to expand your technological expertise and undertake groundbreaking projects.