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How do you calculate the R&D tax credit?

The R&D SRED tax credit is calculated based on the value of qualifying work you have performed on a project in a given tax year.  If you’re not clear on SRED qualifying work, go read the post on that, here: https://www.g6consulting.ca/what-is-sred-qualifying-work/

Are you back? Great. R&D tax credits are calculated per project.  You can submit a claim with 1 to n projects if each project has qualifying work.

Group your expenditures by project and by tax year

SRED is administered by a standalone group within the CRA.  SRED claiming follows income tax timelines.  So, your SRED claim will be split up by your tax fiscal year.  You claim SRED in arrears, that is, you claim SRED for a past years.  You can submit a SRED claim at any point from the end of the fiscal year to 18 months later.  So, if your company’s fiscal year is Dec 31, you can submit a SRED claim for your 2019 year up until June 30, 2021.  For this example, you would be claiming any eligible work carried out on or after January 1, 2019, because that was the first day of your FY19 fiscal year.

Some SRED projects can be long-lived and they can take years to complete.  If that is the case, you split that project into fiscal year chunks and claim year by year.  You do not wait for the end of that project to claim because you could conceivably run into the 18-month deadline described above.  The 18-month deadline is fixed, there is no mechanism to receive an extension to claim earlier work.

Sum up allowable SRED expenses

We now have qualifying work split into projects which are divided into individual fiscal years. We are getting closer to calculating the R&D tax credit.  R&D tax credits are earned for 3 types of expenses incurred when you are performing qualifying work.  Those three expenses are payroll, materials, and sub-contracts.  Up to a few years ago, we could claim capital expenses for SRED.  This is no longer the case.  So, R&D items like buildings, depreciation, lab equipment, test gear, software, leasehold improvements like ventilation, lighting, safety equipment, new CNC machinery.  None of these are claimable as SRED expenses.   We are going to tabulate all the eligible SRED expenses, sum them across all projects for a fiscal year, then multiply the expenses by a percentage to calculate the company’s sred credits.

The No 1 expense claimed for SRED is payroll.  Keep track of the hours of staff members who are directly involved in carrying out qualifying work.   Multiply these hours by the staff members’ hourly pay rate.  For salaried employees, calculate a deemed rate by dividing the employee’s annual salary by hours worked in the year, typically 1920 to 2000 hours.  So, Bob the lab technologist makes $60K per year.  His deemed hourly rate is $60000/yr. /2000 hrs./yr. or $30/hr.  Bob spent 200 hours of qualifying work on Project 1 during FY19.  Therefore, the payroll SRED expense for Bob is $6000.  We are not quite done.  The government allows us to claim an overhead amount for Bob to account for his workplace expenses, lab gear, computing resources etc.  This is called proxy and it is equal to 50% of the employee’s claimed SRED payroll expense.  So, the actual SRED expense amount for Bob’s payroll for Project 1 during FY19 is $6000 x 1.5 or $9000.

You can claim two types of material expenses for SRED.  First are materials used to build prototypes.  Include the cost of shipping the materials to you.  Second, you can claim scrap materials consumed during SRED experiments.

The third and last type of SRED expense is subcontracts.  Subcontractors can be individuals or firms, but they must be Canadian to qualify, that is have a SIN or an HST/BN number.  We total all the subcontract work for a given project then claim 80% of that total as a subcontract amount for the SRED project.

Total all the payroll, material, and subcontract expenses for all projects for the year and this is your total SRED expenditures.

Apply the right percentage to calculate the SRED credit

You earn SRED credits by applying credit percentages to the SRED expenditure total amount.  Claims earn both federal credits, called ITCs, and provincial credits.  In Ontario there are two SRED credits, OITC and ORDTC.  Prior to 2010, provincial credits were paid separately but all credits are paid at one time now since SRED harmonization.

The credit percentage varies based on claimant type.  Large/foreign owned/public corporations, partnerships and individuals are lumped into one class.  These groups get 15% ITCs, no OITC and 3.5% ORDTCs.  SRED credits for these claimants are non-refundable.  Non-refundable means that these credits can only be turned into cash by applying them against an outstanding balance.  You can carry SRED credits back three years or hold them on account for 20 years if you cannot apply them all against tax owing in the year they are earned.

Small business corporations, called CCPCs, get the most lucrative and flexible, SRED credits.  CCPCs, earn 35% federal ITCs, 8% OITC credits and 3.5% ORDTC credits.  You can see that, per dollar of SRED expenditure, a CCPC earns over 2.5 times the SRED credits of a large or foreign-owned corporation.  For a CCPC, the ITC and OITC credits are fully refundable.  This means they are awarded as cash.  This is a key benefit for start-ups and cyclical businesses as you do not have to wait for profits or tax balances owing to cash your SRED credits.

G6 has a spreadsheet which automates the calculation of R&D tax credits.  Call us for a copy!

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The 2nd Most Common Question I Get (Other Gov’t Funding)

The most common SRED question I get, without a doubt, is: “Greg, can I get SRED money for my company? How much?”  Strictly speaking, that is two questions right there.

Let me start over.  Say you are a company who just got their first SRED cheque.   You are in a non-traditional SRED vertical: low-tech manufacturing, agriculture, construction, winemaking, etc.  Finally, let us say it was G6 who convinced you to file for SRED in the first place.  Are you with me?  This scenario was quite a bit more work to set up than I was expecting.

Anyway, here we go. The most common question I get from this customer is “Greg! Why didn’t I claim SRED five years ago?!”  Followed usually by the second most common question (and the topic of this post!):

“What other government programs can I apply to and get money?”

The correct answer, for 99% of companies, is none.

Aren’t there dozens of federal, provincial, and municipal programs and initiatives funding innovation, tech, youth, jobs, green, regional development, eco and whatever its politically correct to call aborigines today? Yes, there are.

Here is my thinking.  20,000 companies get SRED annually.  1% of that is 200.  If we leave out IRAP, which I will cover below, that is probably roughly the number of companies which get funding under the grab bag of government schemes, programs, and initiatives above.

IRAP is a longtime “pure” R&D program run by the feds funding hundreds of start-ups and larger companies annually. I leave it out of this discussion because most IRAP companies are coming out of university or tech incubators or are VC-funded.  In other words, IMO, there are not a lot of companies who could qualify for IRAP which are not aware of it or who are not already enrolled.  IRAP companies can generally also get SRED but that is a separate topic (Call me!)

You are still reading?  Ok, I will run through the government grab bag quickly.  If you want to investigate this stuff, it could be a full-time job.  Do not make it YOUR full-time job.  Do not hire a “consultant”. Designate an employee you do not like or bring on a summer student or intern.  Seriously.

Let us cover three once-big programs that used to pay out lots of incentive money.  First, Ontario Apprenticeship Program.  This program funded many, many manufacturers of all sizes. The definition of apprentice stretched to 100+ categories so it could cover a lot of general labour.  The programs now defunct.  Second, every few years, the ON government funded a manufacturing initiative called SMART which they operated through CME.  It has not run since 2018 and I cannot recommend it when/if it does operate again.  Third, OIDMTC.  This program was at one time so lucrative that it had its own acronym.  Just like SRED.  Fun fact.  Did you know that to be a true acronym, the initials must be pronounced as a word?  Yes.  So, SCUBA’s an acronym and NASA is not.  OIDMTC and SRED are acronyms! (“Wad-mitt-ick” and “Shred”).  Anyway, OIDMTC started out funding “digital media” which morphed into enticing video game companies to locate in a particular province (Go ON, BC and QC!) which changed to…I am not sure what.  The program still exists but it is a zombie, funding little more than its own staff.  Which probably has not changed in size.

What else?  If you are hiring lots of employees or you need a lot of real estate, give your municipal Economic Development Office a call.  Some of these outfits have a reputation of being helpful.  Hamilton, for example.  But I do not have first-hand knowledge.

On the PPP front there is MaRS.  My mom says: “If you don’t have anything nice to say, say nothing”.

Moving up a level of abstraction, you can have your summer student check out FedDev Ontario.  Finally.  A dog’s breakfast of fed initiatives and programs used to be front ended by concierge.ca and are now housed within or repped by Innovation Canada.

As I said quite a few words ago, for 99% of you, it is SRED and get back to work.

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Refundable vs non-refundable SRED credits

You will certainly want to stay awake for this post.  This is where we talk about you getting paid.

Let us back up for just a second.  Three types of entities can receive SRED 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.

Here is a sad SRED story.  When Nortel finally went bankrupt, they had $1.3 Billion of (non-refundable) SRED tax credits on account that they could not cash.  Ugh.  You may have read in the papers about Ericsson, Cisco, Siemens etc. buying Nortel patents, IP, machinery etc. out of bankruptcy.  That was not really what was happening.  These profitable tech corporations were picking over Nortel’s corpse and buying SRED credits for cents on the dollar.

Enough of that.  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 SRED will be fully refundable. Hey CCPC’s.  What are you waiting for? Call g6 today!

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What is SRED “qualifying work”? – Updated!

Are you the type of person who likes to skip ahead and get right to the conclusion?  Yes?  Then this post is for you!

True story.  My wife’s mom would read a book the same way every time.  She would pick up a new book, read the last few pages, then go back to the beginning and read the book.  Why? So, she always knew how the story turned out.

For a SRED claim to be valid, we must demonstrate that you have carried out “qualifying work”.  The definition changes and can get convoluted, but essentially you 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.

If you find this explanation fuzzy or abstract, remember the famous words of United States Supreme Court Justice Potter Stewart in 1964.  He was writing about pornography but, stay with me, it works here: “I can’t define it. … Though I know it when I see it”.

Let us go through a couple examples of the types of projects that contain qualifying work.

Say you are a software developer.  What types of software development work might qualify?  Here are a couple tests.  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.  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.

Last thing 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.

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Engineering Companies and SRED

G6 has a couple engineering firms as long-time clients.  Year in, year out, these companies get substantial cheques from the feds.  Neither company has a lot of headcount, but the staff tend to be highly paid.  Almost all companies’ SRED claims are composed of mostly payroll expenses, so this is a good thing.

Years ago, I took a page out of the Sales 101 handbook and I hired a telemarketer to prospect among engineering companies in Ontario.  The telemarketer called two hundred firms.  We learned a couple things.  One, most engineering companies are not claiming SRED.  Two, I still have 2 long-time engineering customers.  What the heck.

Can I tell you an engineering joke?  I am an engineer, so I think this is fair game.  (Queen’s Mech Eng., Class of ’83.)  No Boomer jokes please, I will tell the jokes on this blog, thank you very much.  This is a sidetrack, but remember the Seinfeld episode where Jerry’s offended because the WASP dentist was telling Jewish jokes?  Anyway, the engineering joke.  “You can always tell an Engineer; you just can’t tell him much.”  Yep.

Certainly, there are engineering companies doing 100% routine work with no opportunity to claim SRED.  HVAC firms come to mind.    But there is lots of prototyping, innovation and experimental engineering work being done in Canada that is going unclaimed.  Call me!

There are a couple areas to look for qualifying SRED work in engineering firms, indeed, these tips hold true for any company performing technical project work for other firms: IT shops,  specialty service firms like 3D printers, automotive and aircraft specialty/niche manufacturers , etc.  The first area to explore for SRED is tools development.  As you carry out repetitive for customers, job in and job out, you may start to investigate ways to automate those tasks.    Your solution might take thee form of software, new business processes, new widgets, or some combination of these methods.  This work is generically called tools development, and it is a highly claimable SRED field.

The second area to investigate in engineering firms for SRED candidate work is work for US and other foreign firms.  Companies performing technical work for other firms cannot claim that work as SRED if your customer is claiming your work as a subcontract expense as part of his SRED claim.  Technically, you can claim this project work, but only the expense amounts that exceed the billed amount to your customer.  Let’s take an example.  Say you are doing prototype work for an Ontario manufacturer.    That manufacturer is planning to claim your prototyping work as part of his larger SRED project.  Many large companies will put right within their purchasing contracts with you that any work or amounts carried out under this contract which may be claimed for SRED are the property of the purchaser.  If the prototyping goes poorly, you may be able to charge nominal amount to the customer for your efforts.  Any expenses you incur beyond those contract payments can be claimed as SRED by you.   The way you claim this sort of work is straightforward.  You calculate your allowable SRED expenses just like any normal SRED project.  Then you subtract the amounts you billed to the customer for the work.  The difference is your allowable SRED expense for this project.

So, here is the opportunity for engineering firms doing work for US and foreign firms.  These customers cannot claim SRED because they are not resident in Canada.  All qualifying work you perform for these foreign customers can be claimed as SRED by you.  You get paid by the customer for your work.  You get paid by the feds for the SRED part of your work with no deductions.  Yes, you read that right.

I will end with an engineering joke that does not make funs of engineers.  (Except maybe the ones who will not claim valid SRED work….)  “I can explain it to you.  But I can’t understand it for you.

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How Much SRED money can I get?

The SRED money you receive is based on qualified expenses you have incurred in prior fiscal years (one- or two-years’ prior depending on the calendar).  Read this post to see what sort of work might qualify for SR&ED:  https://www.g6consulting.ca/what-is-sred-qualifying-work/

SRED is not a traditional research funding mechanism where you write a proposal that says If given $A, I will carry out X, Y and Z plans.  No SRED is awarded in arrears on work you have already performed.   This mechanism is bad for start-ups who have limited to no operating history and need money yesterday.  It can be great for more established firms who could be sitting on one- or two-years untapped claim which can be accessed immediately.

Ok.  You get SRED money based on qualifying expenses in three buckets.  Payroll, materials, and sub-contracts.  Here’s a couple SRED gotchas to avoid.  Payroll must be earned by Canadians.  Well, technically, to people with SIN numbers which can include non-Canadians.   If you are a business owner only your regular T4 earnings can qualify, no dividends, no bonuses etc.

Subcontracts must go to Canadian companies (check for an HST number) or Canadian individuals (we are back to SIN numbers).

Strangely enough, materials that you use for prototyping or for experimentation where the material ends up as scrap as scrap material can come from China or Timbuktu.  And you can claim the shipping costs to get it delivered to you.

Ok, ok.  Once again, how much SRED money can I get?  There are two methods to get an answer.   I can usually give you a close approximation of your claim after a half hour onsite visit and interview.  Or alternatively, if you are a do-it-yourself type, we can email you a detailed worksheet where you enter qualifying payroll, materials, sub-contracts, any claw backs due to IRAP or contracts, etc.  The spreadsheet is also useful for SRED planning purposes and what-if scenarios.   Here’s a more detailed breakdown of how to calculate SR&ED credits to use with the spreadsheet:  https://www.g6consulting.ca/how-do-you-calculate-the-rd-tax-credit/

Are there limits to how much SRED a company can receive?  There are a couple limits, but they don’t tend to come into play in normal circumstances.

For CCPC’s, earning too much money can reduce the SRED credit rates that you earn.  If you earn over $800K in a fiscal year, this will reduce your credit rate for the following year’s SRED claim to zero.  For fiscal years prior to March 2019, this high business income would also have reduced your federal ITC credit rate from 35 to 15%.  This ITC reduction was eliminated for fiscal year ends after March 2019.  There is a limit to the amount of salary expense owners can claim for themselves.  This amount is 5 times the Yearly Maximum Pensionable Amount, YMPE, used for CPP calculations.  That limit for 2020 for maximum claimable owner salary is $293,500, so it is seldom an issue.

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An Income Tax Act joke – You Must leverage favorable ITA provisions!

Most people do not want to hang out with an accountant at a cocktail party.  Tax consultant? CRA agent?  Forget about it!

I get it.  But believe it or not, there is a joke about the Income Tax Act.  And I am going to tell it to you!

If you read something in the Income Tax Act that looks like it’s in your favour, you’re reading it wrong!

Despite that joke, there are things in the Income Tax Act which are in your favour.  The SR&ED Program is certainly one thing.  Since 1986, the SRED program has awarded billions of dollars per year to qualifying corporations engaged in technology.  The government’s definition of allowable technology is broad.  Agriculture, industrial processes, winemaking, engineering, IT, and computers.  All fruitful SRED fields where there is prototyping or experimentation and a search for new or improved products and processes.

SRED is particularly lucrative for Canadian Controlled Private corporations, CCPC’s.  You get credits at over two and a half times the going rate that large public and/or foreign corporations receive.  Wow!  And your credits come to you as cash (well it is a government cheque or these days, 90% of the time it is a direct deposit).  Double wow.

There is one other long-time government program that nets us free money from the government.  No not RRSPs.  That is a tax deferral program only.  Not IRAP.  It is not “large” in the sense of billions of dollars awarded per year.  OK the other free-money large government program is the RESP.  And of course, it is for individuals not corporations.  Part of the RESP since 1995 is something called the CESG which is free money from the government.  Now technically the CESG is matching funds to money you contribute.  And the CESG has restrictions on how when, and where you can spend it.  SRED? No and No.

There is one last set of government programs you should be taking advantage of.  Those are programs related to COVID-19 relief.  These programs are temporary so you need to act while they are available.  I cover the Covid programs in more detail in this post: https://www.g6consulting.ca/sred-during-the-covid-19-pandemic/

You are compelled to comply with the onerous provisions in the Income Tax Act: taxes, tariffs, fees, reporting, surcharges, etc. All 3200+ pages and over a million words of it.  If you don’t take advantage of the precious few provisions in there that you can leverage in your favour, like SRED, you are literally leaving money on the table.  Call G6 Consulting today to see how we can help.

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SR&ED during the Covid-19 pandemic

Just like most of our day to day routines, the pandemic has caused changes in the administration of the government’s SR&ED program too.  The largest change is that the government has suspended audits for the duration of the pandemic.

This no-audit policy means that for existing SRED clients, claims are being processed very quickly, generally in less than a week.  The government states that it wants to get SRED money into the hands of deserving clients as fast as possible as part of its general stimulus efforts.  Great news!  If you have claimed SRED successfully in the past but not in recent years, this is an excellent time to claim.

The pandemic no-audit policy effect for first time SRED claimants is more muddled.  A few years ago, the feds announced a new policy whereby all first-time claimants would receive a SRED onsite review upon submitting their first claim.  This policy was not as harsh as it sounded.  At the same time, the government expanded an existing program called FTCAS – First Time Claimant Advisory Service.  Certain first-time claims that looked good to the government were given FTCAS status.  This meant that the claims were approved.  In SRED lingo, this is called “accepted as filed”.  The government still scheduled a review with the FTCAS client to deliver general SRED education, give general commentary about strengthening record-keeping for SRED and critiquing the SRED submitted with a view to strengthening future claims.

So, you can see a Catch-22 here.  All first-time claims must be reviewed, or at least FTCAS’ed.  But the government is not doing any onsite visits during the pandemic.   Logjam.  Luckily, we have been able to get first time claims approved.

The government has something called service standards for various different operations it performs.  The government has a service standard to review CCPC SRED claims within 60 days.  The government’s service standard starts when they hit the stopwatch button not when you submit a claim.  You can see when the service standard starts for your claim by using CRA’s MyAccount service.  Log onto MyAccount, go down to the Corporation Income Tax section and select the “View return status” bullet.  This will call up a chart with the status of various tax year ends.  Look for the year end entry for the tax year for which you just submitted the SRED claim.If there is a recent entry, it probably has a status which says: “Initial Assessment Received” followed by a date in the last column.  There is your date which the government uses to calculate the start of the service standard window for processing your claim.  The government won’t field inquiries about specific claims before the service standard has been exceeded.  So, put a date in your calendar to call the govt 60 days + 1 after the date we just found.  This presumes that the government doesn’t call you first to set up a SRED review.   When you call the government about your SRED claim, you do not call your T2 tax processing center.  You call the local SRED office which handles claims for your geography.  You can find your office and its co-ordinates here: https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/contacts.html  When you call the local SRED office you have the opportunity to plead your case to get the government to prioritize your claim.

Call g6 for help to efficiently manage your SRED claim during the Covid-19 pandemic.