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R&D vs SR&ED – What’s the difference?

Lots of people struggle with the difference between R&D vs SR&ED.

“Research and Development” is a phrase used to denote activities, the overall goal of which is to gain and use knowledge. These activities are normally well organized, making use of the methods of various branches of knowledge and the services of highly trained personnel. Scientific research and development (referred to generally as “R & D”) signifies activities focused on the natural sciences rather than the humanities and social sciences. R & D is usually classified, according to its aims, into 3 broad categories: pure research, applied research and development. Pure research is curiosity oriented, undertaken to advance knowledge for its own sake; applied research is carried out in anticipation that its results will be useful to technology; development is concerned with transforming technological knowledge into concrete operational hardware.

Scientific Research and Experimental Development is a Canadian federal government program which uses tax credits to incent private enterprises to perform R&D in Canada.  The SR&ED Program has been in existence since 1986.  It is administered by a standalone group within CRA.

SR&ED covers all three categories of R&D noted above.  The government notes that most work funded under the Program is applied research and development as opposed to pure research.

Government R&D tax credits are available to qualifying Canadian corporations doing innovative work or solving technical challenges in their day to day work.

In 2018, over $3 billion was awarded to 18,000 Canadian companies.  That is the biggest R&D credit program in the government.  It dwarfs dedicated R&D programs like IRAP or NSERC and is about 5 times the size of RESP credits disbursed.

Start-ups who have incorporated in Canada and who have staff on a regular payroll are a particularly well-served group under this program. Your qualifying expenses (payroll, prototype materials and qualifying subcontractors) attract credits at well over double the rates paid to large corporations.  Also, all credits are paid to you in cash.  You do not need to show profits to qualify for SR&ED.

SRED is defined in the Income Tax Act (ITA).  Deep in the ITA, page 2709:

“Scientific research and experimental development” is a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis… for the purpose

of creating new, or improving existing, materials, devices, products, or processes, including incremental improvements thereto.

Along with the experimental work itself, scientific research and development also encompasses what the ITA terms supporting activities.  Again, direct from the ITA:

“Work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing or psychological research, where the work is commensurate with the needs, and directly in support, of work described (above).”

R&D vs SR&ED

So, what is the difference between R&D vs SR&ED generally?  SR&ED is a subset of R&D. SR&ED is the portion of your R&D work where you are actively searching and experimenting to overcome a technological obstacle or unknown.

Here is an example of R&D vs SR&ED.  Say you are a bicycle manufacturer and you are not happy with the reliability of your painting process for red bicycles.  Red is the most popular bike color, but it is your most problematic paint to apply reliably. In the summer production months, with high shop ambient temperatures and high and variable humidity levels, the adhesion of your red paint is poor. Also, testing shows that the red paint thickness levels vary widely across different parts of the bike frame.  You know from your logging of warranty repairs that a consistent thickness of paint deposition is key to long term paint adhesion, and resistance to paint chipping and fading.  You enter a due diligence phase where you search for different industry or standards-based solutions to your paint challenges.  This work may include exploring alternatives with paint suppliers, consulting coatings experts and collaborating with other local manufacturers who have experience with paint application in hot environmental conditions.  You pick some promising techniques to determine whether they have applicability to your situation.  This work you are performing is certainly R&D, but it is not SR&ED.  Researching and testing standard industry solutions is considered to be product selection.  It does not rise to the level of experimental development.

After exhausting standard solutions, you decide to start an experimental development project to deliver all-season reliability to your red paint application process.  You hypothesize that a multi-stage painting process is required to deliver reliable long-term red paint application.  You theorize that running your bike frames twice through a modified version of your existing paint line, once wheels-down and once wheels-up, will deliver a consistent reliable result.  Experimentation shows some promising results for this new process, especially for horizontally oriented sections of the bicycle frame.  The depth of paint deposition achieved is much more consistent on those horizontal frame elements on the top and bottom of the tubing vs our single pass “wheels-down” production paint process.  There are still deposition problems on the bike main diagonal tube and in complex join areas near the bicycle crank.  You conduct further tests with 3 and 4 passes of paint deposition, with the frame oriented differently for each pass.  The 4-pass paint process yields excellent results, even under the worst simulated temperature and humidity conditions.  You have now learned something important.  But a 4-pass paint process wrecks your unit manufacturing costs and your cycle time goals for producing 18 bicycle colors.

You experiment with ways to achieve 4 pass paint reliability with a maximum of two passes through your bike paint operation.  You achieve promising results with a modified conveyor which rotates the bike frame through multiple axes as it goes through your paint process.  This process achieves much more even deposition of paint using only two passes.  You experiment with sacrificial coatings where the paint thickness is still too great.  Finally, you add targeted sprayers to the final coating pass at the end of the line when the frame is no longer rotating.  These sprayers precisely add paint to the last undercoated frame areas.  Testing confirms a completely reliable red paint process.  Your SR&ED project is concluded successfully.

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Can I get SR&ED for a private company owned by a non-resident? Non-resident SR&ED eligibility

Is non-resident SR&ED eligibility possible? Yes, companies owned by non-residents, operating in Canada, properly registered with a CRA BN (business number), can receive SR&ED tax credits.

The catch is that these companies qualify for much lower SR&ED credit percentages than a similar private company owned by Canadians.  Foreign- owned companies qualify for federal ITCs (Investment Tax Credits) at a 15% rate on qualifying expenses.  These foreign-owned companies also qualify for an Ontario tax credit called ORDTC which is 3.5% of eligible expenses.   Canadian owned private companies (called CCPCs) qualify for much more generous tax credit percentages.  CCPCs receive 35% ITCs from the feds and two Ontario SR&ED credits, OITCs at an 8% rate and ORDTCs at a 3.5% rate.  If you do the arithmetic, you can see that Canadian-owned firms qualify for SRED credit percentages which total over 2.5 times those available to foreign-owned private companies.  The total percentages are 18.5% credits vs 46.5% credits for foreign vs domestic companies respectively.

Clearly, it is advantageous for private companies, which are eligible for SR&ED, to structure their ownership in such a way that they are designated as a CCPC.

A CCPC is a private corporation which is controlled by Canadian residents. A corporation will not qualify as a CCPC if it is controlled directly or indirectly by a public corporation or non-residents, or a combination of the two.

Let’s break this requirement down.  A CCPC must be controlled 50.1% or more by Canadian residents.  These Canadian residents can be individuals (Canadian residents with a valid SIN card) and/or other CCPCs.  Determining control can be complex when there are nested corporations involved.  Control is tracked by a specialized T2 form called the Schedule 50.  If you have a complex ownership situation, you want to get a lawyer and or an accountant involved who is well experienced in this area.  If the CRA determines that you have been mis-claiming SR&ED as a CCPC, they will go back to prior years and claw back excess credits you have received.  This can involve large sums of money they must be repaid based on the 2.5 times domestic vs foreign SRED credit differential.

Here’s a couple straightforward examples.  A company operating in Canada owned in equal shares by 4 Canadians and 3 Americans will qualify as a CCPC for the preferential large SR&ED percentages on qualifying expenses.  A company operating in Canada owned by 4 Americans will qualify for SR&ED credits but only at the lower foreign-owned percentages.

I will mention here for completeness that publicly owned companies are lumped in with foreign-owned companies to qualify for the lower SR&ED credit rates in Canada.

There are two more big advantages of CCPC’s claiming SR&ED vs foreign-owned firms.  First and most importantly, your federal ITC credits and the Ontario OITC credits come to you as refundable credits, ie cash.  The foreign-owned company gets non-refundable credits, which can only be turned into cash when applied against an outstanding tax balance owing.  That is a big advantage to CCPCs, especially for start-ups and companies with limited or variable profitability.  Second, CCPC SR&ED claims are processed on an accelerated schedule, within what is known as a 60-day service standard.  Foreign-owned and public company SR&ED claims can take up to 365 days to process.

Call G6 Consulting to get all the answers to your questions about non-resident SR&ED eligibility.

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A SR&ED tax credit example

Here’s an SR&ED tax credit example to show the steps involved in claiming an SR&ED tax credit.

The first step is seeing whether your business might qualify for SR&ED money.   Call G6 Consulting and schedule an introductory call with Greg Hills.  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, Greg will meet with you and review potential qualifying SR&ED work you have performed.  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.  We must file your SRED claim 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 we cannot submit your completed claim before the June 30th deadline.  This could be a loss to you of tens or hundreds of thousands of dollars!

Once we identify qualifying work within the proper time frame, G6 will gather details about your work and separate the work into projects by fiscal year.   We build 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.  One of the final steps of preparing a claim is assigning allowable payroll, material, and subcontract expenses to your project.  If you want to learn more about this step, and how sred credits are calculated, read this post: https://www.g6consulting.ca/how-do-you-calculate-the-rd-tax-credit/

Next the SRED projects are transferred onto the proper CRA claiming forms, organized by fiscal year.  If we are claiming SRED for a fiscal year where you have already filed your business taxes, G6 will file the SRED claim as an amendment to your previously filed taxes.  Ideally, and certainly for future claims, G6 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.  G6 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. For more detail on FTCAS and its importance, see this case study.

After a successful review, your SRED credits will be direct deposited into your business bank account within about a month.  At that time, G6 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 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 now 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.

Check out our SR&ED case studies for another SR&ED tax credit example.  Or this post for a software SR&ED tax credit example.  Finally, download our SRED credits calculator here!

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Free Government Money during Covid-19

SRED funding isn’t the only source of free government money during COVID-19.

Imagine. We may look back at today, and our 53.53% marginal tax rate in ON, and think, “Those were the good old days!”  And yet Finance Minister Bill Morneau flew back from Kenya, or possibly it was France or Ecuador, and tells us that we are on track in 2020 for a $340B deficit. Yikes.  As a side comment, it has always struck me as a bit of a mugs game that we put retirement money into an RRSP because “tax rates will be lower X years from now when we retire”.  Hmm, maybe, maybe not.

So, a wise squirrel should probably be putting aside extra nuts for winter.  There are two free money federal  programs arising from COVID-19 you will want to check out.

First up is CEBA.  Receive $40 K as an interest-free loan until Dec 31, 2022.  Repay the loan by that date and $10K is forgiven automatically.  Free government money.

CEBA is simple to apply for.  You apply through your business bank account and you do not have to deal directly with the government.  The app to apply is entirely online, it takes only about 40 minutes to complete.

One of the few criteria for qualifying is that the company must have incurred between $20K and $1.5M in T4 payroll for 2019.  A company’s 2019 payroll amount is shown on Box 14 of the T4 summary which was filed by the company and/or its accountant by Feb 28, 2020

How can smart Canadian businesses leverage their $40,000 CEBA money?   Put the money toward qualifying SRED payroll.   You will receive your $10K free CEBA money and you will also receive $28K in SRED funding.   $40K worth of work for a net cost to you of only $2K.  Wow.  Click here to learn how to calculate SR&ED credits.

Second up is CEWS.  This is a wage subsidy of up to 75% for your eligible staff.  CEWS is not as straightforward as CEBA.  The catch with CEWS is that you must be able to demonstrate a significant reduction in your company revenue during COVID timeframes.  This would be easy if you are an airline, but who wants to be an airline today?! On the plus side, CEWS has no cap on the subsidy amount you can receive. If you have a large staff, CEWS could be very lucrative for you.

For completeness, I will mention two personal subsidy programs related to the pandemic that are available to help people.  CERB is a $2000 per month wage replacement program for people who have lost their job due to COVID.  The program has been extended now until October 2020.  It is a mammoth program, projected to account for $65B of the federal government’s deficit this year.  There is also a program for students who cannot find work this summer, CESB.  It is straightforward and can pay eligible students $1250 per month for up to four months.

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How do you calculate the R&D tax credit?

How do you calculate the R&D tax credit?  It 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 that post, 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.  There are two more steps for how do you calculate the R&D tax credit?

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.

How do you calculate the R&D tax credit?  G6 has a spreadsheet which automates the calculation of R&D tax credits.  Get it here!

See here for a post on the tax and accounting treatment of SRED credits.

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Can I get SRED money for my company? And 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.

You’ve answered the question: Can I get SRED money for my company? Yes! The next 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”.  ddd

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.  Follow these links for detailed discussions on What is SRED qualifying work? and How do I calculate the R&D tax credit?

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Refundable vs non-refundable SRED credits

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

Let us back up for just a second.  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.

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 SR&ED 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!

Not all R&D work you do is SRED qualifying work.  How do we tell the difference?

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.

Go here to figure out how to turn your qualifying SR&ED work into cash!

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 detail.  In particular, it lays out 6 examples of SRED work which are quite well done.  There are 4 scenarios here, scenario 5 here and the 6th and last example is here.

 

Engineering2

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 the 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’s SRED consultant is planning to claim your prototyping work as part of their 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 fun 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.

Engineering companies and SRED should go together .  Call G6. We’ll work with you to uncover SR&ED opportunity in the work you are already performing

Canadian 50's

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.