Common Mistakes in SRED Tax Credit Applications
What is SRED?
SRED is the largest tax incentive program in Canada for technology companies. The program is designed for firms of all sizes to take more risks in their technology development and to perform more R&D. SRED means the Scientific and Experimental Development program. The program has been in place with relatively minor changes in Canada since 1984.
SRED incents work that seeks to deliver new products and processes and improved products and processes.
SRED is not a grant. It is embedded in the Income Tax Act as a tax preference and it is awarded for work already performed in the prior and possibly the second prior tax year.
What is SRED Canada?
SRED is a CRA federal program. 20,000 companies annually receive $4 billion in funding. SRED Canada refers to the fact that each of the provinces (except PEI) offers top-up SRED credits. These credits are awarded automatically once a company qualifies for the federal credits. The provinces team up to award about $1 billion in credits in addition to the federal money. Most provinces, like Ontario, BC and Saskatchewan, offer harmonized credits. This means that when you receive SRED credits, the provincial credits are awarded automatically, and they arrive as a direct deposit or cheque along with the federal money. Two provinces, Alberta and Quebec, have non-harmonized SRED programs. In those provinces, companies who receive SRED money must chase TRAC or Revenue Quebec for the provincial award. On the bright side, Alberta and Quebec offer the most generous credits of any of the provincial programs.
What is The SRED Tax Credit?
A very common question is: Are the SRED credits cash or a tax credit? For small businesses, called CCPCs, with a couple exceptions, virtually all the credits are awarded as cash. This is powerful. Start-ups and companies running losses receive cash SRED funding regardless of their tax position. The two exceptions to all cash credits are located in Manitoba and Ontario. In Manitoba, half the provincial credits come as cash, half as non-refundable credits. In Ontario, there is a small 3.5% credit, called ORDTC, which is non-refundable. Non-refundable credits are turned into cash by applying them against corporate tax balances. For a start-up investing and running years of losses, non-refundable credits can be carried back 3 years and applied to tax balances or the credits are held on account for 20 years. Foreign-owned and public firms mostly receive non-refundable credits. To explore exact credit amounts and type by province and type of firm, use G6’s online credit calculator.
Common Mistakes in SRED Tax Credit Applications
OK. You are sold. You want to get in line for your SRED tax credits. What could go wrong?! Here are the 6 most common SRED mistakes:
1. Your SRED claim is audited and denied.
80% of SRED claims are approved without a detailed review. Audited claims are judged stringently and about sixty percent of audited claims are denied or reduced substantially. A negative SRED audit result greatly impairs your ability to successfully claim in the future.
2. Self-filing SRED
Some first-time claimers will file the SRED forms themselves without the guidance of a SRED consultant. This is a mistake. These companies use an expert to file their taxes, yet they attempt to file a SRED claim on their own. The process of filing an excellent SRED claim is much more difficult than filing a corporate tax return.
3. Describing company projects not SR&ED projects
The CRA doesn’t care about the business objectives or even the technical objectives of your work. SRED is defined by the technology unknowns or obstacles that you face in carrying out your project. Going on at length about the company project work and all the benefits of the new widget that you have built is a common way for a sred claim to be selected for a review.
4. Not claiming all the SRED expenditures
Lots of people underclaim the amount of SRED expenditures they are properly entitled too. All directly engaged labour that is necessary to carry out an experiment is SRED claimable, even routine work. For example, in an agriculture example, if you need to grow 500 acres of canola to test whether a seed is viable for the climate, all labour involved to plant, grow and harvest that crop is a SRED expenditure. Lots of people make the mistake of breaking a valid SRED project into multiple small projects. That wastes time and results in an undervalued claim.
5. People claim the wrong SR&ED expenditures
This is really common. People take all the R&D costs associated with a project and list them as SR&ED expenditures. Wrong. People routinely over-claim materials. Only materials which are scrapped and never serve a commercial purpose can be claimed for SRED. People overclaim sub-contracts. Sub expenditures must be directed to arms-length, Canadian suppliers. People claim tools, software purchases, AWS charges, lab supplies, lab upgrades and equipment. All wrong, all unclaimable. Large claimed material and subcontract expenditures can be a big audit flag because they are often misclaimed.
6. Claiming too many projects
In general, people claim too many projects. You are better served claiming your strongest work only. You want to put your best foot forward so that the SRED meaning of all your work is crystal clear. SRED claims are evaluated in a negative way by the CRA. By this I mean that the reviewers evaluate your work by finding and noting things about your claim that they don’t like or don’t understand. As you accumulate flags, your claim is moving toward an audit. More claims means more information for the CRA to review and dislike. By logic, your last project is your weakest SRED project. That is the project that will put your entire claim into an audit queue.
Conclusion
Avoid these common mistakes and you should set yourself up for many years of lucrative SRED support from Canadian SRED. The experts at G6 Consulting are standing by to assist you with your SRED claims. We have a sixteen year track record of success helping technology companies safeguard their SRED tax credits.
Common Mistakes in SRED - FAQs
The most common SR&ED mistakes include poor technical documentation, claiming ineligible expenses, failing to demonstrate technological uncertainty, describing business objectives instead of scientific advancement, & submitting incomplete or inaccurate claim forms. Avoiding these errors can significantly improve the chances of CRA approval.
The Canada Revenue Agency (CRA) may reject or reduce an SR&ED claim if it lacks supporting documentation, includes non-eligible activities or expenses, fails to demonstrate technological advancement, or contains inconsistencies between technical and financial information.
Yes, businesses can prepare their own SR&ED claim. However, many first-time applicants make costly mistakes due to the program’s technical and documentation requirements. Working with an experienced SR&ED consultant can help maximize eligible credits while reducing the risk of CRA reviews or denied claims.
Eligible SR&ED expenditures generally include qualified employee wages, certain contractor costs, eligible materials consumed during experimentation, and approved overhead expenses. Routine operating costs, commercial production expenses, equipment purchases, and most software purchases typically do not qualify.
Businesses should maintain project plans, engineering notes, design documents, experiment records, testing results, employee time tracking, payroll records, invoices, and financial documentation. Keeping contemporaneous records greatly strengthens an SR&ED application.
To minimize the likelihood of an SR&ED review or audit, maintain detailed documentation, accurately classify eligible expenditures, clearly explain technological challenges and advancements, and ensure all financial information matches supporting records.
Not necessarily. It’s often more effective to claim projects that clearly satisfy the SR&ED eligibility criteria rather than submitting numerous weak or borderline projects. Strong, well-documented claims generally have a higher chance of approval.
Generally, commercial production costs, routine maintenance, quality control activities, equipment purchases, office administration, marketing expenses, and work that does not address technological uncertainty are not eligible for SR&ED tax credits.
Yes. Canadian startups conducting eligible research and experimental development activities may qualify for refundable SR&ED tax credits, even if they are not yet profitable, provided they meet CRA eligibility requirements.
The best approach is to document R&D activities throughout the project, identify technological uncertainties early, accurately calculate eligible expenditures, & prepare a technically sound claim that aligns with CRA SR&ED guidelines.