G6 Consulting Inc Canada's R&D Tax Credit Experts

Deductions from SR&ED: Things that Grind SRED Credits

 

Overview

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.

Provincial SRED credits grind SRED

It does not make a lot of sense, but provincial SRED credits are considered to be government assistance when federal SRED credits are calculated.  Virtually everyone who has filed a SRED claim has experienced the effect of SRED grind down, even though most people were not aware it was even taking place. Let us take an Ontario CCPC as an example.  The company’s ITC credits are reduced by the OITC and ORDTC credits received. The provincial credits are subtracted from the SRED expenditures on the T661 on lines 429 and 513.  For the ON CCPC, the effect is to reduce its federal ITCs by 35%, which is the rate at which ITCs are awarded to the company as calculated on expenditures on Schedule 31.  We can see the grinding effect most clearly with ORDTC credits.  This credit came about back in 2010 when the federal and Ontario SRED programs were harmonized.  ORDTC is a 3.5% non-refundable tax credit.  Non-refundable means that it only becomes cash when it can be applied to a company’s ON tax balance. So, the government gives companies the right to waive ORDTC credits. This option can be useful for start-ups or chronically unprofitable companies who do not expect to incur ON tax balances for several years.  

Let us do an example together.  You can follow along by using the G6 online SRED calculator here.  A company with $100,000 in eligible SRED expenditures will earn $31,073 of ITC’s, $8,000 of OITC and $3,220 in ORDTC credits. You may say hold it!  Why doesn’t the company receive $3,500 in ORDTC? (i.e., 3.5% of $100,000 expenditures).  Well, believe it or not, OITC credits grind not just federal ITC but also provincial OITC credits.  Yep. The reverse is not true, ORDTC does not grind OITC credits.  So, if I take $3,500 in nominal ORDTC credits and subtract 3.5% of $8,000 in OITC credits, you reach the actual ORDTC amount received by the company of $3,220. Now you know. I just report the facts, I cannot discover any logic or plan behind these goings-on. So, getting back to our example.  If a company decides to waive ORDTC credits, the ORDTC received will of course drop to $0. But the ITCs received will increase by $1,127, 35% of the ORDTC which was waived (35% x $3,2220).  

One last note on provincial SRED grind.  Alberta stopped paying 15% AB SRED credits on SRED claims with Fiscal Year Ends after 1/1/20.  This simplifies the calculation but makes Alberta technology firms much worse off.  No matter how much credit stacking and grinding takes place, a company always maximizes its financial position by taking all available assistance.

IRAP credits grind SRED

The federal government IRAP program funds more “classical” technology R&D. It is a small program relative to the $3B federal SRED program, weighing in most years between $200 and $300M in funding. IRAP predates the SRED program by more than 10 years. Most people, when they think of assistance payments grinding SRED, are thinking of IRAP.

IRAP typically funds 75% of designated scientists’ and engineers’ salary. You might think it is not worth claiming SRED on those individuals if I am going to have to grind down almost all their salary due to IRAP subsidies. This is not how the grinding works, and this mechanism becomes extra important when we look at CEWS examples.

Let us look at a scientist in a company making $100K who is 75% subsidized by IRAP. Yes, we must deduct $75K from the company’s eligible SRED expenditures. But, in the case of the scientist, his eligible expenditures are $155K, not $100K. This is due to proxy. We uplift eligible SRED salaries by 55% to account for overhead to support those individuals’ work. Proxy expenditures are based on salary, but they are not subject to assistance grinding or clawback. So, if we follow along with our G6 calculator, the $100K scientist still earns for the ON CCPC company $24,858 in ITC (plus the provincial credits), not the $11,026 in ITCs he would earn if there were no proxy uplift.

Contract payments in respect of SRED grind SRED

If you do technical subcontract work that involves SRED for a Canadian customer, only one of you can claim SRED funding for this work. Both companies claiming the work is not allowed. The government considers that to be “double-dipping”. The money that you receive for the contract is deemed by the CRA to be a “contract payment in respect of SRED” and thus it is non-government assistance. This means that it must be deducted from SRED salary expenditures claimed. Just like for IRAP, the clawback does not affect proxy. Also, like IRAP, once salary expenditures for a given project are reduced to zero, the reduction cannot affect other project expenditures.

If you do subcontract work for a foreign firm there can be no double dipping. There is no contract payment in respect of SRED. Your out-of-Canada customer cannot claim SRED for your eligible work. This is an important point that a lot of companies do not grasp correctly. Many Canadian firms which do technology subcontract work (software, engineering, high tech consulting, system integration) think they cannot claim SRED on any subcontract work for which they are paid. 100% false. Sub work performed for foreign customers is 100% SRED claimable with no setoffs or clawbacks, regardless of how much the firm is paid for the work.

CEWS grinds SRED

This topic is becoming a headline item for SRED companies during the pandemic. Yes, CEWS is considered to be government assistance with respect to SRED. Yes, CEWS benefits received will grind SRED expenditures. This clawback is a big deal because unlike IRAP, ORDTC, subcontracts etc., CEWS receipts for most companies each year are many times larger than SRED expenditures. Just like other assistance types covered above, CEWS should only be deducted from SRED expenditures for directly overlapping amounts. CEWS is typically paid to all headcount within a company. SRED of course is only paid to specific technical practitioners. The CEWS payments made to non-SRED personnel do not need to be deducted from SRED expenditures.

It is very complex and time consuming in a larger company to calculate the exact overlap between CEWS benefits received and SRED expenditures incurred. This calculation must be performed for each SRED practitioner for all SRED projects across each time, typically per month. Complicating matters further is the fact that CEWS receipts are received by companies for arbitrary 30-day periods which do not correspond to months.

G6 has built cloud software, accessible by a secure browser, which calculates a company’s exact minimum CEWS deduction from SRED required. This software saves you money by reducing your SRED by the legally minimum amount. Large companies may save hundreds of thousands or millions of dollars per year with our software. Second, our software delivers a proof file which can be used in any CRA review of your CEWS deduction to keep you audit-proof. Finally, the G6 CEWS software saves you a great deal of time in preparing your FY2020, 2021 and possibly FY22 SRED claims.