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
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.
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?
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.
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!