Key Do's and Don'ts During an SR&ED Audit: Protect Your Claims

At G6 Consulting Inc, we know how important the SR&ED program is for encouraging innovation in Canada. Getting funding through SR&ED can really make a big difference for businesses doing research and development. However, the prospect of an SR&ED audit can often seem daunting. With over 15 years of experience and thousands of successful claims across a variety of industries, we’re here to guide you through the audit process, ensuring your claim stands the best chance of success.

Understanding the SR&ED Audit Process

A SR&ED audit is winnable. However, the statistics are not on your side.  sredstakeholder.ca figures show that less than 40% of audited claims survive without significant reductions in the credits awarded. G6 can help.

Typically, audits are triggered by certain aspects of a claim that require further clarification. The process includes carefully examining both the technical and financial aspects of your claim. Proper documentation and clear reporting are your best allies in this process.

SR&ED Audit Walkthrough

SRED audits follow a well-worn path.

There’s a few minutes of chit chat.  Note. This is the only time in the audit you should speak in an unguarded manner. If you are talking about the Blue Jays, have at it. If you are describing any aspect of your business or your work, get your game face on.  Be brief, authoritative and to the point.

Next the auditors will ask you to give a short overview of your business. Don’t talk about your projects here. Be self-serving. The government writes everything down. If you can talk about employment growth here, do so. If you can talk about your technology focus and technology investments here, do so.  Increasing sales? Talk about that briefly. The government will hear “increased tax bills”. That can’t hurt. Can you spin your increased sales as a result of your unceasing quest for technological advantage. Now we are talking!

Next up. The tech auditor (RTA – Research Technology Advisor) will provide some training on the technical aspects of the SRED program. He will describe “perfect SRED”.  You do not need perfect SRED.  Pay attention anyway. Next, the financial auditor (FR- Financial reviewer) will provide training on the financial aspects of preparing a SRED claim.  This is dumb. Can you imagine, a CRA auditor teaching you about preparing a T2 correctly during a general corporate audit? Your SRED consultant or accountant will handle all the financial and forms aspect of your SRED claim. You have one job.  Get ready to nail the next topic in the audit!

Next topic. Tech review of the SRED projects claimed. OK here it is. The nub of the matter. The RTA will ask some version of this question. “Now that you are fully trained on all matters SRED, please describe in your own words why the work you submitted in Project X is SRED?” Be brief. Be authoritative. Describe your project, focusing on technological obstacles. For work performed, make sure you’re only talking about work performed that addressed one or more tech obstacles. Wrap up with a short statement on one or two advancements achieved. Keep in mind that an advancement in SRED-land is ONLY something that resolves one of the tech obstacles you already described. Inventing cold nuclear fusion is NOT an advancement if it doesn’t relate to one of your obstacles or unknowns. Documenting a technology failure and six months of wasted tech effort IS a SRED advancement. We have identified and closed off an avenue of investigation to resolve one of our tech unknowns. Time to get SRED paid!

Your goal in describing your tech project is to get the RTA to say “I see SRED”. If you can do that for each of your projects, you win. The rest of the audit is clerical wrap-up work.  Let your consultant deal with it. This raises a point. If things go well, your SRED consultant will not speak during the tech review. The RTA wants to hear from the people who did the work.  Not the consultant.

We are in the home stretch. The financial review. Now you get a break. You SRED consultant and/or accountant can do the rest of the talking. Sorry.  There’s one more item where you have to talk. This may be covered in either the tech or the financial section. Time tracking. How did you come up with the hours claimed for the projects. What the government wants to hear is that you have detailed hourly tracking of all tech staff, recorded contemporaneously (at the time the work was performed).

Do's during an SR&ED Audit

Do Prepare Thorough Documentation

One of the most critical aspects of successfully navigating an SR&ED audit is the preparation and maintenance of comprehensive documentation throughout your project’s lifecycle. At G6 Consulting, with over 15 years of experience in guiding businesses through their SR&ED claims, we’ve seen first-hand the difference that well-prepared documentation can make. Here’s why detailed records are so important and what types of documentation you should focus on.

Importance of Maintaining Detailed Records

Documenting every step of your research and development (R&D) activities serves multiple essential purposes. It not only provides a clear, chronological account of your project’s progression but also substantiates your claim by evidencing your systematic investigation and efforts to achieve technological advancements.

Detailed documentation demonstrates to auditors that your work meets the SR&ED program’s criteria, showcasing the scientific or technological uncertainties you aimed to address and the methodologies you employed to overcome them. In essence, these records are the backbone of your claim, providing tangible proof of your eligible R&D work.

Now obviously your documentation is your documentation.  Unfortunately, you can’t time travel backwards upon receiving a SRED audit notice and come up with perfect project tracking.  There are things you can do, documentation-wise, to help this audit, aside from making a New Year’s resolution to document better going forward.  Many SRED audits these days have two RFI’s (Requests for Information) associated with them.  One RFI you may submit pre-audit answering questions asked in your initial audit letter.  A second RFI is often generated by follow-up questions the CRA reviewers have.  You respond to this RFI approximately 3 to 4 weeks post-audit.  Providing good information in these two RFIs can go a long way to helping you achieve a 100% accepted as filed result in your SRED audit.

Do Understand the Eligibility Criteria

Review of the Criteria for SR&ED Eligibility

Understanding the eligibility criteria for the SR&ED program is crucial. At its core, the SR&ED program is designed to support projects that advance scientific knowledge or achieve technological improvements. To qualify, your project must demonstrate:

  • Technological Advancements: The task should help make technology better by either making new things or making existing things better.
  • Scientific or Technological Uncertainty: You need to show that the results of your project couldn’t have been predicted using what we already know about technology and science.
  • Systematic Investigation: The work must have been conducted systematically through experimentation or analysis to test your hypothesis or answer your research questions.

How to Align Your Project Documentation with These Criteria

To ensure your documentation aligns with the SR&ED eligibility criteria, start by clearly defining your project’s objectives in terms of potential technological advancements or scientific knowledge gains. Document the technological uncertainties or challenges you faced and how you systematically approached these problems.

Make sure your records detail the experimental or analytical methods used, the data collected, and how the results contribute to resolving the uncertainties or achieving the project objectives.

Do Communicate Effectively with Your Auditor

Tips for Establishing a Positive Working Relationship with the Auditor

  • Be Prepared: Before the audit, organize your documentation and understand the specifics of your claim. This preparation shows respect for the auditor’s time and demonstrates your professionalism. 
  • Be Responsive: Please reply quickly when someone asks for information or needs something explained. Delays can signal disorganization or, worse, raise doubts about your claim’s validity.
  • Don’t Talk Too Much: SRED claim narratives and information gathered in an audit are mostly reviewed negatively. By this, I mean, our goal is not to achieve an A+.  The goal is to avoid landmines and red flags. Be assertive, make your points, and then shut up. We do not need to outrun a bear in an audit. We just need to be comfortably mid-pack in a group of terrified folk running away from the bear.  Let someone else be the bear’s dinner. Do not argue with an auditor.  Have you ever seen a manager win an argument with a baseball umpire? Neither have I. And I haven’t seen anybody win an argument with a CRA RTA  in 15 years of SRED audits, either.  SRED auditors make mistakes and have incorrect opinions on SRED legalities regularly. Don’t argue. Just like in a fight with your spouse, the time of maximum danger is when you are right and he/she is wrong. Your SRED consultant will step in if he thinks there is a way to re-state or re-direct matters.  If the auditor makes factual errors, we will have time to set the record straight later.

The significance of clear and brief communication.

It’s really important to be clear and straightforward when you communicate. When discussing your project with the auditor, use technical language. You want to use terminology at the level of a Scientific American article. 

Use words like hypothesis, systematic investigation, experiment, failed initiative, preliminary results, control group, new hypothesis formed on the basis of learning from our prior experimentation, etc.  These are all SRED gold words/phrases.

DO NOT “talk-down” your own good work. Don’t use expressions like “trial and error”, “fiddled with”, “played around with”. You want to demonstrate technical expertise in your field. Show that you carried out a systematic investigation.

Don’t use sales or business language. Don’t talk about market potential or revenue opportunities. SRED is a technology game. Make sure you are playing and addressing the correct game. “Commercial validation” and “customer generated data” is poor SRED language. Change that wording to field or real-world or live data.  R&D is a broad set of activities. SR&ED is the subset of experimental activities focused on resolving technological unknowns and obstacles. That’s all we talk about.  Commercial and customer terminology gives auditors the opportunity to characterize your good work negatively. “R&D – yes! SR&ED? No!” As a trivial example, if you are experimenting to build a new toaster that never burns bread, that’s SR&ED. Testing that toaster in a UL or CSA lab to certify it as safe is an R&D activity, but it is not SR&ED. Unless you electrocute someone, in which case you’re back in experimental territory. The expectation is that the toaster is in a state where it will pass UL certification, that classifies the testing as a commercial activity, not SR&ED.

We want to always characterize your work as incremental, systematic progress, salted with blind alleys, failure, conflicting and uncertain hard-won gains in insight and knowledge/practice toward a distant goal. Ballard Power Systems has spent 25 years trying to develop a viable hydrogen cell light enough and strong enough to deploy in vehicles (and claiming lots of SRED every year…). Is that a commercialization effort? Of course. Would they talk about the work in that light for SR&ED reports? No.

Do Review Your Claim Submission

The Benefits of Reviewing Your Claim Before the Audit

Reviewing your claim before the audit can illuminate areas that may require additional documentation or clarification. This pre-emptive approach allows you to address potential questions or concerns before they are raised by the auditor, streamlining the audit process.

How to Identify and Correct Potential Issues in Advance

  • Cross-Reference Documentation: Ensure all stated activities, expenditures, and claimed advancements can be clearly traced back to your supporting documentation. Discrepancies or missing information are red flags that need to be addressed.
  • Seek an External Review: Consider having your claim reviewed by an SR&ED expert, like those at G6 Consulting, before submission. An external review can identify weaknesses in your claim or documentation that you might have overlooked.

Update Your Documentation:

If you find areas where the documentation is lacking or unclear, take the time to update these records. Improving your explanations and including any financial papers that are missing can really boost how strong your argument is.

Don'ts during an SR&ED Audit

Navigating an SR&ED audit successfully requires not only following best practices but also avoiding common pitfalls. Here are critical “don’ts” to keep in mind, based on G6 Consulting’s extensive experience in handling SR&ED claims:

Don’t Overlook the Importance of Technical Narratives

The Role of Technical Narratives

Technical narratives are at the heart of your SR&ED claim, telling the story of your project from conception through to its challenges and outcomes. They provide a detailed account of the scientific or technological advancements you aimed to achieve, the uncertainties you faced, and the systematic research or experimentation you conducted to overcome these challenges.

Common Pitfalls to Avoid

  • Being too Vague: Avoid general statements that don’t offer specific insights into your project’s innovative aspects. Be detailed about the technological uncertainties and the experimental processes undertaken to address them.
  • Lack of Technical Details: While it’s important to be concise, omitting crucial technical descriptions or results can weaken your narrative. Ensure you include enough detail to substantiate your claims of advancement or innovation.
  • Ignoring Failures: It’s just as important to learn from what didn’t work as it is from what did. Documenting failures and subsequent adjustments can demonstrate a systematic approach and learning process, which is a key component of SR&ED eligibility.

Don’t Underestimate the Financial Aspect

Why Accurate Financial Reporting is Crucial

The financial component of your SR&ED claim is scrutinized just as closely as the technical one. Accurate financial reporting ensures that you receive the appropriate tax incentives for your eligible expenditures. It also reflects the integrity and reliability of your claim.

Common Financial Documentation Mistakes

  • Misclassifying Expenses: Ensure that labor, materials, equipment, and subcontractor costs are accurately categorized and directly linked to SR&ED activities.
  • Overlooking Supporting Documents: Receipts, payroll records, and contracts are essential to substantiate your financial claim. Missing or incomplete documentation can lead to disallowed expenditures.
  • Failing to Track Project-Specific Expenses: Allocate costs to specific projects as accurately as possible. General overhead or indirect costs need a clear and logical method of allocation to SR&ED projects.

Don’t Ignore the Auditor’s Requests

The Consequences of Not Responding

Ignoring or delaying responses to the auditor’s queries can have severe consequences, including increased scrutiny, delays in processing your claim, and potentially reduced or denied claims. Giving complete and clear answers shows that you’re dedicated to being open and honest about your statement.

How to Effectively Handle and Respond to Requests

  • Organize Your Documentation: Keeping your records well-organized helps you to promptly and accurately fulfill any requests from auditors.
  • Be Proactive: If clarification or additional information is requested, provide comprehensive responses to address the auditor’s concerns fully. If necessary, offer to meet or have a call to discuss the query in detail.

Don’t Try to Navigate the Audit Alone

The Advantages of Getting Help from Experts.

The SR&ED program’s complexity, combined with the stakes of the audit process, means that navigating it without expert help can be risky. Professional SR&ED consultants bring a depth of experience and knowledge to the table, helping to avoid common pitfalls and strengthening your claim.

How SR&ED Consultants Can Add Value

  • Expertise in Eligibility and Documentation: Consultants like those at G6 Consulting understand the intricacies of SR&ED eligibility criteria and documentation requirements, ensuring your claim is both compliant and compelling.
  • Audit Support: From preparing for the audit to addressing queries and even negotiating with the CRA, SR&ED consultants can provide invaluable support every step of the way.
  • Maximizing Your Claim: Professionals can help identify all eligible expenditures and activities, ensuring you claim the maximum amount possible.

Best Practices for a Smooth SR&ED Audit

By adhering to the do’s and don’ts outlined above, you can significantly improve the audit process’s smoothness and outcome. Always remember, thorough preparation, understanding of the SR&ED criteria, and effective communication are key.

Conclusion

An SR&ED audit is important for getting funding for your innovative projects. At G6 Consulting, we view it as an opportunity to solidify the credibility of your claim and reinforce your commitment to innovation. With our expertise and guidance, you can navigate the audit process confidently, ensuring your SR&ED claim is robust and well-protected. Trust your SR&ED claim with the best—let G6 Consulting be your partner in innovation. 

Get your SR&ED done right with G6 Consulting Inc – Canada’s R&D Tax Credit Experts!

G6 Consulting can work with you to build your claim, co-ordinate with your accountant, submit your claim and get you your cheque. No cost until you get paid

Check out our SR&ED overview page to learn more about SR&ED and how to qualify

Contact an Expert for a free no obligation consultation to see if your business can qualify

Check out our SR&ED calculator to get an idea of how big your SR&ED cheque could be

Key Do's and Don'ts During an SR&ED Audit Protect Your Claims
Key Do's and Don'ts During an SR&ED Audit Protect Your Claims