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Maximize Your SR&ED Tax Credits: Engineering & Design Work

If you’re an innovator, engineer, or designer in Canada, the Scientific Research and Experimental Development (SR&ED) tax incentive program can help you save on taxes. When you file a claim for qualified SR&ED expenditures, you can receive a tax credit or deduction which can lead to significant savings. 

But how do you ensure that your projects qualify for SR&ED benefits? In this article, we’ll explore what qualifies as qualified SR&ED expenditures, the eligibility criteria, expenditure types, and common mistakes to avoid. 

SR&ED tax credits are tax incentives provided by the Canadian government to encourage and support businesses and individuals engaged in scientific research and experimental development (SR&ED) activities. These tax credits aim to promote innovation, competitiveness, and economic growth in Canada.

The SR&ED tax credit program allows eligible companies and individuals to claim a portion of their expenditure on qualifying SR&ED activities as a tax credit. The credit can be used to reduce the amount of taxes owed to the government or to obtain a refund for taxes already paid.

The amount of tax credit that can be claimed is calculated based on eligible SR&ED expenditures and varies depending on factors such as the type of entity (e.g., corporation or individual), the nature of the project, and the size of the business. 

Types of Qualified Expenditures for SR&ED

Qualified expenditures in SR&ED vary based on the nature of the project. The eligible expenditure categories are:

Salaries and Wages

Salaries and wages account for the compensation paid to employees who were directly involved in the research and development activities. This category covers the financial remuneration for the time and effort put forth by the individuals contributing to the project’s innovation and technical advancement.

Materials

Research supplies and materials used in testing, experimenting, and analyzing the results of systematic investigations fall under this category. It includes the costs incurred in acquiring and utilizing materials essential to the R&D process. This encompasses a wide range of items such as laboratory supplies, prototypes, and testing components.

Subcontractors

Payments to third-party contractors for services or works related to the project are categorized as expenditures in the SR&ED program. This may include specialized expertise, outsourced development work, or specific tasks that require external input. Including and documenting these expenditures can help in maximizing your SR&ED benefits.

Overhead Costs

Overhead costs pertain to the expenses associated with maintaining and upgrading facilities, utilities, or rental equipment used in the research and development work. This could encompass a variety of expenses such as rent, utilities, maintenance, and depreciation related to the facilities and equipment utilized during the R&D process.

SR&ED Contract Payments

Payments made toward constructing or enhancing tax software for use in Canada fall under the category of SR&ED contract payments. This includes costs incurred in the development, improvement, or modification of software with the primary purpose of addressing tax-related functions or requirements within the Canadian context. 

For your project to qualify for SR&ED benefits, it must meet specific criteria. These criteria are centred around innovation, systematic investigation, and technical advancement.

Innovation

Your project should aim to develop new ideas, processes, or technologies that push the boundaries of your field. It should involve exploring uncharted territory and finding creative solutions to existing problems. The emphasis should be on making significant advancements rather than simply making incremental improvements.

Systematic Investigation

Engaging in a series of experiments is necessary to qualify for SR&ED benefits. You should actively seek out new, untested approaches and hypotheses, and conduct experiments to test their validity. This demonstrates your commitment to systematic investigation and your willingness to take calculated risks to achieve breakthroughs.

Technical Advancement

The results of your experiments should lead to technical advancement within your industry. This means that the outcomes of your research and development should have the potential to improve or modify existing technologies, processes, or tools. The goal should be to contribute to the overall progress and growth of your field.

Factors That Affect Eligible SR&ED Expenditures

Several factors can affect eligible SR&ED expenditures that can be claimed under the Scientific Research and Experimental Development (SR&ED) program. Understanding these factors is necessary for businesses that wish to maximize benefits under the program. Here are some of the critical factors:

Timeframe

Eligible expenditures must relate to the SR&ED activities carried out during the SR&ED period. The period is determined by the CRA and can vary depending on the nature of the project and the parties involved.

Size of Business

The size of the business can impact the eligibility of expenditures for SR&ED tax credits. For example, CCPCs can qualify for enhanced tax credits, whereas larger businesses may face stricter scrutiny of their claims.

Documentation

Proper documentation determines eligible expenditures. The CRA expects careful documentation of expenses, methodology, and results to be submitted as supporting evidence for your SR&ED claim.

Compliance

Compliance with the SR&ED program’s regulations is essential to claiming tax credits. Failure to meet the eligibility criteria or follow the prescribed procedures and timelines can result in rejected claims or even penalties. 

Capital expenditures refer to expenses related to the acquisition or improvement of capital assets used in SR&ED activities. The CRA has specific guidelines on what can be claimed as capital expenditures and the related depreciation, amortization, or capital cost allowance. These guidelines can be found in the CRA’s Policy on Capital Expenditures.

Contract Expenditures and Third-Party Contractors

Contract expenditures are costs incurred for using third-party contractors or subcontractors to perform SR&ED activities. The CRA has policies that outline the criteria for claiming these contract expenditures, including the conditions that must be met for third-party contractors to qualify.  According to CRA, the work performed by the third-party contractor must meet the definition of SR&ED as defined by the CRA, involving the resolution of technological uncertainty through systematic investigation or experimentation.  The payment must also be for direct SR&ED work, such as experimental development, applied research, basic research, or support work directly in aid of the SR&ED work.  The payments must be made to arm’s length third-party contractors, meaning that the contractor and the business engaging their services are not related or connected in a way that could potentially influence the contractual terms or payments. The CRA’s policy also specifies certain types of contract expenditures that may not qualify for SR&ED claims. For example, expenditures related to routine data collection, quality control, or commercial production may not be considered eligible for SR&ED tax credits.

Legislative References

The policies mentioned above are supported by legislative references, which are the applicable sections of the Income Tax Act and other relevant laws. These legislative references provide the legal framework for the SR&ED program and specify the eligibility criteria for various types of expenditures.  Consult the appropriate legislative references, such as sections 37 and 127 of the Income Tax Act, to understand the legal requirements for SR&ED expenditure claims. Section 37 pertains to allowable business expenses and disallows expenses related to illicit activities or prohibited expenditures like bribes or fines. These expenses do not qualify for deductions under Section 37 of the Income Tax Act.  Businesses engaged in SR&ED activities should adhere to the guidelines under this section to ensure that their expenses are eligible for deduction. Section 127 is significant in establishing guidelines for the calculation of SR&ED investment tax credits. This section delineates the criteria for claiming SR&ED tax credits, including the rate of credit earned based on the qualified expenditure pool and other applicable provisions.  

Common Mistakes and Tips for Maximizing Qualified SR&ED Expenditures

When it comes to claiming SR&ED tax credits, we suggest that you avoid common mistakes and maximize qualified expenditures. Here are some tips for maximizing your qualified SR&ED expenditures.

Ensure Proper Documentation

Maintain contemporaneous records, technical content, project descriptions, and financial records to avoid the common mistake of poor documentation. Properly identify, document, and categorize eligible expenditures to support your SR&ED claims effectively.

Project Descriptions

When documenting your research and development activities for claiming SR&ED tax credits, provide clear descriptions of the project’s objectives, scope, and timeline. Moreover, include details about the scientific or technological uncertainties that the project aims to overcome.

Technical Content

Ensure that the documentation explains the scientific or technological advancements you pursued during the project. Describe the experimentation or iterative process used to achieve your goals and include any technical challenges or obstacles encountered along the way.

Contemporaneous Records

Maintain contemporaneous records, which means that they are created or recorded at the time the work is performed. These records should include progress reports, project notes, research plans, and other relevant documentation.

Eligible Expenditures

All expenditures directly related to the SR&ED activities should be documented. Categorize expenses such as employee salaries, materials and supplies, overhead costs, and subcontractor fees. Ensure that expenses are properly supported by invoices, timesheets, receipts, and other relevant documentation.

Financial Records

Keep meticulous records of all financial transactions related to the SR&ED project. This includes payments made to employees, subcontractors, and suppliers, as well as financial statements, general ledgers, and other financial documentation.

Transferring Qualified SR&ED Expenditures

If you have outsourced or subcontracted work for your research and development project that qualifies for SR&ED, consider transferring these expenditures to your SR&ED claim. This can help you maximize your eligible expenditures and potentially increase your tax credit.

Verify Qualification

Before transferring any expenditures, ensure that the work done by the subcontractor meets the criteria for SR&ED eligibility. Confirm that the activities undertaken align with the scientific or technological advancements you are pursuing.

Maintain Documentation

Keep detailed records of the outsourced or subcontracted work, including invoices, contracts, and evidence of the services provided. This documentation will be essential when transferring these expenditures to your SR&ED claim.

Note Restrictions on Expenditures

Remember that if the services were provided outside of Canada, the expenditures incurred cannot be claimed as part of your SR&ED expenditures. Be mindful of any restrictions or limitations that may apply to outsourcing activities for your SR&ED project.

Understand Expenditure Limits

Be aware of available expenditure limits and distinguish between allowable and non-allowable expenses. Understanding these limits can help you maximize your SR&ED credits by ensuring that only qualifying expenditures are included in your claim.

Canadian-controlled private corporations (CCPCs) may earn an investment tax credit (ITC) at an enhanced rate of 35% on their qualified SR&ED expenditures incurred in the year, up to a maximum threshold of $3 million. This $3 million threshold is known as the expenditure limit.

Expenses over this special rate earn SR&ED investment tax credits at the basic rate of 15%.

Use an SR&ED Calculator

An SR&ED calculator can be a useful tool in determining the potential tax credits you may be eligible for under the SR&ED program. These calculators can help you estimate the amount of tax credits you could claim based on your qualified SR&ED expenditures.

Note that while SR&ED calculators can give you an idea of the potential tax credits, they are not a substitute for professional advice. Consulting with a tax professional who specializes in SR&ED can provide you with a more comprehensive analysis and guidance on maximizing your SR&ED tax credits. 

Consult with a Tax Professional for SR&ED Tax Claims

The Scientific Research and Experimental Development (SR&ED) tax incentive program in Canada offers significant opportunities for innovators, engineers, and designers to save on taxes through tax credits or deductions. 

To ensure that your projects qualify for SR&ED benefits, understand the eligibility criteria, qualified expenditures, and common mistakes to avoid. As you maintain proper documentation, leverage eligible expenditure categories, and adhere to the regulations and legislative references, you can maximize your qualified SR&ED expenditures and tax credits.

G6 Consulting, the leader in building and submitting SR&ED claims in Canada, offers full-service SR&ED consultant services. With over twelve years in the business, our experts have submitted thousands of successful claims across several industries. 

Leverage their experience and expertise in SR&ED claims and optimize your claim with the best SRED consultants. Schedule a consultation with G6 Consulting today!