Let’s look at the Who, What, When, Where and Why of SR&ED Eligibility. We will also examine SR&ED qualifying work
SR&ED funding is available to Canadian-resident individuals, partnerships, and corporations. Canadian-resident has a specific meaning in the Income Tax Act. It means that you have a base of operations in Canada and you are subject to Canadian taxes. Citizenship is not important, tax residency is important. Canadian-resident groups who are not subject to tax are not eligible for SRED credits. This non-eligible group includes non-profits, governments, crown corporations, many research organizations, schools and universities.
There is a definite pecking order in SRED Eligibility. At the top of the heap for SR&ED eligibility are Canadian Controlled Private Corporations, CCPCs. CCPCs receive many SRED preferences. CCPC’s receive higher SRED credit rates. Federally, CCPCs earn 35% credits vs large corporations and individuals who earn 15% credits. That’s a big advantage! 2.33 times the credits per unit of R&D expenditure for R&D. Those higher credit rates carry on in some (but not all) of the provincial SRED piggyback programs. CCPCs in Ontario get 8% OITC credits. Large corporations get no OITCs. CCPCs in Quebec get 30% credits, large or foreign-owned corporations get 14% credits (all credits in Quebec are earned above a $50K reducible expenditure threshold). CCPCs get refundable credits for the most part. Refundability is a big deal. Refundable credits come to firms as cash regardless of their tax position or revenue position. The final preference we’’ mention for CCPCs is speed of processing. The CRA commits to processing CCPC claims which are not audited within 60 days. This compares to a service standard for processing large corporation SRED claims of 365 days.
Next on the totem pole for SR&ED eligibility are large, public and/or foreign-owned corporations. These firms’ claims are processed in the same way as CCPCs but without the preferential treatment described above. Non-refundable credits means you need to have tax balances available to turn your credits into cash. This can be a big issue. Nortel Networks went bankrupt in 2009 with over $1 billion of SRED credits on its books, unused. Despite the non-preferential treatment vs CCPCs, large corporations still accrue the majority of the $3B ITC federal credits awarded annually. This is logical when you consider that the scale of R&D carried out by large corporations in Canada dwarfs that conducted by start-ups and small businesses.
Partnerships and individuals tax resident in Canada are also eligible for SRED credits. In practice, it is difficult for these groups to take advantage of SRED funding, particularly individuals. Partnerships and individuals cannot claim payroll expenses. These expenses are the majority of expenditures claimed in most SRED claims. Partnerships and individuals don’t therefore qualify for proxy overhead funding. Finally SRED credit rates and refundability generally follow the rules for large/public/foreign corporations which mean they do not receive any of the preferential treatment conferred on CCPCs.
Not all R&D work is SRED qualifying work. For a SRED claim to be valid, you must demonstrate that you have carried out “qualifying work”. The definition changes and can get convoluted, but essentially you must have performed experimentation, prototyping, even trial and error to attempt to resolve a “technological uncertainty”. In other words, your project must have faced risk that you could not complete it satisfactorily due to technical obstacles or unknowns. There it is. The heart of the matter.
There are secondary requirements. Your efforts should be systematic. You have some record of your work. But striving to resolve a technological uncertainty is the meat.
An important note on qualifying work. If you have a project which has failed for technical reasons, this likely is SRED qualifying work and it can be fully claimed for payroll, materials, and any subcontract work.
The government released a detailed document in 2015 called Eligibility of Work for SR&ED Investment Tax Credits Policy. This piece is a bit of a deep dive, but it covers the concept of qualifying work for SRED in great detail.
The government recently updated this document and condensed much of the information here; https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/policies-procedures-guidelines/guidelines-eligibility-work-sred-tax-incentives.html
There are 3 buckets of expenditures which qualify for SR&ED eligibility. Payroll, materials and subcontracts. Payroll is generally the largest expenditure claimed for SR&ED. An important principle for SRED claiming is that not just direct experimentation and R&D payroll is claimable. Supporting work that is necessary for the overall prosecution of the experiment is also SRED eligible. Let’s say you are claiming a software project to increase the throughput of an application by 100%. Routine computer programming is not normally claimable as a SRED expense. But for this project, routine programming is required to build out the application to test whether increase in throughput has been achieved. That would make the payroll for the programmers sred eligible as a supporting activity.
Materials are also eligible SRED expenditures. Both scrap material generated during experimentation and materials used to build prototypes are claimable.
Finally subcontracts qualify for SRED eligibility if the work performed is part of a project’s required experiments. There are two types of subcontracts, arm’s length firms and contract employees.
Capital costs used to be an eligible expenditure. Since 2012 these expenditures are no longer SRED-eligible. This rule change also ruled out things like leasing costs for equipment used in SRED.
People familiar with the US R&D tax credit program will often ask whether AWS and Google Cloud charges are eligible for SRED as they are in the American program. These types of expenses don’t qualify for SRED eligibility.
SRED claiming is always done in arrears, after the work is performed. For projects that are long-lived, work is claimed fiscal year by fiscal year, you do not need to wait until a project is complete to claim SRED.
As a best practice, SRED is claimed yearly as part of a firm’s normal T2 filing. The SRED forms, the T661, T661 part 2, the Schedule 31 and the provincial SRED forms are all included with the normal corporate tax T2 schedules.
It is possible to claim SRED expenditures up to 18 month after a firm’s fiscal year end. Unlike filing a normal T2, this 18 month deadline is strict. SRED claims submitted late will not be processed.
For the first time, as a result of COVID pandemic disruptions, some SRED deadlines were extended. For more information, see this post: https://www.g6consulting.ca/sred-filing-deadline/.
For salaries and for subcontracts, all SRED practitioners must be Canadian tax resident. Generally that means SIN numbers for individuals and HST numbers for corporations. Interestingly, there are certain federal programs that bring in foreign workers, often for agriculture. Because these people receive a temporary SIN while they are working in Canada, their payroll qualifies as a SRED expenditure if it is qualifying work.
CCPCs require majority Canadian ownership to meet the qualifying corporation standards. The Canadian requirement here is again one of tax residency, not citizenship.
In general, SRED work must be carried out by Canadians, within Canada, to qualify. There is a limited exception to this rule for SRED work performed by Canadians outside of Canada. This exception was put in place by the CRA many years ago to accommodate Nortel workers who performed SRED work in Research Triangle Park in North Carolina with their American colleagues. This exception allows for up to 10% of claimed payroll to be performed outside of Canada.
Another interesting exception to the made-in-Canada rules for SRED is materials. Materials claimed for SR&ED can be sourced worldwide. There is no preference for Canadian-sourced materials. In fact, not just the materials can be claimed but their landed cost is claimed. This means the material cost plus any shipping and duties to get them to the experimentation site in Canada are valid expenditures.
Canada’s SR&ED Program is generally recognized as the most generous R&D incentive program of its kind in the world. That is certainly the case with its focus on small business and start-up R&D. The program’s purpose is to incent firms to increase the time and money spent on experimental development. This focus will raise firms’ technology base over time and hopefully make them more competitive against foreign competitors. Contact G6 Consulting today to make sure you are leveraging this one-of-a-kind program to your best advantage.
G6 Consulting Inc has over 12 years of experience specializing in the SR&ED program. SR&ED experts such as G6 often work on a contingency basis, with payment only based on a percentage of SRED credits once received. You can contact G6 for a free consultation here. https://www.g6consulting.ca/contact/