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Calculating SR&ED Tax Credits

Calculating your Scientific Research and Experimental Development (SR&ED) tax credits can appear daunting at first glance. Here, at G6 Consulting, we’re committed to demystifying these intricacies and equipping you with the necessary knowledge and tools to accurately determine your SR&ED tax credits. This guide aims to break down the SR&ED tax credit calculation methodology step-by-step, ensuring your business can maximize its financial benefits from the CANADA Revenue Agency’s (CRA) SR&ED tax incentive program.

Step 1: Identify Your SR&ED Projects

It’s essential to understand that not all R&D activities qualify for SR&ED tax credits. Only those projects that involve systematic investigation in science or technology meet the criteria.

  • Basic Research: This involves exploratory work with no specific practical objective, aimed at acquiring new knowledge.
  • Applied Research: Here, the primary goal is to achieve a specific practical outcome or application.
  • Experimental Development: Involves amplifying existing knowledge or skills to create new materials, technologies, processes, products, or devices, or improve existing ones.

The CRA primarily focuses on the purpose behind your research and the degree of innovation involved. The key is to continually question and reassess your project’s fit for SR&ED eligibility as you progress through each stage.

Step 2: Calculate Your SR&ED Expenditures

Once you have identified your SR&ED projects, the next critical step is to determine all associated expenses. This stage requires careful record-keeping and a clear understanding of what costs are eligible.

  • Salaries and Wages: Include both direct and indirect labour costs associated with SR&ED projects, covering full-time, part-time, and even contract employees.
  • Materials: Cost of materials consumed or transformed in the SR&ED process.
  • Equipment: The portion of equipment costs used directly in the SR&ED activity.
  • Third-Party Contracts: Costs related to SR&ED activities subcontracted to a third party.
  • Overhead and other expenditures: Include those for rendering SR&ED projects.

Step 3: Determine if You’re an SME or a Large Corporation

Determining the status of your company—whether it is a Small and Medium-sized Enterprise (SME) or a large corporation—is vital as the SR&ED program offers different Investment Tax Credits (ITCs) rates depending on the size of your firm.

Small and Medium-Sized Enterprises (SMEs)

If your company is an SME, it will likely qualify for larger ITCs. For SR&ED tax incentive purposes, an SME typically refers to a Canadian-controlled private corporation (CCPC), with some specific financial characteristics.

  • Taxable Income: The taxable income should not exceed $500,000 in the previous year to be eligible for the enhanced (refundable) 35% tax credit rate. The amount of qualified expenditures eligible for this refundable tax credit starts to phase out when a company has a taxable income between $500,000 and $800,000.
  • Taxable Capital: It’s important to note that the company’s taxable capital should also be considered. CCPCs with taxable capital of up to $10 million are eligible for the entire $3 million expenditure limit at the enhanced ITC rate. This limit starts being reduced for CCPCs with taxable capital between $10 million and $50 million and is completely phased out when taxable capital reaches $50 million.
  • Canadian Control: A key requirement for CCPCs is that they are indeed under Canadian control—which entails that more than 50% of the controlling interests of the corporation’s shares are owned by Canadian residents, public corporations, or a combination of the two.

Large Corporations

If a corporation does not fit the above criteria, it is generally considered a large corporation for the purposes of the SR&ED program. The ITC rate for large corporations, or corporations that are not CCPCs, is a non-refundable 15% regardless of the amount of eligible expenditures.

Large corporations, foreign-owned corporations, and public corporations are considered non-CCPCs. The 15% non-refundable ITCs can be used to reduce tax payable and can be carried back up to three years or carried forward up to 20 years.

Determining if your firm qualifies as an SME or a large corporation can be quite involved and will often require the advice of a tax professional to accurately establish. Ensure to analyze all the factors above before applying for the SR&ED tax incentive program.

Step 4: Calculate Your Investment Tax Credit (ITC)

Calculating the Investment Tax Credit (ITC) is a crucial piece of the SR&ED claim. The ITC rate differs based on the status of your corporation – whether it’s an SME or a large corporation. Below we delve further into the calculation process for each category.

Small and Medium-Sized Enterprises (SMEs)

As an SME, your eligible SR&ED expenditures can benefit from two distinct ITC rates:

  • Refundable ITC: You’re entitled to a refundable tax credit of 35% on the first $3 million of eligible SR&ED expenditures. This means that once your tax liabilities are covered, any remaining amount from this ITC is given to you as a cash refund.
  • Non-Refundable ITC: Any amount that exceeds the $3 million cap is applicable for a non-refundable tax credit of 15%. These ITCs can’t be refunded but can be used to decrease any taxes owed now, carried back 3 years, or carried forward 20 years.

The calculation is pretty straightforward. For instance, if your qualified SR&ED expenditure is $4 million, the first $3 million will fetch an ITC of 35%, and the remaining $1 million will get an ITC of 15%.

Large Corporations

Large corporations have a simpler situation when it comes to SR&ED ITCs. Regardless of the total eligible SR&ED expenditure, you’re entitled to a flat, non-refundable ITC of 15%.

Non-refundable ITCs can be used to reduce any taxes owed and may be carried back up to three tax years or carried forward up to twenty tax years, providing flexibility for the corporation to strategically maximize its financial benefits.

It’s essential to correctly calculate your ITC to maximize your benefits from the SR&ED program. This calculation process becomes easier if you have properly identified SR&ED projects and correctly evaluated the associated expenditures.

Step 5: Subtract Government and Non-Government Assistance

Next, subtract all government or non-government financial assistance you received for the SR&ED project from your ITC – grants, subsidies, funds, or other types of assistance. The CRA insists on this subtraction to prevent “double-dipping” – benefiting from two financial advantages for the same expenditure.

Step 6: Determine Refundable and Non-Refundable Tax Credits

All SR&ED ITCs are either refundable or non-refundable. As an SME, you receive 100% refundable tax credits on the first $3 million of qualified expenditures. If your costs exceed this limit, 40% of the remaining credit is refundable, and 60% is non-refundable. For large corporations, your tax credits are non-refundable, but you have options to use them. You can carry them back up to three years to recover taxes paid in the past or forward up to 20 years against future tax liabilities.

Step 7: File Your SR&ED Claim

Finally, it’s time to file your SR&ED claim. Use the CRA’s Form T661 to detail your project descriptions and incurred expenditures. Ensure it’s submitted within 18 months of the fiscal year-end when the expenditure took place. This process requires meticulous record-keeping, documentation, and the ability to present your R&D activities clearly, justifying their eligibility for SR&ED credits.

Remember, SR&ED tax credit calculations involve careful evaluation of many factors. It’s often beneficial to engage experienced SR&ED consultants like us to streamline the process. While our guide offers a general outline for computing your SR&ED tax credits, every situation is unique. At G6 Consulting, we’re here to help your business navigate SR&ED tax credits and ensure you receive every penny you deserve for contributing to innovation in Canada.

 

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