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What can you claim for research and development?

What can you claim for research and development under the Scientific Research& Experimental Development (SR&ED) program?  SRED claims are built by claiming eligible expenses for projects.  Projects are split into fiscal years. So, a complete claim for SRED is composed of 1 to many projects with all eligible expenses included for a given fiscal year.

SR&ED is a subset of R&D.  The portion of R&D work which is claimable is called qualifying work.  See this piece for detailed information on identifying qualifying work:  https://www.g6consulting.ca/what-is-sred-qualifying-work/  Briefly, qualifying SRED work is that portion of R&D performed while you are experimenting to resolve the technologic obstacles or unknowns which the project faces.  In a physical example, qualifying work is building a minimum feature set prototype which can then be tested. You learn about your technological unknowns as you iteratively test and modify your prototype. As you learn about the unknown(s) you are making technological advances. This work is the heart of SRED, and it is called qualifying work.

A well-known example of very large scale prototyping was NASA’s work to put a man on the moon in the 1960s. When President John F Kennedy challenged NASA to go to the moon in 1962, there were many technological obstacles and unknowns to fulfilling that mission,  NASA planned their prototyping and experimentation into a series of missions, grouped into phases called Mercury, Gemini and Apollo.  These missions broke the huge unknowns NASA faced into smaller experiments: unmanned spacecraft orbiting Earth, chimpanzees orbiting Earth, etc., all the way to Apollo 11 which successfully proved NASA’s hypothesis that they could put a man on the moon and return him to Earth safely.  The later missions relied on expertise gained, and technological unknowns resolved, in the earlier missions. If Apollo were being claimed as SRED, the qualifying work would encompass not just the direct experimental development carried out to stage each of the Mercury, Gemini, and Apollo missions.  The qualifying work would also be comprised of all the engineering, analysis and planning work which was a critical part of supporting the missions successfully.

Now that we have a project defined and we know the scope of work that is considered to be qualifying work, we are close to sizing up how much we can claim for an SR&ED project.  There are three types of expenses which we can claim for SRED.  These expenses are payroll, materials, and subcontracts. For a detailed explanation of calculating the R&D tax credit, go see this article: https://www.g6consulting.ca/how-do-you-calculate-the-rd-tax-credit/

Briefly, the first and largest SRED expense bucket is payroll.  We enumerate the hours spent by each company staff member as they are performing qualifying work.  We calculate employees’ hourly rate by dividing annual salary by hours of work in the year.  The government allows a 1.5 times uplift factor to this hourly rate to account for overhead costs to support the employee in his work.  This overhead factor is called proxy.  The second claimable expense is materials. Allowable material expenses are comprised of scrap and prototype costs.  If your experiments generate scrap material, this expense can be claimed.  If your experiments require a prototype to be built, the material costs in that prototype are claimable.  A software claim or a process improvement SRED claim will generally not generate material costs.  The last claimable SRED expense is subcontracts.  Subcontracts are payments made to people outside your organization who are performing qualifying work on your project.  These subcontract payments may be for a company performing specialized testing on your prototype, or it might be hiring a subject matter expert in computer security for a software SRED claim.  Allowable subcontracts for SRED must be to Canadian individuals and Canadian companies.

Now that we have all the allowable expenses assembled for our SRED project, we are ready for the final step.  We need to multiply the SRED expenses by a SRED credit percentage to determine the amount we can claim. For a small business corporation, called a CCPC, the SRED credit percentages are 66, 42 and 34% respectively for payroll, materials, and subcontracts. That’s it, you’ve gone through all the steps to determine what you can claim for your SR&ED project.