Governments’ primary support for industrial R&D




THE SR&ED PROGRAM

The Scientific Research and Experimental Development (SR&ED) Investment Tax Credit (ITC) program is the Canadian government’s primary mechanism for supporting industrial research and development (R&D) in Canada.  The financial benefits from the program are intended to persuade Canadian businesses to conduct more R&D in Canada. The government believes that this will lead to increased competitiveness, and a more technically advanced society. The Canada Revenue Agency (CRA) administers the SR&ED program, while the Finance department sets the SR&ED ITC tax laws.
If your corporation is doing any of the following, you may be eligible for up to 63% tax refund/credit of your R & D costs:

  • Developing a new product or process;
  • Improving your existing process, products or equipment;
  • Developing a new tool or technical procedure;
  • Extending a product line or improving a product;
  • Exploring doing things better/cheaper;
  • Trying to meet regulatory requirements;
  • Exploring new uses;
  • Investigating new materials; or
  • Pushing the boundaries of science or technology.

This refund/credit is normally available regardless whether you have paid any corporate tax and therefore, it represents new money to your company. You may also be entitled to Provincial SR&ED ITC.

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WHAT IS SR&ED?

SR&ED is nothing more than industrial R&D. It is defined in the income tax legislation to be: “a systematic investigation or search carried out in a field of science or technology by means of experiment or analysis”
In many cases SR&ED is innovation that occurs daily on the shop floor!

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HOW TO IDENTIFY SR&ED PROJECTS

Eligible SR&ED projects will incorporate the following three criteria:

  1. Technological Advancement: There must be advancements in technology and/or technical knowledge beyond what is commonly available through normal channels of information, or standard engineering practices. To be recognized as SR&ED, technological advancement has to be stated as non-trivially pushing the boundaries of technology beyond what the current state of the art and/or knowledge base of the company. Technological advancement is looked at in the context of the company, not the industry.
  1. Technological Uncertainty:  Technological uncertainty means that the technical staff doing the project do not know for certain the precise outcome of a project or the exact route by which it can be accomplished, without conducting experimentation to remove the unknowns. They may be confident that they will achieve results, but are not certain whether those results will be consistent with what they set out to accomplish.
  1. Technological Content: This criteria requires that the project was:
    1. A systematic investigation in a field of science or technology;
    2. Carried out by experiment and/or analysis;
    3. By suitably qualified personnel who have relevant experience;
    4. Incurred expenses (attributable to the project); and
    5. Left a historical trail of evidence such as emails, reports, contracts, receipts, photos, engineering notebooks, discarded parts, etc.

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ELIGIBLE EXPENDITURES

Most current and capital expenditures directly attributable to the R&D project are eligible costs.  This is a very complex aspect of SR&ED claims. There are many application guidelines and an extensive Information Technical Bulletin (IT 151-R5) on the topic of eligible SR&ED expenditures. In general, current expenditures that are eligible for the SR&ED tax incentives include:

  • salaries or wages of employees directly engaged in SR&ED;
  • the cost of materials consumed in SR&ED;
  • lease costs relating to machinery and equipment used all or substantially all (90 per cent or more) for SR&ED;
  • eligible expenditures incurred by Canadian contractors performing SR&ED directly on behalf of the taxpayer; and
  • eligible expenditures incurred by certain third parties where the taxpayer is entitled to exploit the results of the SR&ED.

In general, capital expenditures that are eligible for the SR&ED tax incentives consist of expenditures for machinery and equipment that is intended 90% or more for SR&ED.

Taxpayers have a choice in how they wish to treat overhead and administrative expenditures.  They can use either the traditional method or the proxy method. The traditional method includes overhead and administrative expenditures that must be specifically identified and allocated in respect of SR&ED and may be eligible for both the SR&ED tax deduction and credits.  With the proxy method only directly attributable costs are eligible for the SR&ED tax credits. Allowable labour costs are for those individuals directly involved in the SR&ED work. With the proxy method, labour costs are increased by a factor of 65% as an allowance for overhead and administration personnel (1.65 multiplier). 

All grants, Provincial SR&ED ITC’s, and revenues for SR&ED are deducted from the eligible expenditure pool.

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SR&ED ITC BENEFITS

Federal SR&ED Tax Credits
There are two categories of Federal SR&ED ITC:

  • 35% per cent Investment tax credit (ITC) for Canadian-controlled private corporations (CCPC) with prior-year taxable income under $400,000 and prior-year taxable capital employed in Canada under $15 million. ITC up to $2M of eligible expenditures are refundable.
  • 20% per cent ITC for all other companies. ITC may be deducted from federal taxes otherwise payable.  Unused tax credits can be carried back three years (to the extent that they were not deductible in the year they were earned) or carried forward 10 years.  

Provincial SR&ED Tax Credits
Eight of the ten provinces have additional SR&ED ITC benefits for SR&ED work carried on in the province. As an example, corporations carrying on SR&ED in British Columbia claim a credit equal to 10% of the qualified BC SR&ED expenditures incurred after August 31, 1999, but before September 1, 2009. However, for calculating the Federal SR&ED ITC the Provincial ITC is considered a grant, and is deducted from the eligible expenditure pool.

Table 1: Federal SR&ED ITC Benefit

Business TypeRefund Rates
Expenditures ITC (%) Current Expenditures Capital
Expenditures
CCPC with prior-year taxable income of $250,000 or less:
Expenditures up to expenditure limit 1 35 100 40
Expenditures over expenditure limit1 20 40 40
CCPC with prior-year taxable income of $250,000 to $450,000:
Expenditures up to expenditure limit 2 35 100 40
Expenditures over expenditure limit2 20 0 0
CCPC with prior-year taxable income over $450,000:
All Expenditures 20 0 0
All other Businesses
All Expenditures 20 0 0
Unincorporated Businesses and individuals
All Expenditures 20 40 40
1 Expenditure limit is $2 million per annum.2 Expenditure limit depends upon income, based on a sliding scale: {1 - ([income - 200,000]/200,000)} $2m.


SR&ED Example 1

An example of a SR&ED tax credit calculation under the proxy method for a CCPC in BC with less than $300,000 taxable income and the following SR&ED expenses:

  • SR&ED wages $300
  • SR&ED material $200
  • SR&ED equipment (capital) $100

Current expenses ITC
Refundable ITC

= {(300 x 1.65 (Proxy allowance) + 200) – ([300 x 1.65 + 200] x .10)} x .35 (Federal ITC)
 + [300 x 1.65 + 200] x .10 (Provincial ITC)
= (625.50 x .35) + 695 x .10
= 218.93 + 69.50
= $288.43  
 

Capital expenses ITC
Refundable ITC

= {(100 – [100 x .10]) x .35} x .40 (Federal ITC)
+ [100 x .10] (Provincial ITC)
= (90 x .35 x .40) + 100 x .1
= 12.60 + 10.00
= $22.60


ITC accrued

= {(100 – [100 x .1]) x .35} x .60 (Federal ITC)
= $18.90   
                     

Total Refundable ITC = $288.43 + $22.60 = $311.03
Total Accrued ITC= $18.90
Total SR&ED ITC Benefit = $311.03 + $18.90
= $329.93 for a $600.00 investment

 

SR&ED Example 2
An example of a SR&ED tax credit calculation under the proxy method for a publicly traded or foreign owned company in BC and the following SR&ED expenses:

  • SR&ED wages $300
  • SR&ED material $200
  • SR&ED equipment (capital) $100
Current expenses ITC
ITC

= {(300 x 1.65 (Proxy allowance) + 200) – ([300 x 1.65 + 200] x .10)} x .20 (Federal ITC)
 + [300 x 1.65 + 200] x .10 (Provincial ITC)
= (695.00 – 69.50) x .20 + (695) x .10
= 125.10 + 69.50
= $194.60

Capital expenses ITC
Refundable ITC

ITC = (100 – [100 x .10]) x .20 (Federal ITC)
+ [100 x .10] (Provincial ITC)
= (90 x .20) + (100 x .10)
= 18 + 10
= $28.00  
 

Total Refundable ITC = $0.00
Total SR&ED ITC Benefit = $194.60 + $28.00
= $222.60 for a $600.00 investment

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REVIEW PROCEDURES

There are two levels of CRA audit; a science review and a financial review:

Science Review:
A Research & Technology Advisor (RTA) from CRA will review your claim's technological information. The RTAs have scientific or technical backgrounds. They examine submissions to ensure they comply with the program's eligibility criteria as stated above.

Financial Review:
Tax department auditors validate the SR&ED expenditures and the investment tax credit you claim. They ensure that the amounts you claim and your calculations comply with the legislation.
CRA conduct all reviews under strict confidentiality rules that recognize the sensitive nature of your technical and financial information. CRA usually completes the review process within 120 days of receiving a complete claim.

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