The SR&ED program is a federal tax incentive program, administered by the Canada Revenue Agency (CRA), that encourages Canadian businesses of all sizes, and in all sectors to conduct research and development (R&D) in Canada. It is the largest single source of federal government support for industrial R&D. The SR&ED program gives claimants cash refunds and/or tax credits for their expenditures on eligible R&D work done in Canada. If your company innovates, the company may be eligible for cash or tax credits.
Canadian-controlled private corporations (CCPC) can earn an investment tax credit (ITC) of 35% up to the first $2 million of qualified expenditures for SR&ED carried out in Canada, and 20% on any excess amount. Other Canadian corporations, proprietorships, partnerships, and trusts can earn an ITC of 20% of qualified expenditures for SR&ED carried out in Canada. Generally, a CCPC with a taxable income in the immediately preceding year that does not exceed the business limit may receive a portion of the ITC earned as a refund, after applying these tax credits against taxes payable. The ITC earned by a Canadian corporation that is not a CCPC is non-refundable, but may be used to reduce any taxes payable. The ITC earned by a proprietorship or certain trusts may be partially refunded after applying these tax credits against taxes payable. While corporations have a more straightforward connection to the ITC, proprietorships can apply for these tax credits as well.
The good news: you can ask "Am I eligible?" online: http://www.cra-arc.gc.ca/txcrdt/sred-rsde/ssssmnt/menu-eng.htmlWhat constitutes Research and Development?
Work that qualifies for SR&ED tax credits includes:
- experimental development to achieve technological advancement to create new materials, devices, products, or processes, or improve existing ones;
- applied research to advance scientific knowledge with a specific practical application in view;
- basic research to advance scientific knowledge without a specific practical application in view; and
- support work in engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, or psychological research, but only if the work is commensurate with, and directly supports, the eligible experimental development, or applied or basic research.
The following activities are not eligible for benefits under the program:
- social science and humanities research;
- commercial production of a new or improved material, device, or product, or the commercial use of a new or improved process;
- style changes;
- market research or sales promotion;
- quality control or routine testing of materials, devices, products, or processes;
- routine data collection;
- prospecting, exploring, or drilling for or producing minerals, petroleum, or natural gas; and
- development based solely on design or routine engineering practice.
- common clerical work - One company designed a way to track their staff time. Work on projects was tabulated for the eventual application for an SR&ED tax credit. They designed their time tracker so that when in doubt: time went to R&D. When the receptionist spent an hour photocopying and stapling handouts and she didn't know where to allocate her time. That "miscellaneous" time was slotted into SR&ED time
The technical work has to have three components: technological advancements, technological obstacles; and work performed in the tax year.
Technological advancements - You have to define the work carried out-- the goal of the advancement and the foundation of the work. The advancement doesn't have to be work in the field at large: it solely has be innovative inside of your company. Yes, lots of companies have e-commerce systems. The struggle to build your e-commerce system is applicable work.
Technological obstacles - There has to be some element of risk and obstacle. If you sit someone down to carry out routine work that is a repeat, that's going through known territory and its not a risk. If you going into uncharted territories, there will be obstacles: competing priorities and perimeter of the development work.
Work performed in the tax year - This is straight forward: work carried out within the fiscal year is applicable. A project can start before the year; or end in later financial years-- but only the work initiative in one year can be included.
A quick rule of thumb: your SR&ED tax credit for a given year will be less half of than your payroll plus your contractor fees. Usually, it's much less because of how much time staff will spend in routine tasks. It's certainly less than half of the amount spent on your technical, research and engineering staff and contractors. One company was up to fishy stuff when their SR&ED claim for a given year was as much their payroll. True, you can add in the expense of prototypes, but that is unlikely to warp your claim.
Work Performed Outside of Canada
You have to remember a few things when you have non-Canadian work involved with your project:
- Only the expenses incurred for salaries or wages paid to the taxpayer's employees who carried on SR&ED work outside Canada can be claimed.
- Only 10% of the total salary or wages paid in respect of SR&ED carried on in Canada by the taxpayer can be claimed for work outside Canada.
- The SR&ED must be directly undertaken by the taxpayer and must be related to the business of the taxpayer.
- The employees must have been resident in Canada at the time the expense was incurred and the SR&ED carried on by the employees outside Canada must have been solely in support of SR&ED carried on in Canada.
Specified employees aka partners have to be handled with care. As owners of the company, they may work long hours as a matter of course. This makes two dilemmas: how much of their work can be claimed. And if a partner works 80 hours per week, then 1.0 FTE (usually 35-40 hrs./week) is half of their time and half of their wage.
Number one, documentation is key. Work for which you have no relevant supporting evidence will likely be disallowed. SR&ED is a Canadian program. Contractor fees paid to companies outside of Canada are no eligible. They allow some of the expenses associated with the production of a prototype on the provision that the prototype is destroyed, or at least not put into the marketplace.
Very Important Milestones
You need to submit your claim with 18 months of the end of an financial year end. Claims will linger at CRA for up to 120 business days (aka 6 months) before you can expect word. It's not impossible for CRA to misplace files. If a claim goes in, gets misplaced, and then word of that surfaces after the 18 month cut-off, your tax credit will be denied. It has happened. There are two ways to limit the risk. First, submit earlier than six months before the 18 month limitation: this allows for accidents to happen but your claim will still be active. Second, documentation. When your claim is submitted, get a receipt and keep it safe. It could be a million dollar slip of paper. If you don't get it and accidents happen, your claim can be disallowed. If CRA loses your claim but you have the all important receipt, you can urge them to continue to process the claim-- if it's lost, they can be obliged to accept your copy of the claim for evaluation in lieu of their original. A lost claim is likely to get messy, but at least your company may still collect. These limitations cut both ways: if you submit an inherently unready claim, it will stop the clock. CRA will let you know what you are missing. While you are working on rounding out the list of elements to complete a submission, the 120-day window for processing is suspended. If you have submitted an incomplete claim, it doesn't get caught in the 18 month rule. Only a complete claim submitted before the 18 month cut-off can be assessed.
Be Your Own Contact
When a claim goes in, it specifies who can contact CRA for updates. Your consultant should also be a point of contact. If a claim is audited, CRA will decide who they contact, when and for what. But, only the contacts connected to a claim are allowed to inquire about the status of a claim. Make certain that someone from your company is listed as a contact. Given the active and dynamic field of the SR&ED industry, you cannot guarantee your consultant and their role 120 days later when a claim is supposed to process out. Some consultants may try to control the flow of information and omit a contact from your company for your claim. If a consultant does omit your contact information, then you can file an update with CRA to be added to your own claim. In some situations, you can also check the timeline of milestones from the source (CRA) and how they may contrast from what your consultant could be reporting. In one instance, there was three week discrepancy between an event as reported by the consultant; vs. the same event as logged by CRA.
Fee For Service Vs. Contingency
Fee-for-service is an arrangement where the consultation time and accounting fees for preparing the claim are paid up front. Commission is a situation where the consultant assumes the risk for the claim preparation fees. If the claim goes through, they get a percentage. If the claim does not, they eat the expense of the claim preparation and the associated accounting fees. A word of caution about commission or contingency based arrangements: some consultants will charge 25%, then they may try to charge interest on top. If they let the claim preparation linger, the interest can rack up. Consultants may claim that their fee is 25%, but with interest and tax, they can take in excess of 30% of the whole claim.
The driving force is different between these two approaches means a very real outcome. A fee-for-service consultant gets paid when the claim is submitted. The sooner they do it, the sooner they get paid. However, the more time they put into the claim, the more it eats into your net gain. With a contingency based consultant, the later they start, the later they have to pay out an accountant and related expenses. Also, the less time they dote on a client, the thicker is their net gain. You will get the same amount, but they will work to spend less time and allow them to pursue more projects. If they cut corners on your claim, then the impact could be huge: for every dollar they lose on a claim, your company will lose almost three.
If your financial records are in good order and your project management is strong, then Fee For Service is a decent consideration. The larger your claim, the more sense there is to go with a fee-for-service. In one example, the claim was for $140,000. One consultancy estimated the preparation costs, based on fee-for-service, to be $21,000. Another consultancy was going to charge at least $35,000 based on contingency. The preparation costs could only climb a little for a higher dollar claim; but with a contingency based claim, the fees will climb in step with the value of your claim.
Why would anyone choose a contingency model? Two reasons: risk and expense. There is real risk when you submit a claim to CRA for processing. One man's technological innovation is another man's routine business. CRA could gut your claim if they find weaknesses. If a claim for $100,000 is gutted to $20,000, then a contingency based model would cost $5000+. If the same claim is gutted down to $20,000 in a fee-for-service, then you spend $20,000+ to net less than the preparation fees. With contingency, you share the risk. In truth, there isn't much risk. Both fee-for-service and contingency based consultants should be able to estimate your likely tax credit plus or minus 20%. If you're submitting a risky claim, you should get a reality check from your consultant and bring the dollar amounts and claimed expenses to Earth. The other reason to use a contingency model: expense. It's not uncommon that companies are drilling for an SR&ED credit because they low on cash. In some cases, the company may have folded its tents and this is the way for the principal to glean cash from its remains. Compare staring down an expense of $21,000 up front when you may not yield a sizable amount of cash vs. paying $35,000+ when the cash arrives. For companies there is no decision: they need to cash but don't have it up front. For those companies, the answer is contingency.
If you get a consultant to handle your return, there are some important things to consider:
They can navigate through the process better than a novice. But don't let them oversell themselves. You shouldn't put in a dodgy or aggressive claim. They should be able to give you advice on what is safe to claim. What a consultant can help you do is identify the expenses that are associated with your eligible work. The make-up of the CRA staff has changed over the years from people who come from a background of scientific research to those who may be eager to find ways to disallow claims. There are advisories and tax bulletins that are meant to inform the public and inform the CRA staff. Just because the information is out there, don't take for granted that your consultant or the CRA staff are working from the most recent facts. If your consultant is good, they may have to walk the CRA staff through their own regulations.
Some consulting firms and accounting firms boil your relationship down to its cold hard math. If CRA reviews your claim and revises it down to a fraction of its original value, some firms will roll over and accept the smaller claim without any resistance. In a fee-for-service situation, they have nothing to lose if you make a dollar or a million. With some firms that take contingency work, they won't go to bat for their client fearing throwing good money after bad. With some firms, they only go after big fish. If your claim is worth $200,000 they may sideline your business in favour of the $1 million claims.
Want to know more? http://www.cra-arc.gc.ca/E/pub/tg/t4088/t4088-08e.pdf