Canadian-owned businesses who perform scientific research and experimental development to create new or refine existing products or processes may be missing out on a valuable opportunity. By meeting a few simple criteria, they could take advantage of a valuable federal and provincial tax incentive program which distributes more than $3 billion to more than 20,000 businesses every year.
These are the top five things businesses need to know about the Scientific Research and Experimental Development (SR&ED) tax credit.
What is SR&ED?
The SR&ED tax credit is a government incentive which encourages Canadian-owned companies of all sizes to innovate by subsidizing their research and development (R&D) costs. The program is available to organizations who perform basic research, applied research or experimental development – including the creation of new technologies or improving the design, function, or durability of existing technologies.
Potential SR&ED rebates can be as high as 66 percent of total qualifying expenditures and therefore a valuable component of a business’s overall innovation strategy. Eligible expenses include employee wages and bonuses, administrative overhead, subcontractor payments and the value of any materials consumed and transformed throughout the R&D process. Importantly, a business need not achieve the specified or intended outcome to qualify for the SR&ED tax credit.
Recent Program Changes
SR&ED has undergone recent changes which organizations will want to be conscious of. These include:
- The reduction in the Ontario Innovation Tax Credit (OITC) rate to 8 percent for refundable tax credits and Ontario R&D Tax Credit (ORDTC) rate to 3.5 percent for non-refundable tax credits. This is effective from June 1, 2016 onward and any filings straddling this date will be prorated accordingly.
- The removal of capital as an eligible cost category for SR&ED claims. This means claimants cannot include any items that did not form part of the prototype during the R&D process.
- The requirement for claim preparers to include information in the SR&ED claim. If the information is missing, incomplete or inaccurate, the filing business could face a penalty of $1,000 per claim – with joint responsibility shared by both the preparer and taxpayer
Ensuring a business realizes maximal value from any SR&ED claim requires documenting the activities, costs and insights gained throughout the R&D process. The Canada Revenue Agency (CRA) wants to know when the project was initiated and completed, who was involved and in what capacity, what knowledge the company gained and how it contributes to the public domain.
Required information includes:
- Technical report for each project describing technological uncertainty, technological advancement and all activities performed
- Spreadsheet identifying all costs claimed
- Employee labour rate calculations
- Logs for employee SR&ED activities
- Supporting technical documentation
Timelines and Processes
Companies should include their SR&ED claims as part of their annual tax filing with the CRA.
Important to remember – it is easier to track activities, insights and costs as they occur than to work backwards through every receipt, technical report and timesheet when filing a claim. Organizations will want to ensure they have systems in place to capture information as it happens. This could include using specific tracking templates and project management software to store everything in a centralized, easy to locate area.
Businesses should identify and document potential SR&ED projects throughout the year. Steps for incorporating this strategy into an organizational structure could include:
- Assigning an internal SR&ED champion
- Creating a central repository (such as a project management system) for information capture
- Setting up a time tracking and cost tracking system for employees and contractors
- Discussing SR&ED initiatives and progress during monthly team meetings.
Subcontractor Costs – Work performed by subcontractors and costs claimed are facing increasing scrutiny. Businesses need to understand how subcontractor payments relate to eligible SR&ED activities and, whenever possible, have those consolidated into a single signed document for their submission.
Employee Workweek – Employee wages and how time worked translates to a SR&ED wage is another growing concern. Businesses must ensure they fair estimates for employee workweeks and whenever possible, document hours worked in timesheets.
Costs Covered Under Proxy Filing Method – The CRA is drawing clear lines between costs for R&D and the incidental costs of running a business. Therefore, SR&ED claims should tie back to organizational charts to demonstrate which employees are directly engaged in the R&D process to differentiate between direct business and arm’s length costs.