The Scientific Research and Experimental Development (SR&ED) program pumps almost $4B into companies doing research in Canada. There are a number of ways to get your fair share and strategies to maximize the benefit you receive. Some strategies are obvious while others are simple enough but few companies utilize them. This tactical guide will help any company get the most out of the SR&ED tax credit program.
SR&ED Education
Knowledge is the most important factor to ensure that an SR&ED claim is as large as it can be. If the team has a good understanding of what qualifies for SR&ED, and how to track and support it, there is a greater probability that projects will be identified and included in the SR&ED claim.
Knowledge of SR&ED starts from the top of any organization. If the leadership embraces and supports R&D, not only do they want results but they’re looking for efficiency. Being able to claim SR&ED is vital for optimal productivity. With leadership being aware of, and sharing the benefits of SR&ED, they will motivate the organization to gain a deeper knowledge of SRE&D eligibility.
People involved in R&D are the key staff to educate. They are the ones who can identify projects that may be eligible for SR&ED. With more education, the technical team has the insight to retain specific documents to support the SR&ED claim, more effectively track SR&ED-eligible time and make decisions on resources more efficiently. Engineers don’t need to be SR&ED experts. They do benefit from having a clear understanding of the SR&ED program so that they can assist the experts in identifying the key aspects of SR&ED.
Employees Salaries
There are a few items that qualify for SR&ED but none more important than having employees. An SR&ED claim (prepared with the proxy method) is made up of employee expenses, contractor expenses and material expenses. Let’s assume there is $100,000 of expenses. If it were employee expenses, the CRA grosses up the expense to $155,000. If it were a material expense, you could claim $100,000. However, if it is a contractor expense, you can claim only $80,000 for SR&ED. Therefore, it is far more lucrative to have employee expenses relative to other eligible expenses.
The reason for the CRA providing more incentives for employees goes back many years. When the SR&ED program started a company was able to claim overhead expenses. The proxy method of claiming SR&ED approximates the overhead expense for employees. The CRA has set this at 55% of their salary. This would account for items like employee health benefits, equipment, office leases and other expenses that could be attributed to employees. The other reason that the CRA has provided this level of incentive for employees is that they want companies to employ Canadians rather than offshore the activities.
As the world becomes more globalized, Canada needs to compete on a global scale. If the average salary of a software developer in Canada is $100,000, in the US $180,000 and in India $50,000, the SR&ED program levels the playing field between Canada and India. It also provides an incentive for US companies to have Canadian employees if they can take advantage of the SR&ED program.
Employee Incentives
It is rare that engineers and scientists receive an incentive for their SR&ED-related efforts. Often times SR&ED falls into the same category as paperwork, emails, compliance and other domains that don’t directly impact the work done but are very important. However, there is a better way to look at providing an incentive for SR&ED claims to employees. Because up to two-thirds of an employee’s salary can be refunded with SR&ED, R&D leaders and management should provide an incentive to these employees to encourage and maximize SR&ED activities. The relatively small cost of providing incentives is paled by the potential SR&ED refund from the CRA.
Unused Vacation Can Increase SR&ED Expenses
Accounting for accrued vacation can increase the size of the SR&ED claim. At the end of the year, there are some employees who have remaining vacation. The vacation accrual is typically maintained as a liability on the company balance sheet. The good news is that this accrual can be included for the employees who qualify for SR&ED. Many companies don’t go to this level of detail as it is a fair amount of work for relatively small numbers but it can help companies maximize every possible SR&ED expense.
SR&ED Time Tracking
There are two components to tracking. The first is how to track eligibility of R&D. The second is how to track the time an employee spends on eligible activities. If these are done properly, the SR&ED claim will be maximized and be defensible if the CRA selects the claim for review.
Let’s focus on time tracking for employees as many companies struggle to understand how much tracking is needed. The answer to how much tracking is needed is it depends on the company and the nature of the SR&ED claim. For larger and more sophisticated companies, the CRA has a higher expectation of time tracking.
Contractors That Provide R&D Services
There are a number of factors that a company should consider when maximizing its contractor expenses. Before any work is started, it is important to have a clear understanding of who owns the intellectual property and the potential SR&ED claim. Therefore, whoever is responsible for SR&ED claims within the company should carefully review the contractor contracts to ensure they would withstand a CRA audit.
Invoices from contractors can also play a vital role in maximizing an SR&ED claim. The more detailed the invoice the better a company can determine which items qualify for SR&ED. By clearly identifying the challenge that the contractor faced, it is easier to support the SR&ED expense. The type of engagement, being fixed price or time and materials can also affect SR&ED eligibility. The reason this is important is it can define which entity has taken the risk for rectifying challenges.
One of the key details in hiring a contractor is that they have a Canadian business number. Not only does the contractor have to be domiciled in Canada, but they also need to have completed the work in Canada. These are important questions to ask a contractor before signing an agreement so you can be assured the work being done qualifies for SR&ED.
Payments to Third Parties
As with many tax programs, the SR&ED program is simple on the surface but complicated when the details are properly understood. For example, when is it OK to claim a material expense? When the materials are ordered? When they are delivered? When they are consumed? Or when they are paid for? As it turns out there are some specific rules around this. Generally, to be an eligible expense, items must be paid for or paid within 6 months of the fiscal year-end. Therefore, to maximize the SR&ED claim, a company would want to ensure that the items, may it be salary, contractors or materials are paid in a timely manner to be able to include the expense in the SR&ED claim.
SR&ED Supporting Documentation
Documentation is not critical to file an SR&ED claim or to maximize the SR&ED claim. However, if the CRA selects the claim or specific projects for review, supporting documentation is critical in defending the SR&ED claim. Documentation can be many different things. It can be Git logs, photographs, sketches or log books. The CRA is not looking for specific types of documentation, but rather contemporaneous documentation to support the expenses claimed.
Contemporaneous documentation is a fancy term for documentation that was created at the same time as the activity was undertaken. It is important to continually capture evidence of SR&ED activities. As long as the information is captured and stored, there is no reason to organize it all when submitting an SR&ED claim. However, it is important to know where all the documentation is so that if the CRA selects an SR&ED claim for review, the proof of work can be produced relatively quickly.
Supporting Work
SR&ED supporting work refers to activities that directly contribute to or support the core SR&ED work. In Canada, supporting work is eligible for SR&ED tax credits if it is undertaken to directly support the main SR&ED activities.
Examples of SR&ED supporting work include:
- Engineering: Developing prototypes, conducting simulations, or optimizing designs to support experimental development.
- Design: Creating models, blueprints, or plans for experimental trials.
- Operations Research: Using mathematical and statistical techniques to improve experimental processes.
- Data Collection: Gathering and analyzing data that is essential for SR&ED activities.
- Testing and Analysis: Performing tests, measurements, or analyses necessary to support SR&ED experiments.
- Programming: Writing software code to create tools, scripts, or models used in SR&ED activities.
The key is that to qualify as supporting work, the activities must be closely tied to the main SR&ED objectives and necessary for overcoming technological uncertainties. Activities that are routine, such as quality control, regular data collection, or standard software development, typically do not qualify as supporting work.
Ownership
A Canadian Controlled Private Corporation (CCPC) receives the enhanced tax credit rate from the federal government. The enhanced rate is 35% compared to the basic rate of 15%. This is a material difference so being a CCPC is important. Determining if a company is a CCPC can be complicated and should be done by a professional accountant. If too much equity is owned by non-Canadians, it can put your CCPC status in jeopardy. In fact, control of the corporation does not even need to be direct. If a majority of your company is indirectly held by non-Canadians, it is likely that the company would not qualify as a CCPC.
Public companies, partnerships or other corporate structures also do not qualify for the enhanced rate. Therefore, when contemplating any establishment or changes to the corporate structure, it is important to contemplate the effect on the SR&ED claim.
Arms Lenth Companies Effect on SR&ED
Contractors have been discussed but what happens if the contractor is non-arm’s length from your company? Non-arm’s length means that one party can exert control over the other party. The non-arms length company can claim SR&ED relating to work performed on behalf of the other party. However, the non-arm’s length company cannot be considered a contractor to the other party.
To maximize the SR&ED expenses, it is best to consult an expert. The method of calculating tax and expenses for the two parties can be complicated.
When is a Project a SR&ED Project?
One of the greatest debates is at what level is R&D considered an SR&ED project. If too many items are included in the same project it may not qualify for SR&ED and if too few are included it may also not qualify. Determining when a project can stand on its own and should be claimed as a separate item is important.
SR&ED consultants deploy a number of strategies in determining when R&D uncertainty can stand on its own as a project. To start with, is there a technical uncertainty that is different from other technical uncertainties? For instance, was one team solving a performance challenge while another was solving a security challenge. It is most probable that these would be separate projects. Some consultants want to ensure there are sufficient expenses to justify claiming a project. For instance, if a project has very few expenses, it is possible that very little uncertainty exists and it would not qualify for SR&ED. There are some claims that are a single project. There is no issue with this except when the project is focused on a business problem. One must be careful to focus on technological uncertainties rather than business problems.
SR&ED Consultants to Maximize SR&ED
While we are consultants, and I am biased, probably the single best way to maximize an SR&ED claim is to engage a qualified professional. Professionals, may they be lawyers, doctors or SR&ED consultants have specialized expertise that cannot be replaced by the internet. Their expertise can be augmented by AI to improve the results. However, companies should be wary of confusing an internet search with professional assistance. A quality SR&ED consultant will guide companies in the right direction, offload a significant amount of work, and maximize the SR&ED claim within the guidelines of the SR&ED program.
Choosing the right consultant to get the best value also requires skill. At some points in time price may be the most important consideration. At others, a quality claim may be critical. There are some companies for whom speed and flexibility are the most important factors. Quality SR&ED consultants provide good value, accommodate their clients’ schedules, have deep expertise in many fields of science and are a true business partner.
Conclusion
Getting the most out of the SR&ED program requires meticulous planning, education, activity tracking, strategy and knowledge. While the CRA has made steps to simplify the program, because of the nature of SR&ED, it continues to be a tax incentive that is best optimized by professionals. However, if you are planning to go at it without a professional, and would like assistance with anything mentioned in this article, please reach out to us. We’re here to help.
