The Canadian Federal government has several programs designed to encourage and promote innovation in the country. There are fundings accessible to innovators through Research and Development (R&D). One of the prominent among these programs is the SR&ED (Scientific Research and Experimental Development) Tax Credit Program.
Luckily, you don’t have to possess a Ph.D. and a modern lab to be involved in R&D or qualify for an SR&ED tax credit in Canada. This brings us to the question ‘What is SR&ED is in Canada and how does it work?
SR&ED Tax Credit in Canada
The Scientific Research and Experimental Development (SR&ED) tax credit is a refundable tax credit program in Canada that gives cashback to businesses even if they are not making profits. The R&D activities can be linked with any company.
It is the most prominent and most significant federal government support designed to promote research and development(R&D) in Canada
SR&ED aims to deliver tax incentives in a timely, consistent and predictable way while fostering businesses to prepare their claims according to tax laws, policies, and procedures.
Aside from the business eligibility perks, R&D tax incentives offer a full tax deduction in the year the expenses are incurred, even if they are capital expenses. R&D deductions can be carried over till they are not needed in the current tax year.
Businesses Qualified for SR&ED Tax Incentives
As mentioned above, the SR&ED program is available to businesses operating in Research and Development (R&D) in Canada. Still, some business expenses for SR&ED carried out outside Canada are eligible.
Sole proprietors and partnerships may qualify as long as they meet the requirement. Generally, any business that operates basic or applied research or advanced technology to improve or develop raw materials, devices, products, or processes is eligible under the SR&ED program.
There are currently three categories of businesses that are eligible under the SR&ED program in Canada. They are:
- Canadian-controlled private corporations (CCPCs)
If your business falls under CCPC, you may be eligible to receive a refundable investment tax credit (ITC) on your qualified SR&ED expenses. To get this refund, you must apply the ITCs against taxes payable in the year of the Claim. Once this is done, the balance will be refunded. Note that the refundability rate depends on your taxable income and taxable capital in the previous year and expense limit.
- Corporation outside CCPCs
Other corporations are eligible for about 20% of current and capital SR&ED expenses. Businesses can claim this after applying the ITCs against taxes payable. You may get a cash refund on 40% of the balance of the ITCs earned in the tax year.
- Proprietorship, partnerships, and trusts
Proprietorship, partnerships, and trusts are eligible for a 20% ITC rate of qualified current and capital SR&ED expenses. Once the ITCs against taxes payable is applied, a Proprietorship, partnerships, or trust is eligible for a cash refund on 40% of the balance of the ITCs earned in the tax year.
Expenses claimable under SR&ED
You can claim any expenses incurred for SR&ED during your tax year. Some of these expenses may include:
- Lease cost of equipment
- Third-party payment
- SR&ED contracts
You can determine your SR&ED expense through proxy or the conventional way. The traditional means involves claiming all of the SR&ED costs you incur during the year.
Note that you must be able to identify your overhead costs. The proxy method on the other hand consists of calculating a substitute amount for overhead expenses using a formula.
Claiming SR&ED Tax Incentives in Canada
To claim the SR&ED incentive, you must first file the applicable prescribed forms by the reporting deadline. The reporting deadline is 18 months for corporations and 17.5 months for individuals. This deadline commences from the end of the tax year the expenses were incurred.
Note that if you fail to report expenses or projects on the prescribed forms by the reporting deadline, you will not be able to include the costs in your list of deductible SR&ED expenses to be used to lessen your income. Also, you will not be able to earn an investment tax credit (ITC) on the purchases.
To claim SR&ED, you must file an income tax return using the following forms:
- Form T661 – Scientific Research and Experimental Development (SR&ED) Expense claim
- Form T2SCH31 – Investment Tax Credit – Corporations
- Form T2038 (IND) – Investment Tax Credits (Individuals)
Once you send in your Claim, the CRA will review your application to check if it meets the required eligibility standard. When your Claim is processed as filed, the CRA will reduce your taxes payable or, if applicable, issue you a cheque. However, if the CRA cannot process your Claim as filed, the CRA will contact you to request more details.
Once you qualify, your Claim takes about 120 days to be processed after the CRA receives it.
Documents needed to support your SR&ED Claim
It is crucial to have substantial evidence that will prove the SR&ED work performed and the expenses incurred. If the CRA selects your SR&ED Claim for review, you will request proof during the interview process. Below are some documents you can provide to support your Claim:
- Project planning documents
- Experimentation plan
- Project records
- Laboratory notebooks
- Records of trial runs
- Paper on the design of experiments
- Project progress reports
- System architecture
- Source code (software development)
- Minutes of project meetings
- Accounting records
- Videos test protocols
- Descriptions of resources allocated to the project
- Activity records
- Payroll records
- Analysis and conclusions
- Scrap and scrap records
- Prototypes, samples
- Lease agreements
- Purchase invoices
- Proof of payment
SR&ED Review Process
During the review process, businesses are subject to technical and financial evaluation by the CRA to ensure that all claimants meet the eligibility and compliance requirements established in the Income Tax Act.
The technical reviewer evaluates your work to determine whether it meets the SR&ED eligibility criteria. While the financial reviewer evaluates the cost linked with your business project to ensure they are eligible for SR&ED expenses.
Note that these reviews might include a visit to the site to assess your documents and a chat with your technical ad financial team.
The SR&ED is an excellent way to get cashback on expenditures incurred while running eligible projects. Claiming this incentive is relatively easy.
However, if you feel stuck, you can contact businesses that specialize in helping other companies leverage their R&D tax credits and work through the claim process. Note that their service is not free.