In the dynamic landscape of Canadian business, innovation and experimental development play a pivotal role in driving growth and competitiveness. To encourage and reward companies for their efforts in this area, the Canadian government offers the Scientific Research and Experimental Development (SR&ED) tax incentive program.
This generous program is available to most companies operating in Canada, and yet the majority of Canadian business owners don’t fully understand how it works. That’s why we put together this comprehensive guide, which provides a detailed overview of the SR&ED tax incentive program, including available deductions and credits, eligibility criteria and potential benefits.
What is the SR&ED Tax Incentive Program
Administered by the Canada Revenue Agency (CRA), the SR&ED tax program is the single largest source of financial support the Canadian government offers. It provides more than $3 billion in tax incentives to over 20,000 claimants every year. The goal of the program is to further technological advancement, improve processes and drive innovation.
Tax Incentives Provided by the SR&ED Program
The SR&ED program offers two types of tax incentives. The first is a deduction against income, whereby eligible businesses can deduct allowable SR&ED expenditures from their income. These deductions can reduce tax liability in the year the expenses were incurred or be carried forward to future years.
The second is an Investment Tax Credit (ITC), which reduces a company’s income tax payable by a percentage of their eligible SR&ED expenditures. As we’ll see in the next section, businesses can earn ITCs at either the basic or enhanced rate.
Investment Tax Credit Rates
The ITC rate determines the percentage of eligible SR&ED expenditures that can be claimed as a tax credit. There are two set rates for ITCs depending on how the business is structured.
Basic Rate – Eligible individuals, trusts, partnerships and corporations receive the basic ITC rate of 15% on qualified SR&ED expenditures. If the tax payable reaches zero, 40% of the ITC amount will be refunded.
Enhanced Rate – Most Canadian-controlled private corporations (CCPCs) can receive an enhanced ITC rate of 35%, up to a maximum expenditure limit of $3 million (this limit becomes reduced once a company’s taxable income exceeds $10 million for the previous year). Any qualified expenditures that exceed this limit will earn an ITC at the basic rate of 15%. If the tax payable reaches zero, 100% of the ITC amount will be refunded.
Benefits of the SR&ED Tax Incentive Program
The SR&ED program is a crucial lifeline for many companies in Canada, offering lucrative financial support and incentivizing business owners to strive for optimal solutions. There are many benefits that businesses can receive by successfully utilizing the SR&ED program, which include:
Cost Offsetting – The tax credits and deductions can significantly offset the costs associated with research and development efforts, promoting innovation within an organization.
Enhanced Competitiveness – Investing in SR&ED can lead to new products, processes, or services, giving businesses a competitive edge in the market.
Cash Flow Improvement – The SR&ED tax program can result in a reduction in tax liability or even a refund, improving a company’s cash flow.
Long-Term Growth – By fostering innovation, the SR&ED program contributes to the long-term growth and sustainability of Canadian businesses.
Activities That Qualify as SR&ED
SR&ED activities are defined as a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis. To be considered eligible activities for the SR&ED program, the work needs to fall into one of the following categories:
Businesses That are Eligible for the SR&ED Tax Incentive Program
Many Canadian business owners think that the SR&ED program is restricted to large companies with dedicated R&D facilities. In actuality, of the $3 billion in tax incentives provided by the SR&ED program annually, around 75% goes to small businesses.
To be eligible for the SR&ED tax incentive program, a business simply needs to meet the following criteria:
☑️ Be a corporation, a proprietorship, a partnership, or a trust that carries on a business in Canada
☑️ Have a permanent establishment in Canada and file an income tax return
☑️ Conduct eligible SR&ED work in Canada
☑️ Incur qualified SR&ED expenditures in Canada
SR&ED Tax Incentive Program Eligibility Criteria
As we saw above, any innovating and ideating company can carry out work that is eligible for the SR&ED tax incentive program. This can include startups working on a new product, or manufacturers developing a new production process. In the past, businesses determined their eligibility using the following key criteria:
Technological Advancement – The project must further technical or scientific knowledge in some way. This does not mean it must be successful, however, as eliminating the wrong ways to do something is still an advancement.
Scientific or Technological Uncertainty – The project must involve an element of uncertainty, wherein it’s not possible to predict the outcome with certainty based on current knowledge or experience.
Systematic Investigation – The SR&ED activities should be organized and systematic, involving a series of tests, experiments, or analyses to resolve technological uncertainties.
Qualified Personnel – The project must employ experts in the given field with relevant scientific or technical expertise to conduct the research effectively.
However, in order to simplify the question of whether or not work is eligible, the CRA recently released its new Guidelines on the Eligibility of Work for Scientific Research and Experimental Development (SR&ED) Tax Incentives.
Applicants must now answer just two critical questions to determine the eligibility of their project: “Why” and “How”.
The CRA defines these requirements as follows:
The WHY requirement – Work must be conducted for the advancement of scientific knowledge or for the purpose of achieving technological advancement.
The HOW requirement – Work must be a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis.
If applicants can answer yes to both of these questions with concise yet critical descriptions, then their work should qualify as an eligible SR&ED activity.
SR&ED Qualified Expenditures
Only qualified expenditures can be claimed when applying for the SR&ED program. These are costs directly related to SR&ED activities or that are directly attributable to them, including:
Salaries and Wages – Compensation for employees directly involved in SR&ED activities, including researchers, technicians, and support staff.
Materials and Supplies – Costs of consumable items used in conducting eligible experiments, tests, or analyses.
Lease Costs – Costs of any leases taken out on equipment directly related to SR&ED activities.
Contract Payments – Payments to third parties, such as subcontractors or consultants, for services directly related to the SR&ED project.
Overhead Costs – A portion of overhead expenses related to SR&ED activities, such as utilities, rent, and administrative costs.
Applying for the SR&ED Tax Incentive Program
To apply for the SR&ED tax program, businesses need to file Form T661: Scientific Research and Experimental Development (SR&ED) Expenditures Claim, as well as one of the following:
- Corporations – Form T2SCH31: Investment Tax Credit
- Individuals and trusts – Form T2038(IND): Investment Tax Credit
These forms should be filed alongside the income tax return for the year. SR&ED claims can be made up to 18 months after the end of the tax year in which they were incurred. The CRA will review the claim before issuing a notice of assessment or reassessment. They may request additional information or conduct an audit at any time, so it is vital that companies keep all records related to their SR&ED work for at least six years.
Filing SR&ED claims can be a complicated process with many steps and requirements, from identifying eligible work and grouping it into projects to calculating allowable expenditures. Businesses are therefore strongly advised to consult with an SR&ED specialist before making a claim. To simplify the process, companies should familiarize themselves with the CRA’s guidelines for preparing a claim and consider the following steps when implementing the project:
Final Thoughts
The SR&ED tax incentive program is a valuable resource for Canadian business owners seeking to drive innovation, improve processes and remain competitive in their respective industries. By understanding the eligibility criteria, qualified expenditures, application process, and potential benefits, businesses can leverage the SR&ED program to drive growth, achieve technological advancements, and contribute to the nation’s overall economic development.
If you need help planning and preparing your claim or want to learn more about how the program can help your company reach its goals, get in touch with our expert team today!
This article was written by the NVS Professional Corporation team, your knowledgeable Barrie and Markham accountants. The content is intended as a general guide for informational purposes only. For specialist advice tailored to your specific situation, please reach out to our expert team.
