This is everything you’ve ever wanted (or not wanted) to know about the SR&ED tax credit in Canada, we’re not kidding. This guide contains everything we know about this most excellent tax incentive, still, if you want to have a leisurely ride through the process and make sure you’re getting every penny you’re eligible for, it may be worth getting a specialist on your side. There are hundreds of companies specializing in helping you navigate these waters, and it’s clear why – the SR&ED tax credit can be complicated, and there is lots of taxpayer money on the line. To help us verify our facilities, we partner with the best of Canada’s SR&ED providers. Feel free to chat with us if you’d like a no-obligation intro.
Canada has one of the most successful R&D tax incentive programs in the world. Unfortunately, the number of companies applying to these schemes is still meager, even though many are eligible to do so. It may be that you are eligible, even if you don’t think you’re conducting R&D. As always, it often pays to chat with a specialist to get a free assessment.
In this guide, we provide detailed information to make it clearer to companies when they can claim under the scheme. We explain how Canada’s SRED tax relief framework operates and answer a range of frequently asked questions relating to it. Specifically, we:
- Explain how SR&ED tax credits work;
- Identify the current SR&ED rates;
- Identify the sorts of activities and projects that will qualify for SR&ED tax relief;
- List the different expenses that can be claimed as eligible research and development;
- Explain the process for claiming SR&ED tax credits;
- Demonstrate how the SR&ED tax credit can be calculated;
- Look at whether there is any template that can be used for the purpose of making this application;
- Explain how governmental measures in response to COVID-19 affect the program.
Introduction to SR&ED tax credit in Canada
The Scientific Research and Experimental Development (SR&ED) tax incentive is a business incentive program managed by the Canada Revenue Agency (CRA) to support organizations to conduct R&D work that they may not have started or pursued otherwise. At this point, it has become a major source of financing for innovative Canadian companies.
In recent years, regulation has become stricter around both eligible technology and claimable expenses. Companies need to provide thorough records of their process and comply with a set of complex demands to prove that their projects fit within the definition of R&D. We recommend you discuss your claim with a reputable advisor, especially if you will be seeking to finance your tax incentive. We are happy to recommend an advisor if the time is right for you to file a claim.
What does SRED mean?
SRED, SR&ED, or sometimes referred to as Shred tax credits are acronyms for the Canadian Scientific Research and Experimental Development Tax Incentive Program headed by the CRA. The purpose of the program is to incentivize and reward companies that are investing in innovative technologies.
How does SR&ED work?
The SR&ED Incentive Scheme provides over $3 billion in tax incentives for more than 20,000 businesses every year. It is the largest federal incentive program for innovative businesses in Canada. The tax incentive is managed by the Canada Revenue Agency (CRA).
The SR&ED tax incentives can come in one of three forms: an investment tax credit (ITC), an income tax deduction, and a refund.
Who can claim SR&ED?
Different types of companies will have different ways to access SRED tax incentives and different rates. The major categories of businesses eligible for the incentive are:
- Private corporations – CCPC (under Canadian control)
- Individuals (proprietorships) and trusts
- Other corporations – For other corporations, such as publicly listed companies, the ITC is 20%. This can be applied against other taxes payable and is non-refundable.
- Partnerships: Any entities that are not tax-paying will not be eligible for tax credits, this applies to partnerships as well. Claims for partnerships can be done at the level of the component members, be they Individuals, trusts, or corporations.
What are the benefits of the SRED tax incentive?
The SR&ED program has a twofold benefit: deduct the eligible expenses from your income, and claim a tax credit.
- By pooling SR&ED expenditures, companies are able to deduct them against income in either the current year or in the following years, up to 20 years.
- The SR&ED investment tax credit (ITC) can be used to reduce a company’s corporation tax bill. If corporation tax payable is less than the value of the ITC, companies may receive a refund.
Overall, the ITC can range from at least 15% and can be as much as 35% of your qualified SR&ED expenditures and can be carried back 3 years.
How much is the SR&ED tax credit?
The rates vary depending on the type of business:
- Canadian-controlled private corporations or CCPC can access SR&ED of up to 35% on their SR&ED expenditures of $3 million and 15% on amounts over $3 million. If the company also fits the definition of a qualifying corporation, it is also eligible for 15% over $3 million in spending, and 40% of this can be claimed as a tax credit.
- If qualifying expenses are over $3 million, you can claim a non-refundable 15% tax credit.
- Capital expenses are only refundable up to 40%, the rest of the credit is completely refundable.
- Individuals or trusts also qualify for 15% on qualified SR&ED expenses. This tax credit can be used to reduce the payable tax burden and if some of the credit is left over, you can get a refund of 40% of the remaining amount.
- If your company doesn’t fit the criteria for a CCPC, your credit is 15% of your eligible expenses, and it’s non-refundable.
What work is eligible for SR&ED tax incentives?
To fit the criteria laid out by the CRA for SR&ED tax incentives, your project must meet three standards, in addition to being carried out in Canada. It must show:
- Technological Advancement – This means the project must further technical knowledge
- Technological Uncertainty – This means that in the course of the project you must have faced technical uncertainties and overcome them.
- Technical Content – This means the project has gone through an iterative process to attempt to resolve technical uncertainty.
The main question a CRA auditor seeks to answer (and wants you to have answered in your claim) is “The company engaged in a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis?”.
Take a look at the new Guidelines on the Eligibility of Work for SR&ED Tax Incentives released in 2021 that provides additional information about how SR&ED work is defined under the Income Tax Act and who may e eligible to receive SR&ED tax incentives.
The types of activities that may fall under these criteria include the following categories:
- Experimental development – Work was done to further technological advancement: create, or improve, new products, materials, or processes.
- Applied research – Work was done to advance scientific understanding with a practical application.
- Basic research – Work was done to advance scientific understanding on the level of basic exploration, without a specific target application.
- Support work – Work was done to directly support the processes described in the first three categories. This can include only the following types of work:
- engineering;
- operations research;
- mathematical analysis;
- design;
- computer programming;
- testing;
- psychological research.
- data collection;
What work is not eligible for SR&ED?
Scientific research and experimental development may cover a wide range of different activities in different fields, but some are explicitly not qualifying. The easiest way to assess if you could have a qualifying research and development project is to rule out the activities that are not qualifying.
Work that does not qualify for SR&ED:
- Market research, testing & development, sales promotion. Routine testing and analysis of any of the following: materials, components, products, processes, soils, atmospheres, etc.
- Activities aimed at developing, customizing, or changing style elements;
- Research in the area of social science, also in the arts or humanities.
- Prospecting, exploring or drilling for minerals or petroleum.
- Routine data collection and processing;
- Activities that aim for the reproduction or improvement of a commercial product, service, or process by emulating any existing system or blueprint/plan.
How is the SR&ED tax credit calculated?
Consider the following case of a company that had $100,000 of income and $50,000 of R&D expenditure.
The R&D expenditure directly reduces your taxable income to $50,000. You can then also claim a 35% tax credit on the qualifying expenditure: $17,500, which you can offset from your tax bill.
In this case, the tax bill would be 11.5% of $50,000: $5,750
The company in this example would be eligible for a cash benefit of: $11,750 (net of tax liability – SR&ED credit)
What is the First Time Claimant Service?
The First Time Claimant Service is a program created to help businesses that are new to the SR&ED Program. The CRA offers informational material, special seminars, and targeted contact points to companies claiming for the first time. Additionally, upon request, a member of the team can visit your business and advise in person.
Is SR&ED taxable?
As SR&ED is a tax incentive that offsets a company’s tax burden and is therefore set against it at the end of a financial period, it is not taxable.
How to file a claim for SR&ED?
Typically, we would recommend you work with a reputable SR&ED tax advisor, especially if you are looking for SR&ED financing. Alternatively, you can, of course, also self-file your tax credit application.
Essential elements
Here are the essential elements:
- Filing your T661 form – Claim for Scientific Research and Experimental Development Expenditures (SR&ED) Carried on in Canada;
- Filing your T2 SCH 31 form – Investment Tax Credit – Corporations or Form T2038 (IND) Investment Tax Credits (Individuals)
- Filling in your company tax return with the forms. If not possible, file them no later than 12 months after the tax return.
- An explanation as to how your activities meet the requirements for claiming the tax credit. This is often referred to as a ‘Technical Narrative’;
- Calculations of what costs qualify and to explain how you arrived at the final amount.
Can I use an SRED tax incentive claim template?
We wouldn’t recommend it. The main factor in the application is your ability to keep records and assess which activities fall into the category of qualifying R&D. This means there is generally a lot of variation in these applications. It can be a good idea to seek professional advice on whether you are eligible for SR&ED tax incentives and if you could benefit from SRED financing to access these funds early. Contact us to chat about options around financing.
What is the impact of COVID-19 on SR&ED?
COVID-19 has had a significant impact on Scientific Research and Experimental Development tax incentives in Canada. The main consequence of the pandemic is that it has led to an increase in non-SR&ED tax subsidies to companies in the effort to support them through the crisis. Given that the subsidy programs are classed as government assistance, companies taking advantage of these new facilities will not be able to “double-dip” and claim SR&ED on these expenses as well. Most of these subsidies are targeted towards wage assistance, so there is a significant overlap between qualifying costs, such as developer or engineer salaries, and subsidized wages.
The full impact of the support packages is not yet clear, but they will invariably lead to a reduction in eligible SR&ED in the coming year. During this time, we especially recommend that you should seek professional advice on how to approach your application and eligible costs by talking to specialists that have recent experience with the CRA and their treatment of applications. Maneuvering through these uncertain times can be easier if you can rely on the experience of specialists.
Conclusion
The Scientific Research and Experimental Development (SR&ED) tax credit is an excellent source of funding for innovative companies that are on a growth path. However, there is a range of matters you need to consider before applying for this scheme including:
- Does the activity of your business count as R&D according to the regulatory definition?
- Which of your activities might be claimed as R&D and which are either ineligible or being carried out by another entity?
- Assess which expenses, relating to your research and development can be claimed. Note, not all of them can be.
- Work out your justification and explanation for SR&ED tax activities in the records that you will need to supply with your application.
- Consider whether your access to any COVID-19 business support packages might affect your SRED tax situation.
We have also rounded up some of the best resources of information and support for businesses to help their continued growth at these unprecedented times, here.
We hope that you found this guide useful, and If you think you could benefit from professional SR&ED tax relief advice, don’t hesitate to chat with us.
Note: There are programs similar to SR&ED in other countries. Given that many governments have adopted a proactive approach to encouraging technological discovery, there are equivalent financing options all around the world. For example, you could access R&D incentive loans in Australia, or R&D tax credit loans in the UK as well, which our local Fundsquire teams can help you with.
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