As the economy shifts more and more toward rewarding innovation, the types of financing that companies can access have followed this trend as well.

Both through the government and the private sector, a wide variety of support mechanisms and funding schemes have popped up. This means that entrepreneurs aren’t limited to having to sell equity or bootstrapping growth any longer. A new form of financing that is specifically geared at supporting innovative companies is the SR&ED loan, alternatively called SR&ED financing.

The purpose of this form of finance is to help smooth out the timeline of how SR&ED tax credits get paid, enabling growth. So, in this post we want to give you information on the factors that go into a lender’s decision to offer SRED financing.

But first, it makes sense to look at the normal timeline for payouts and why it makes sense to finance a future SR&ED claim.

SRED tax loan qualification

How are SR&ED claims paid?

SR&ED tax credits are paid after the income tax return (T2) has been filed together with the T661 after the company’s financial year-end.

The main issue with the payout is that even though the funding is reliable, it is very slow to materialize. This is understandable, the CRA has cultivated a careful and considered approach to handing out taxpayer money. For a company on a steep growth path, though, this slow and steady pace can seem glacial at times.

A lot of founders end up spending months waiting for the payment to come through and it isn’t always a predictable schedule. Though the typical timeline between filing and receiving funding is around 8-12 weeks from submission, it can take longer. This uncertainty can be bridged with products like SRED finance.


What is SR&ED finance?

SR&ED finance is a form of funding that allows a company to make use of its tax credit early, in the form of a loan.

The way SR&ED financing works: The lender uses the estimated future tax credit as collateral for an affordable loan, typically starting many months before the tax credit is expected to be refunded by the CRA.

Why it works: The SR&ED tax credit is a reliable scheme that has been running for decades, representing one of the most predictable receivables that a company can have. This is all, of course, conditional on the quality of the claim that the lender is evaluating, and working with a great advisor can yield dividends here.

The main condition for accessing SR&ED finance is, of course, qualifying for the SR&ED tax credit.

“Since as early as 1944, the Canadian Federal Government has been supporting scientific research through tax deductions. This incentive has evolved into the SR&ED program and is now one of the most reliable receivables a company can have.”

What qualifies for SR&ED?

The three main qualification criteria for the company are:

  • You’re a Canadian company
  • Has carried out qualifying r&d activities.
  • Has spent money on said activities in Canada

As the first condition is easy to figure out, that leads
us to the next two: technology and spending.


What technology qualifies? 

The CRA has set broad criteria for the types of activities it considers qualifying. This means that independent of the sector, companies could be investing in qualifying activities.

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?”.

This could mean anything from the creation of a new piece of software that resolves a problem that was not easily solved by a competent professional to creating a new manufacturing sub-process that saves time and resources.

The key is to create something that is a technological innovation rather than simply a market innovation. This can be tricky to understand, as the type of technology, however complex or filled with buzzwords, isn’t always important.

Take something cutting-edge like neural networks – if a company takes an existing neural net technology and brings it into a new market, say, neural networks for pet food distribution, this would not in itself be bridging technical uncertainty. But if the company works to integrate this neural net into other, unrelated technologies and creates more software in the process, that software would most probably be qualifying, just as if the company built its own neural net-based algorithm.

sred technology

What types of spending qualify?

Though interpreting the technology can be quite a nuanced problem, seeing what spending qualifies is more clear cut.

Costs that can be claimed include:

  • salaries and wages
  • materials
  • contracts
  • third-party payments
  • overheads

These costs must be directly attributable to the definable project that involves research and development. This must be backed up by timesheets and documentation, as it will need to be defendable in an audit.

eligible sred spending

Are there any other things to consider when applying for SR&ED credit loans?

If you can claim SR&ED, you’ve fulfilled the baseline criteria for SR&ED finance. If that’s a given, there are a few more details to consider when applying for a loan.

Profit or Loss-making 

A company that is looking to get an advance on their SRED will need to be receiving a refundable tax credit from the CRA, which will act as the collateral and repayment mechanism for the loan. If the company is not receiving a cash refund and is only getting an offset on their tax burden, there is no asset to be financed. As most of the companies who receive a cash tax credit are loss-making, this is an important factor for lenders as well.

Tax debt

One of the main factors a lender will look at is tax debt. If the company has significant debt outstanding to the CRA, this will preferentially be extinguished through the SR&ED tax credit. What this means is that if you owe money to the CRA, they will keep your potential tax credit payments. This is the case even if a payment plan is in place.

Other debt and charges

If the company has multiple charges and is burdened with a lot of pre-existing debt, it becomes harder to arrange suitable security for the new debt facility.  For most companies that are claiming SR&ED and incurring a loss, this won’t be a problem as debt finance is typically unavailable at this stage.

Overall company health

SR&ED lending is ideal for companies that are on a growth path and want to use this type of funding to put fuel on an already existing fire. If the company does not have a coherent plan for the future and solid documentation that backs this up, it will be hard to make the case to a lender that the company should be funded.

Conclusion

To sum up, the main condition to be able to apply for SR&ED finance is, as you would have expected, eligibility for the SR&ED tax credit. Outside of that, you should be aware if you are going to be incurring a profit or a loss at the end of the financial year. A potential lender will also look at other debt you have on the balance sheet, especially if it is owed to the CRA, and at securities held by other lenders against the company. The last but not least important factor is the trajectory of your company. If the company will use the funds to accelerate its upward trajectory and not to plug existing holes in its plan, getting funding is all but a certainty.

Let us know in the comment if you have any questions about how SR&ED finance works, or if you have any experience that you’d like to share.

Alexandra Kaschuta

Alex is a tech-focused funding expert, helping innovative companies grow through innovative funding through her work at Fundsquire. She also has a background in journalism, having written for outlets like Vice and many others in the past on topics ranging from philosophy to economics.