Program Overview

Answers to Your Questions on SR&ED Tax Credits

March 2006

I was asked if I have considered claiming tax credits for “SR&ED”. What is SR&ED?
It stands for “Scientific Research and Experimental Development”. It’s a government incentive program to encourage Canadian businesses to develop new or improved products or processes. The federal government pays out almost two billion dollars annually under this program. It is estimated that for every dollar paid, two dollars go unclaimed because companies are not aware of their eligibility.

Do I need to be some kind of research laboratory to qualify?
Scientific Research (whether Pure or Applied) is one of the activities the program supports: that’s the “SR”. But by far the larger share of the pay-outs of this program go to Experimental Development (the “ED”). If your work includes creating new products, or improving your old ones, you are performing product development. The key question is whether this development is experimental in nature.

I’m not sure I follow. Isn’t any development process “experimental”?
In a sense, yes. But what this program is trying to encourage is development that advances the technology base of Canadian businesses and makes them more competitive in the global marketplace. The work has to meet these criteria: it seeks a technological advance; it attempts to resolve a technological uncertainty; and, it involves systematic investigation by appropriately qualified people.

The last criterion is pretty clear. But what qualifies as a “technological advance”?
It’s more than building a better mousetrap: it’s something that creates knowledge that advances our understanding of some aspect of science or technology that goes beyond the standard practice in the field.

But any development involves uncertainty, and may fail. Doesn’t this make any development project eligible?
The key factor determining eligibility is the nature of the uncertainty, and the reasons for possible failure. Technological uncertainty means that whether the desired result can be achieved, or how to achieve it, is not known or cannot be determined from generally available knowledge or experience in that field of science or technology.

I wouldn’t call my product developers very systematic, but they always seem to come up with improvements anyway. Is that “systematic investigation” criterion important?
The belief is that true scientific and technological advances come about by methodical, planned investigation, not by random trial-and-error or luck. But in fact your developers may not be working quite as haphazardly as you (and even they) may think.

It appears we do indeed carry out what would be considered “experimental development”. Does this mean I can claim a credit on all my expenses?
You can only claim for “eligible SR&ED work”, work done to achieve a technological advance in your field of expertise. Other business activities, such as market research, sales promotion, quality control and other commercial production activities, as well as routine development using standard practice, would not be considered eligible.

We’re a small start-up company: until our development is complete, we have no taxable profits, just expenses. How will a tax-credit scheme help us?
If your business is a Canadian-controlled private corporation with less than $400,000 taxable income in the previous year, you may be eligible to receive a refundable investment tax credit (ITC) of 35% or more of your qualified SR&ED expenditures. You may receive it even if you have no taxable income.

I think I have a general idea of the program, but I’m sure it is more complicated when you get down to specifics. Is it a lot of work to claim these credits?
This was only intended to give you a very general overview of the SR&ED program — just enough to help you decide whether to consider claiming.

The Strategy
If you believe that you are eligible for making a claim, you should pursue the matter further. Visit the CRA website, or contact a knowledgeable consultant for more information.

Links
http://www.cra-arc.gc.ca/taxcredit/sred/menu-e.html [1]

Overview of Scientific Research and Experimental Development Tax Incentives in Canada

March 2006

The federal government and many of the provincial governments provide incentives through the taxation system to individuals and companies that perform scientific research and experimental development (SR&ED) in Canada. These incentives take the form of tax credits, and accelerated or additional tax deductions for expenditures made on SR&ED.

Where SR&ED is conducted by in Canada, the expenditures are deductible as a regular business expense, and also generate substantial tax credits. These tax credits range from 20% of the expenditure, to almost 50%, in favourable circumstances. Often these credits are refundable (even if no taxes have been paid), and thus offer a critical source of funding for many companies.

SR&ED as a term is defined in the Income Tax Act. The term is defined to mean a systematic investigation or search carried out in a field of science or technology by means of experiment or analysis. A systematic search would normally encompass a process by which a hypothesis is formulated or a technological objective is set , a methodology is devised for testing whether the technological objective is met, the tests are performed, the results are observed, and conclusions are drawn. Systematic searches are often performed by skilled individuals who wear the white coats, but also can be performed by individuals in overalls on a shop floor. The qualification of the individuals to do the work, and the systematic search itself is often referred to as the technological content of a project.

SR&ED is defined to include basic research, applied research and experimental development. Experimental development is defined to be work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes. Work need not be revolutionary. Eligible work includes incremental improvements to existing technology.

Activities such as market research, sales promotion, quality control, routine testing, social science or humanities research, prospecting for natural resources, style changes, routine data collection and commercial production activities are not included in the definition of SR&ED.

A key part of assessing whether a project is an SR&ED project is whether it was undertaken for the purpose of achieving technological advance. A technological advance is generally understood to be the discovery by the taxpayer of technical knowledge that advances their understanding of scientific relations or technologies. The requirement for a discovery implies that there is an unknown or uncertainty of a technological nature at the beginning of a project which will be resolved through the systematic investigation process.

SR&ED activities are also defined to include support work or linked activities undertaken by or on behalf of a taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing or psychological research, where the work is commensurate with the needs and directly in support of core scientific research and experimental development activities.

In 1994 the Auditor General reviewed the operations of the SR&ED program. Although somewhat dated, the report provides some incite into the type of activities being claimed. Included in the report on the review were lists of some projects that received tax incentives under this program. A few examples are summarized below:

developing a new line of fibreglass windows and improving window hardware and locking mechanisms
developing processes for the recycling of a wide range of solid waste materials
designing and developing a machine that assembles hanging file folders from paperboard blanks and runners
developing an automatic guidance system for underground mining vehicles
developing software relating to interfaces for weigh scales, bar coding and digitizers
developing new software for an on-line, fully functional general ledger system
developing an on-line system to validate credit information
developing a comprehensive payroll system for personal-type computers
designing and developing computer controlled multimedia products using graphics, video, sound and text, and three dimensional images
developing an integrated material handling/optics/computer system to inspect fruit after mechanical halving and pitting
developing a single component polyurethane foam system that is ozone-friendly
designing, developing and testing a landing gear control unit
developing unreinforced and fibre-reinforced polymer modified cementitious material systems for products that provide coatings for rust protection and waterproofing of cement surfaces
researching and developing human diagnosis and therapeutic health care products
developing new drugs based on their effects on leukotriene-mediated diseases such as asthma
developing medical diagnostic instruments for heart valve problems
developing devices to rapidly detect cardiovascular risk
developing more environmentally acceptable muds for drilling to replace oil-based muds without compromising drilling performance
developing a process to bleach kraft pulp to a specific brightness without using chlorine

The Strategy
The federal government provides more than one and a half billion dollars in funding towards claims made under the SR&ED tax credit program. It is estimated that there is almost three and a half billion dollars in funding that goes unclaimed, because companies are not aware of the program, or are not aware of the types of activities that are eligible for funding. All companies should review their activities to determine their eligibility under this program.

Links