SR&ED Tax Credit Claims for Machinery and Equipment Manufacturers

There are number of issues related specifically to filing SR&ED tax credit claims within the Machinery and Equipment Manufacturing Industry. CRA has prepared an application paper [1] that discusses some of these issues. The paper (IC 94-2) is intended to clarify what constitutes SR&ED within this industry. In practice, there are conceptual issues that are complex and do not lend themselves to simple definition. Some of these are:

Determining project eligibility for SR&ED tax credits
It is not relevant whether the equipment manufactured is sold, or transferred to production. This is important because people often start with the premise that SR&ED eligibility is limited to projects that experienced significant cost overruns, or which failed i.e. could not be sold or transferred to commercial production. CRA’s position is that “the subsequent commercial sale or use of the resulting product, device, or process, is not a factor when determining project eligibility, since it is not relevant to the intrinsic eligibility of this work” (CRA IC 94-2 s3). It is conceivable a project could be at or below budget in terms of cost and still qualify for SR&ED tax credits. The ultimate success of the project and the amount of money spent are indicators that may bear on deciding if the project met the requisite technical criteria, but they are not conclusive.

The Strategy

Keep an open mind. Do not limit thinking to only projects which experienced significant cost overruns, or which failed.

Determining the “envelope of SR&ED”
Only activities within the “envelope of SR&ED” potentially qualify for SR&ED tax credits. Defining the size of this envelope involves considering several factors. The beginning of a project typically occurs when the technological objectives are determined. Few companies will formally define a hypothesis and test it in the classic scientific model sense. CRA recognizes that intuitive thought can replace a formal hypothesis if there is a concept that can be formalized to form technical objectives (CRA IC 94-2 s2). The development cycle may involve several iterations of machine versions or components. Projects may stop and start again over time. Completing a project to arrive at a conclusion may require field-testing. This would typically be at or near the conclusion of the project.

The Strategy

Definition of the “envelope of SR&ED” requires careful thought. The size of a claim is dependent on the size of the envelope. Consider the boundaries of the envelope in defining the scope of your SR&ED project.

Start up production costs
SR&ED work must be distinguished from troubleshooting. CRA takes the position that “the work generally associated with trouble-shooting, debugging, and fine-tuning after the start-up of any new equipment, process, or technology…is ineligible” (CRA IC 94-2 s4.8). However, work done after the start up of new equipment may be directed towards resolving technological uncertainty. The work may be done with the goal of achieving advancement in technology. Where work on resolving technological uncertainty is done in a systematic manner for the purpose of achieving technological advancement, that work will likely be considered SR&ED.

The Strategy

Where start up is particularly problematic, there may be a case to be made that SR&ED work has commenced or is ongoing. Review the characteristics of production start up activities for the existence of technological advancement, uncertainty and content.

System Uncertainty
Clients in this industry sector often manufacture equipment that can be rationally viewed as made of a number of major components. Some of these components may be well understood by the client and their manufacture would not in and of themselves generate SR&ED tax credits. However the integration of these components may carry a major element of technological uncertainty; this may be called a system uncertainty. ” Identifying and assessing system uncertainty can be a very complex exercise. A high degree of technical experience and training is required” (CRA IC 94-2 s4.9).

The Strategy

Projects in the machinery and equipment industry may involve system uncertainty. The existence of system uncertainty can significantly expand the envelope of SR&ED.

Links

• Machinery and Equipment Industry Application Paper
  [2]