Can Your Small Business Claim Scientific Research and Experimental Development (SR&ED) Tax Incentives?

Science and technology are expensive as a lot of money goes into research and development (R&D), with no guarantee of success. But this is a cost a business has to bear as a breakthrough or success can be revolutionary for business and the economy. The Canadian government supports such efforts by offering several incentives, such as the Scientific Research and Experimental Development (SR&ED) tax incentive. It is available to both domestic and foreign companies conducting R&D in Canada. 

Annually, the federal government provides over $3 billion in the SR&ED tax incentive claimed by over 20,000 claimants, 75% of which are small businesses. The Canada Revenue Agency (CRA) executes this incentive.

What Is Scientific Research and Experimental Development (SR&ED) Tax Incentives? 

The Canadian government offers the SR&ED incentive to corporations, individuals, trusts, and partnerships (domestic and foreign) doing qualifying R&D work in the country. If you are a foreign business wanting to avail of this benefit, you need to create a Canadian subsidiary and perform R&D work in Canada. 

The CRA offers this incentive in two ways: 

• The company can deduct the eligible R&D expenses from its income to reduce overall taxable income. 
• The company can pay the tax and claim a refund. The CRA will review the claim and refund a certain percentage as an investment tax credit (ITC) in 120 days or reduce that amount from your tax bill. 

Small businesses can carry back the unused lTCs by three years or carry them forward by 20 years. But if your business is getting other government funding for research, it could reduce the SR&ED incentive. Small- and mid-sized entities can claim a federal tax refund of 35% of qualified expenditure, while large businesses can claim 15%. 

What Research Work Qualifies for SR&ED Incentive? 

Under the Income Tax Act, SR&ED is “a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis…to advance scientific knowledge (basic or applied research) or to achieve technological advancement (experimental development) for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto…”

Let us break down the definition for better understanding. 

Systematic investigation or search includes identifying the problem statement, formulating an objective, and developing a plan of action involving experimentation, analysis, or testing the hypothesis. It excludes market research, quality control or routine testing of materials, devices, products or processes, and routine data collection.

The field should be science or technology. It does not include social sciences or humanities. 

The objective is to advance in science and technology, whether the project is successful or not. The CRA believes that when developing or improving products, materials, and devices, you may face problems and may or may not succeed. However, the learnings from that experiment can help advance the process. 

The work could be: 

• Basic research that doesn’t have a specific practical application
• Applied research that has a specific practical application or 
• Experimental technology development to create new or improve existing materials, devices, products, or processes. 

Supporting functions needed to conduct the research, such as engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, and psychological research, are covered by the SR&ED. 

What is not covered is commercial production of the new and improved product or process; quality control or routine testing of materials, devices, products or processes; and prospecting, exploring or drilling for or producing minerals, petroleum or natural gas. These are operational expenses and do not form a part of R&D. 

Instead of confusing yourself with this comprehensive definition, ask yourself two questions: Why are you doing the research (to advance in science or technology)? How are you conducting the research (systematic investigation or search)?  

Once you know your research qualifies, you must know what expenses you can claim. 

What Expenses Qualify for Claim in SR&ED? 

The CRA allows sole proprietors partnerships and trusts to claim 40% of capital and current expenditure. However, Canadian-controlled private corporations (CPCC) can claim 100% of current expenditure up to a certain limit and 40% beyond that. They can also claim up to 40% of capital expenditure.

Current expenditure includes salary and wages, materials, overheads, amount on SR&ED contracts outsourced to a third party, and other third-party payments. Capital expenditure includes lease costs for equipment. However, the property lease cost does not qualify for the SR&ED claim. 

You can use the traditional method, wherein you identify every overhead cost, or the proxy method, wherein you use a formula to identify overhead cost. You must file your SR&ED claim within 18 months (for corporations) or 17.5 months (for individuals) from the end of the tax year in which you incur the expense. 

If you miss the deadline for the claim, the CRA will not allow you to claim these qualifying expenses for the tax incentive. 

How Does the SR&ED Claim Work? 

Once you file your SR&ED claim, the CRA will review it and, if satisfied, will accept and file it in 60 days. It will usually process the claim by reducing your taxes payable or issuing a cheque within 120 days of receiving it. You can also carry forward the claim for up to 20 years.

But if the CRA puts the claim under review/audit, the refund could take 180 days. Like every audit, the CRA may contact you to request more information or discuss the claim review. 

The claim could be subject to 

• Conduct a technical review to determine whether the research meets the SR&ED eligibility criteria. 
• Conduct a financial review to determine whether the costs associated with the research qualify as SR&ED expenses. 

If you get a call for the audit, select technical and financial staff involved in the project to provide necessary information to the auditor. The information provided to the CRA staff is protected. The audit can be stressful and would require a whole list of documents such as project planning documents, design documents, laboratory notebooks, source code in case of software, minutes of the project meeting, and more. 

Contact DNTW Toronto LLP to Help You With Tax Planning 

A skilled tax expert is well-versed in the different incentives and schemes the government offers small businesses. They can help you avail of these incentives and represent you in the CRA audit. To learn more about how DNTW Toronto LLP can provide comprehensive tax planning support, contact us online or by telephone at 416.924.4900.