The Missing Guide To The SR&ED Tax Incentive Program For Innovation Projects In Canada
Among manufacturers in North America and Europe, there’s a misconception that the Scientific Research and Experimental Development (SR&ED) tax incentive program is only available to domestic firms innovating in Canada. That’s not true.
The SR&ED incentive is claimed by more than 20,000 applicants and has an annual impact worth CA$3 billion. On the face of it, the program is applicable to basic and applied research and experimental development – as the name suggests – and results in one of two forms of benefits, an income tax deduction or an income tax credit.
According to the definition of SR&ED in section 248 (1) of the Income Tax Act and clarification issued by the Canada Revenue Agency (CRA), so long as the work is undertaken in Canada, individuals and organizations are eligible for the tax credit – even if they’re not Canadian. That means, even foreign entities are eligible to gain from this tax incentive program.
The Canadian government’s global investment attraction and promotion agency – Invest in Canada – confirms the point about eligibility of foreign entities as well. It says that foreign companies can apply for the Canadian SR&ED tax incentives indirectly by forming a Canadian subsidiary company to perform eligible R&D work in Canada for itself or on a contractual basis on behalf of the parent company.
Is there any difference between the quantum of benefits that accrue to a Canadian entity versus a foreign entity participating in the incentive program? What about the incentive applicable to smaller entities as compared to large enterprises? The simple answer is yes.
Advice from Deloitte shows that federal tax credit is equal to 35% of qualified expenditure and is refundable up to a maximum of CA$1.05 million per year in the case of small- and mid-sized entities. This group is also eligible to claim credit from the province they’re based in and quantum of credit range from 10% to 30%.
Large enterprises, on the other hand, are eligible for federal tax credit of 15% of qualifying expenditure; various provincial rates of the credit they’re eligible for range from 3.5% to 20%. Foreign entities, irrespective of size, usually receive benefits in-line with this category of participants in the SR&ED tax incentive program.
The SR&ED tax incentive program is focused on technological advancement
The CRA places great emphasis on what kind of work is considered eligible for the program.
Guidelines issued by the CRA suggest that work must be conducted for the advancement of scientific knowledge or for the purpose of achieving technological advancement (contained in paragraphs (a) to (c) of the definition). The key to both is the generation or discovery of knowledge that advances the understanding of science or technology.
An important thing to keep in mind is that while the goal of an entity’s innovation project must be to achieve scientific or technological advancement, the tax incentive is available whether or not the project is successful.
The CRA also recognizes that while developing new or improved materials, devices, products or processes, problems can occur when there is a need to achieve a set of features, functions, or capabilities, while being restricted by a set of constraints.
When the technological knowledge available to an entity is insufficient, say for example when existing design methods being inapplicable or data is not readily available, attempting to resolve these problems through experiment or analysis will result in the generation of new technological knowledge.
This new technological knowledge can be incorporated in the new or improved materials, devices, products, or processes, and is often represented by the technological know-how, methodologies or techniques gained.
As mentioned previously, the program is applicable to basic and applied research as well as experimental development – but it also includes support work such as engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, and psychological research that is commensurate with the needs and directly in support of basic research, applied research or experimental development work. All of this, of course, needs to be undertaken in Canada.
Systematic investigation v. systematic approach
An important point that the SR&ED tax incentive program makes is that its benefits only apply to systemic investigation carried out by entities (in their pursuit of technological advancement) and not by simply using a systemic approach.
By the CRA’s definition, systematic investigation is a search that is carried out in a field of science or technology by means of experiment or analysis (contained in the beginning of the definition) and may include:
Generating an idea consistent with known facts, which serves as a starting point for further investigation towards achieving an objective or resolving a problem. An idea may be expressed as a possible solution to a problem, a proposed method, or an approach. This can be referred to as a hypothesis.
Testing of the idea or hypothesis by means of experiment or analysis. The idea can evolve and change as a result of testing.
Developing logical conclusions based on the results or findings of the experiment or analysis.
Keeping evidence that is generated as the work progresses.
A primer on what expenses can be claimed
Armed with a basic idea about who can participate in Canada’s SR&ED tax incentive program and what kind of work qualifies, let’s quickly learn what kind of expenses can be claimed.
The CRA has made effort to simplify what qualifies as expenditure necessary to develop technological advancements. These obviously include salary and wages, materials, and overheads – but for most organizations – the important items are contracts for SR&ED and third-party payments, especially as the more expensive phase of their innovation cycle is outsourced to a manufacturing partner such as Advantage Engineering.
For a deep-dive into SR&ED contracts eligible for benefits per the incentive program, you can read the CRA’s guide online. However, there are three things most businesses need to know:
When an entity contracts another party to have SR&ED performed on their behalf, 80 percent of the amount payable under the contract is allowed as a qualified SR&ED expenditure for investment tax credit (ITC) purposes.
When making a claim, it is important to show that the SR&ED work was carried out in Canada and was related to the entity’s own business.
Expenditures of a capital nature or expenditures for the right to use capital property (leases) don’t qualify for SR&ED tax incentives.
The last word on the SR&ED tax incentive program
Advantage Engineering has worked with several companies in Canada, the US, and even Mexico and helped them with their innovation programs. Our capabilities in additive manufacturing, among others, is immediately useful to clients looking for technological advancement in their particular industry, be it medical devices, consumer goods, automotive, or even aerospace. Of course, other capabilities we have such as urethane casting and injection molding are also very useful.
Our clients tell us that the SR&ED tax incentive program is very helpful. The quantum of the benefit that it provides is a great motivation, but the fact that claiming is as simple as making the necessary calculations and adding it to the tax return. That’s it. It doesn’t require any special forms, declarations, or anything of that sort.