Canadian businesses that engage in research and development activities may be eligible to claim the Scientific Research and Experimental Development tax credit and income tax deduction. This government fund to support scientific research is a powerful incentive to small business to engage in R&D for their benefit and the benefit of the country.
Businesses that are operating in Canada should understand this program, the types of research and development that qualify for it, how to claim the credit, and the types of documentation that they need to save to support their claims.
The SR&ED incentive is a tax incentive offered by the Canadian government to encourage companies to conduct SR&ED activities. The government fund to support scientific research is available to companies of all sizes and across industry sectors and is available in three forms, including a tax deduction, a tax credit, and a refund.
Each year, the program provides incentives that total more than $3 billion to companies. It is the largest government program that is designed to incentivize research and development by businesses in the country and is administered by the Canada Revenue Agency or CRA.
SR&ED incentives are available for the following three types of research:
Basic research involves work to advance scientific knowledge instead of discovering a new practical application. Applied research is research that is undertaken to advance scientific knowledge and to achieve a particular practical application. Experimental development is research that is performed to advance technology and to create new devices, processes, products, or materials or to improve existing ones.
In the context of taxpayers, the work can include design, mathematical analysis, engineering, computer programming, psychological research, operations research, data collection, or testing if the work is performed in Canada for basic or applied research or experimental development. The work must involve a systematic investigation, which means planned experiments that are based on hypotheses.
Some types of research and investigation are not considered to be SR&ED, including the following:
The tax incentives that are offered to Canadian businesses through the SR&ED program offers two primary benefits. Businesses can aggregate their SR&ED expenses and deduct them against their income or roll them over to deduct in a future tax year. They can also claim the SR&ED investment tax credit to reduce their payable income taxes. IN some situations, the remaining investment tax credit can be refunded to businesses by the CRA
The investment tax credit ranges from 15% up to 35% of the qualified expenditures. If there are unused ITCs, businesses can carry them forward 20 years or back three years to apply against their taxes payable in other years. The incentives are available to corporations, sole proprietors, trusts, and individual members of partnerships.
Canadian-controlled private corporations can claim a 35% investment tax credit on their SR&ED expenditures of up to $3 million. For amounts that exceed $3 million, you can earn a 15% non-refundable tax credit. For businesses that are CCPCs that are also qualifying corporations, 40% of the investment tax credit for amounts that exceed $3 million is refundable.
For corporations other than CCPCs, they can claim an ITC of 15% for their SR&ED expenditures. The tax credit can be used to reduce their payable taxes. Sole proprietorships and trusts can earn a 15% refundable investment tax credit on their qualified SR&ED expenses. The ITC must first be applied against the payable tax before 40% of the balance earned during the year can be refunded.
Partnerships are not taxpayers, which means that they cannot earn investment tax credits. For partnerships, the SR&ED ITC is calculated at the level of the partnership and then divided between its eligible members.
The expenditures that you can claim for your SR&ED work include the following:
Businesses must choose either the proxy or traditional method when they calculate their SR&ED expenditures when completing the Form T661. Once a method has been selected, it cannot be changed for that year. Under the proxy method, businesses use a formula that is based on the salaries and wages that they have paid to calculate an amount for their SR&ED expenses. Under the traditional method, each type of overhead from SR&ED work is included.
Businesses must keep careful records and supporting documentation proving that the SR&ED work was completed and that the businesses made allowed expenditures during the tax year. The CRA will ask for the supporting documents and records that were generated when the work was being performed if your claim is chosen for a review. If you are a first-time claimant, you can ask a tax professional for help with identifying the types of documents and records that can be used to support your claim and expenditures.
Documents and records that offer support that the research and development work was completed during the tax year normally are generated while the work was carried out. The best evidence includes documentation that is specific to the work and that is signed and dated.
Businesses that want to claim the SR&ED ITC for their expenditures should keep organized and complete records that support the expenditures that they claim. The CRA might ask for the following types of documents during a detailed review:
The types of documents that provide evidence that the SR&ED work was performed include the following:
The SR&ED expenditures must be claimed by filing a Form T661 together with the income tax return. The Form T661 should be used to calculate the qualified expenditures for the ITC and to provide technical data about the SR&ED. Corporations must also file the Form TSCH31 to claim the ITC. Sole proprietors must file the Form T2038 to claim the investment tax credit.
Individuals are allowed to report the SR&ED expenditures and the ITC that they have earned within 12 months following the due date for their business income tax returns. Corporations can also file a report of their SR&ED expenditures and the ITC that they have earned within 12 months of the date when their corporate income tax return was due.
After you file your tax return and your SR&ED claim, it will be checked for accuracy and completeness. If the CRA processes your claim without a further review, your income tax return will be assessed. The CRA may select your claim for further review. If it does, the return will be sent to an office for a technical and financial review.
When claims are chosen for detailed reviews, your business may be visited by reviewers from the CRA. The reviewers will interview your financial and technical staff who were involved in your claim and review the supporting evidence that you have to substantiate your claim. The technology and research advisor will evaluate the work to determine whether it qualifies as SR&ED work. The financial reviewer will examine the expenditures related to the work to ensure that they are qualified. The job of the reviewers is to verify that you only receive the incentives for which you are entitled. You need to keep open lines of communication with the CRA reviewers during a detailed review.
You can expect a detailed review to include the following three phases:
During the preparatory and planning phase, the reviewers will review the information that you have filed with the CRA and identify any issues that exist. During this phase, the first contact with the business will occur. During the review phase, the reviewers will conduct a visit to the business. Before the site visit occurs, the business will be sent a letter that identifies the issues that will be examined and includes the date and time of the site visit. This provides the business with time to prepare for the visit. The letter should include an estimate of the time that the meeting will take and request that key people involved with the SR&ED work are available for interviews. It will also include requests for any information that the CRA believes would be helpful to the review.
After the review is completed, the CRA will communicate its findings and finalize its report. If you do not agree with the CRA reviewers’ decisions, you can go through a dispute resolution process before your business’s file is closed. The decisions may result in a reassessment of your tax return and additional tax that is due.
You will be informed by the CRA of the expenditures and ITCs that it is allowing or disallowing following the completion of the detailed review. If you believe that the law has been misapplied or that factual errors have been made, you can file a notice of objection with the CRA.
If you have an objection to the findings, you must file your objection within 90 days of the date that the notice of assessment was sent to you. You should explain why you are objecting and provide all of the relevant information that supports your objection.
When an objection is received by the CRA, the assessment or reassessment will be reviewed by an appeals officer at the tax centre. You or your representative will be contacted by the appeals officer to talk about the issues and to try to resolve the dispute.
If you feel that the appeals officer did not adequately resolve the dispute, you can file an appeal of the tax assessment to the Tax Court of Canada. If you want to file an appeal, it is a good idea to get help from an experienced tax lawyer.
Partnering with our tax professionals for your SR&ED claims can help to ensure that you receive the incentives to which your company should be entitled while reducing the chances for a detailed review and mistakes.
Our firm has helped businesses with their SR&ED tax credit claims and ITCs for years, and we have a 100% success record for our clients’ SR&ED claims and ITCs. To learn more about how we can help you with this tax incentive to small business, contact us today to schedule a consultation.