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Scientific Research and Experimental Development (SR&ED) is a longstanding tax incentive program aimed at promoting the advancement of technology in Canada. Companies of all sizes and industry sectors making qualified expenditures in connection with SR&ED activities in Canada are entitled to receive an investment tax credit.
The investment tax credit reduces taxes payable and, for certain entities, the amount of the credit in excess of taxes payable can be refunded to the entity, providing valuable assistance to emerging businesses and others that are not taxable in the year. The federal program is administered by the Canada Revenue Agency (“CRA”). Most provinces offer parallel programs with tax credits for qualifying activities in the particular province.
A “Canadian-controlled private corporation” (“CCPC”), which is, in general, a privately held Canadian corporation that is not controlled by non-residents of Canada or public entities, can claim the following credits:
The maximum expenditure limit of $3 million is reduced where:
The corporation’s prior year taxable income (together with the prior year taxable income of each associated corporation, if applicable) exceeds $500,000 and is eliminated where the prior year taxable income exceeds $800,000; and
The corporation’s prior year taxable capital employed in Canada (together with the prior year taxable capital of each associated corporation, if applicable) exceeds $10 million and is eliminated where the prior year taxable capital exceeds $50 million.
A “qualifying corporation” means a CCPC for which the prior year taxable income (together with the prior year taxable income of each associated corporation, if applicable) does not exceed the “qualifying income limit”, as determined by a formula. For corporations with a total taxable capital (including that of associated corporations) of up to $10 million, the “qualifying income limit” is $500,000. The limit is reduced to nil when taxable capital reaches $50 million. For example, a CCPC with no associated corporations and taxable capital of $20 million in Year 1 will have a “qualifying income limit” of $375,000 and will be considered a “qualifying corporation” in Year 2 so long as its taxable income did not exceed $375,000 in Year 1.
Provincial investment tax credits for qualifying SR&ED expenditures can be claimed in addition to the federal investment tax credits. Provincial credits range from 4.5% to 20% and are refundable in certain provinces.
In BC, the investment tax credit rate is 10% for corporations and corporate members of partnerships, and is refundable for CCPCs up to their expenditure limit.
In general, to determine whether work meets the definition of SR&ED, there must be:
Scientific or technological uncertainty;
An effort to address the uncertainty, which involves formulating hypotheses specifically aimed at reducing or eliminating that uncertainty;
An overall approach that is
Consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis; and
Undertaken for the purpose of achieving a scientific or a technological advancement; and
A record of the hypotheses tested and the results obtained as the work progresses.
The following activities are specifically not eligible for benefits under the program:
Where there is a project that meets the definition of SR&ED, the following types of expenditures directly attributable to the project can be claimed:
Overhead expenses may also be claimed. An entity can elect to either use the “traditional method” to claim specific overhead costs related to the project or use the simplified “proxy method” to approximate the related overhead expenses by multiplying eligible SR&ED salaries by 55%.
The traditional method is more complex to calculate and is generally preferable for entities with significant overhead infrastructure cost in comparison to salary cost, such as a manufacturing company. The proxy method is simpler to calculate and is generally preferable for entities with significant salary cost in comparison to infrastructure cost, such as a software company.