What is SR&ED?
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.
Available Tax Benefits
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:
- A federal investment tax credit of 35% on qualifying expenditures up to a maximum expenditure limit of $3 million. For all CCPCs, the 35% federal investment tax credit must first be applied to taxes owing and any excess credit is fully refundable; and
- A federal investment tax credit of 15% on qualifying expenditures in excess of the expenditure limit of the corporation. The credit must first be applied to taxes owing.
- For CCPCs that are “qualifying corporations”, the amount of the 15% federal investment tax credit in excess of taxes owing is 40% refundable. The non-refundable portion of the credit balance can generally be carried forward up to 20 years to reduce taxes payable in future years; and
- For CCPCs that are not “qualifying corporations”, the amount of the 15% federal investment tax credit in excess of taxes owing is non-refundable. It can generally be carried forward up to 20 years to reduce taxes payable in future years.
The maximum expenditure limit of $3 million is reduced where:
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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
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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.
- Corporations other than CCPCs can claim a federal investment tax credit of 15% on qualifying expenditures. The credit is first applied to reduce taxes payable and any excess credit balance can generally be carried forward up to 20 years to reduce taxes payable in future years.
- Partnerships can claim a federal investment tax credit of 15% on qualifying expenditures. The credit is allocated to the partners and applied to reduce their taxes payable. Partners that are qualifying corporations, individuals and certain trusts may be refunded their allocated ITC at a rate of 40% of the excess. Any remaining credit balance can generally be carried forward up to 20 years to reduce taxes payable in future years.
- Individuals and certain trusts can claim a federal investment tax credit of 15%. The credit must first be applied to taxes owing. Any excess credit balance is 40% refundable. The non-refundable portion of the credit balance can generally be carried forward up to 20 years to reduce taxes payable in future years.
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.
Qualifying Projects
In general, to determine whether work meets the definition of SR&ED, there must be:
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Scientific or technological uncertainty;
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An effort to address the uncertainty, which involves formulating hypotheses specifically aimed at reducing or eliminating that uncertainty;
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An overall approach that is
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Consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis; and
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Undertaken for the purpose of achieving a scientific or a technological advancement; and
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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:
- Market research or sales promotion;
- Quality control or routine testing of materials, devices, products or processes;
- Research in the social sciences (psychology, economics, business, law, history, archaeology, literature, philosophy) and humanities research;
- Prospecting, exploring or drilling for or producing minerals, petroleum or natural gas;
- Commercial production of a new or improved material, device or product, or the commercial use of a new or improved process
- Style changes to an existing product; or
- Routine data collection.
Qualifying Expenditures
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:
- Employee salaries related to that project;
- Materials used in that project;
- Payments to contractors for work performed on behalf of the entity for that project (80% eligible); and
- Payments to “third parties”, such as approved associations or universities, to perform SR&ED work the results of which the entity can make use of for their project (80% eligible).
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.
