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Surprisingly, not all businesses who are conducting qualifying R&D activities in Canada apply for the tax incentives |
To maintain their competitive edge, Canadian businesses must devote significant resources to the scientific research and experimental development (SR&ED or more commonly referred to as simply R&D) of new products and processes. The Canadian government has recognized the benefits to the Canadian economy that are achieved through encouraging Canadian businesses to be more productive by investing resources into R&D and foreign businesses to perform their R&D in Canada. As a result, the Canadian tax benefits for R&D activities carried on in Canada are among the most generous R&D incentives in the world.
Surprisingly, not all businesses who are conducting qualifying R&D activities in Canada apply for these incentives. We believe that may be because many people associate the term R&D with work done in a formal setting, such as a laboratory, by skilled scientists. Businesses may also believe that applying for R&D credits involves incurring costs for a tax benefit that may be disallowed. Both of these points are simply not true.
R&D activities for small and medium-sized businesses are usually integrated with daily business activities. R&D can just as easily be carried out on the production floor of your business. This is shown by some R&D success story examples summarized in the box on the next page. And, as we discuss later, it is possible for you to apply for R&D incentives without the risk of incurring costs for an unsuccessful claim.
What is R&D?
Under the Canadian tax rules, R&D is defined as “a systematic investigation or search carried out in a field of science or technology by means of experiment or analysis”.
Generally, R&D occurs when a business’s objective is technological advancement, development occurs in a systematic manner through the efforts of individuals who are skilled in the technologies involved and technological uncertainties are overcome. Therefore, three basic criteria must be met if an activity is to qualify as R&D under our tax rules and these criteria are:
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Scientific or technological advancement;
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Scientific or technological uncertainty; and
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Scientific or technological content.
What are the R&D tax incentives?
Under Canadian tax law, there are three major benefits for qualifying R&D expenditures. These are:
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A full tax deduction in the year the expenditures are incurred, even if they are capital in nature;
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The ability to “pool” R&D expenditures, which enables you to carry over deductions to the extent that they are not needed currently; and
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Eligibility for attractive Investment Tax Credits (ITCs), which can be refundable in cash if you don’t need them to reduce current taxes payable.
The main focus for most businesses is the ITC on qualifying expenditures and this is particularly attractive for Canadian-controlled private corporations (CCPCs) that carry on qualifying R&D activities.
Federally, the general rule is that businesses can claim a non-refundable credit equal to 20% of eligible expenditures. However, for CCPCs, the credit can be as high as 35% and can be refundable. The higher rate and refundability is available on the first $3 million of eligible expenses incurred by the CCPC (or the associated group, if your corporation is associated with other corporations). This limit is phased out where a CCPC/associated group’s income exceeds $500,000 or taxable capital exceeds $10 million in the prior year.
In addition to the federal tax incentives, many of the provinces have their own R&D tax incentives.
How do I know whether I qualify?
Unlike tax filings in general, the Canada Revenue Agency (CRA) carefully reviews first-time R&D claims. The initial review is usually the technical review performed by the CRA based on the technical descriptions you have submitted. The CRA may also review the financial side of the claim. The length of the review is generally determined by the size and complexity of your claim. Once the CRA has verified that the claim is eligible, then the ITC is allowed.
While some activities will clearly be R&D, BDO realizes that there are other situations where there will be some uncertainty around whether your activities will qualify. The important thing to remember, however, is that our work and professional fees take this uncertainty into account.
As part of an R&D review, a member of our R&D group will discuss your business activities with you and provide you with our initial feedback on whether we believe you have eligible R&D expenditures. If we believe you have a bona fide claim, we can then provide our services to prepare the tax forms needed, including a technical summary of your activities and submit this claim to the CRA as part of your corporate tax return or as an amended return. The fee for our services can be based on an hourly charge for the work done or a percentage of the tax savings arising from the claim.
Many clients opt for a success-based fee as a percentage of successful claims, as they will not incur any costs if the CRA ultimately does not allow the claim. Although BDO has a high success rate in terms of identifying activities that will qualify, a success-based fee ensures you will not be at risk of incurring professional fees for an unsuccessful claim. The fee amount varies depending on the size and nature of the claim and will be negotiated in advance of BDO performing the work. Consequently, this is a very low-risk alternative while proving to be an opportunity for sizeable financial benefits.
For more information on the R&D process, contact your BDO advisor.
Success Story Examples
Here’s a selection of some recent successes in terms of claiming R&D incentives:
- A manufacturer of well drilling and other equipment for the oil sector in western Canada was certain that they were not doing R&D work as part of their business activities. BDO advisors discussed the qualification requirements for federal and provincial R&D credits with the business people and prepared a claim in exchange for a fee based on a percentage of the tax credits allowed. A sizeable credit was recently allowed by the CRA.
- A client in the business of developing specialized communications systems recently received a sizeable ITC claim. In this situation, the work was done for a variable success fee, where the percentage increased based on the size of the ITC allowed. Under this alternative, the client would keep more of a smaller ITC if not all of the projects were allowed as R&D by the CRA.
- A food processor in Ontario had never claimed ITCs previously and was again certain that they were not doing work that would qualify. After discussions over the course of a year, a sizeable R&D claim was filed for the client that was successful.
These situations all involved businesses that were uncertain in terms of eligibility and entered into an R&D engagement with a contingent fee. Although the claims were all successful, these businesses would not have incurred costs for an unsuccessful claim. |
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