To maintain their competitive edge, many Canadian businesses devote significant resources to the scientific research and experimental development (SR&ED) of new products and processes. For some time now, the Canadian government has recognized the benefits to the Canadian economy that are achieved through encouraging both Canadian businesses to be more productive by investing resources into SR&ED and foreign businesses to perform their SR&ED in Canada. As a result, the Canadian tax benefits for SR&ED activities carried on in Canada are amongst the most generous SR&ED incentives in the world.
Unfortunately, not all businesses that are conducting qualifying SR&ED activities in Canada apply for these incentives. We believe that this may be because the term SR&ED is commonly associated with work done in a formal setting, such as a laboratory, by skilled scientists. Businesses may also believe that applying for SR&ED credits could involve incurring costs for a tax benefit that may be subsequently disallowed by the Canada Revenue Agency (CRA). Both of these points are simply not true.
SR&ED activities for small and medium-sized businesses are usually integrated with daily business activities, meaning that SR&ED can just as easily be carried out on the production floor of your business. And, as we discuss later, it is possible for your business to apply for SR&ED incentives without the risk of incurring costs for an unsuccessful claim.
Under the Canadian tax rules, SR&ED is generally defined as a “systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis…”.
Generally, SR&ED occurs when a business' 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. In order to determine whether an activity qualifies as SR&ED under Canadian tax rules, five questions should be asked:
- Was there a scientific or a technological uncertainty?
- Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
- Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
- Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?
- Was a record of the hypotheses tested and the results kept as the work progressed?
In the CRA's opinion, a business will be considered to have SR&ED if the answer to each of these questions is “yes”. However, take note that due to the relationships between the questions, they should all be considered jointly across the entire body of work being evaluated.
Under Canadian tax law, there are three major benefits for qualifying SR&ED expenditures. These are:
- A full tax deduction in the year that such expenditures are incurred;
- The ability to "pool" SR&ED expenditures, which enables you to carry over deductions to the extent that they are not needed currently; and
- 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 SR&ED activities.
Federally, the general rule is that businesses can claim a non-refundable tax credit equal to 15% of eligible expenditures. However, for CCPCs, the credit can be as high as 35% and can be refundable. The higher rate and refundability are available on the first $3,000,000 of eligible expenses incurred by the CCPC (or the associated group, if the corporation is associated with other corporations). This limit is phased out where a CCPC/associated group's prior year taxable income exceeds $500,000 or taxable capital employed in Canada exceeds $10 million in the prior year. It is eliminated where prior year taxable income exceeds $800,000 or taxable capital reaches $50 million.
In addition to the federal tax incentives, many of the provinces have their own SR&ED tax incentives that businesses can take advantage of. Other types of incentives may also be available to support commercial or technological development.
The CRA states that they are committed to administering the SR&ED program “with fiscal integrity and to ensuring that businesses are aware of the program and can access it as easily as possible”. Note that the CRA carefully examines SR&ED claims and may even choose to review some files in more detail. First time claimants may be subject to a First-Time Claimant Advisory Service which occurs when the CRA determines that the claim is low risk and allows it, but visits the claimant to help educate them about the program in more detail. A more detailed review can include a technical review based on the specific descriptions you have submitted, a review of the financial side of the claim, or both. 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 SR&ED, we at BDO realize 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 SR&ED review, a member of our SR&ED group will discuss your activities with you and provide you with our initial feedback on whether we believe you have eligible SR&ED 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. We can also support you through a CRA review should the claim be selected. The fee for our services can be based on an hourly charge for the work done or as a success-based percentage of the tax savings arising from the claim.
Many clients opt for a success-based fee. While BDO has a high success rate in terms of identifying activities that will qualify, a success-based fee reduces the 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 SR&ED process, contact your BDO advisor.
The information in this publication is current as of April 17, 2017.
This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.