The Innovator's Guide to SR&ED (Scientific Research and Experimental Development)
The Government of Canada wants to encourage companies to create innovative technologies because doing so improves people’s lives and leads to more jobs and economic growth. But doing something actually new takes time and money, and it doesn’t always work out. The Scientific Research and Experimental Development (SR&ED) program is the most popular tax credit program in the country because it helps mitigate the risk for innovators by reducing the taxes you pay.
All Canadian entities can apply for the SR&ED Tax credit program. A Canadian company that generated less than $800,000 of taxable net income in the prior fiscal year may be eligible for tax refunds in the form of a cash return which can represent a substantial boost in cash flow. You submit SR&ED claims as part of your company’s tax returns, within 18 months of the fiscal year end.
A company that generates more than $800,000 of taxable net income in the prior fiscal year or has foreign ownership of more than 50% is also eligible for the tax credit which is applied to corporate tax and can be carried forward for 3 years.
The Short Version
SR&ED is a tax credit program administered by the Canada Revenue Agency.
SR&ED is designed to incentivize Canadian companies to do research and development in Canada.
Tax Credits apply to costs and time associated to develop new or improved technology and processes, where success is not assured.
Canadian corporations from all industries can apply for SR&ED.
Documentation is essential to your claim, to justify the work that was completed for CRA auditors to review. Keep all records that could be relevant and log your progress as you go.
Not all research and development activities qualify for SR&ED.
Eligibility is limited to activities where the goal is to make a new discovery and where the success of the project isn’t obvious or assured.
Attributes of a Successful SR&ED Project Claim
- Technological Uncertainty – The problem can’t currently be solved, or the objective you want can’t be achieved with existing products, processes or knowledge.
- Hypothesis – Based on existing knowledge, you develop an idea or a solution that might work as a starting point to test through experimentation.
- Experimentation – This is an iterative process and includes unsuccessful attempts and shifts in the hypothesis. You can still claim the experiments that don’t work out. In fact, if your first hypothesis turns out to be true based on your first experiment, it’s probably not an eligible activity because it’s too obvious.
- Technological Advancement – As you experiment, you create new knowledge and methodologies. Your results become repeatable and form the basis for a new technology or process.
- Timely Documentation – Detailed records are essential in making an SR&ED claim. Log all engineering, design and technical discussions, operations research, mathematical analysis, computer programming, data collection, testing and analysis. Track time with workflow management software. Include white papers and research notes. And don’t forget informal documentation like photos of whiteboard scribbles or videos of experiments.
The timeline of your material and labour costs should match your experimental logs. It’s also important to keep logs as you work. Recreating logs after the fact, months later at tax time will be too difficult and will likely make it harder to get your claim approved.
Expenses claimed with the SR&ED Tax Credit
- T4 salaried employee’s performing research and development for SR&ED eligible projects
- Material costs and other expenses essential to your discovery process, including samples, prototypes and scrapped materials that are not commercially sold
- Canadian subcontractor fees associated with the SR&ED eligible project
What is NOT Eligible?
- Routine R&D costs, such as buying and testing the capabilities of competitor products
- Commercialization efforts such as sales and marketing
- Basic administrative costs
- Capital costs for buildings, equipment or fees for business licenses
- Contracts with foreign service providers
SR&ED Claim Process
Depending on the size of your company and the expertise on your team, you may choose to use an outside consultant or accounting firm, or prepare your claim in-house.
Using a SR&ED consultant might be the way to go if you are a small team and you’re simply too busy building the next big thing.
After all, the policies can be complex, and a SR&ED consultant will have the experience and knowledge to give your claim the best chance of success. Either way, expect the review process to take anywhere from one month to a year depending one the quality of your claim.
Working with a consulting firm or internally you would need to complete the following steps:
- Are you a startup and don’t pay yourself? You can still claim. If you spend hours working on an eligible R&D project, determine an industry-benchmarked salary you might pay yourself, pay the payroll taxes to CRA, then claim the amount of your salary.
- There are tax credits available for Canadian provincial taxes as well, though rates and review process may vary.
- Where SR&ED expenditures exceed $3 million or the company is not Canadian-owned, the rules are slightly different and the basic rate drops to 15%, but the tax savings can still be worth the effort.
For more information about SR&ED, visit this page.
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