SR&ED-ing the Misconceptions: What most Businesses don't know about SR&ED Credits

On Tuesday, I wrote about the financial benefits of claiming Scientific Research & Experimental Development (“SR&ED”) expenses. Today, I have a guest blog on SR&ED claims by James McDermott, the director of marketing & business development of the BeneFACT Consulting Group Inc. (“Benefact”) a SR&ED consulting company. My firm Cunningham LLP , has worked with various R&D consultants including Benefact over the years to assist clients in maximizing their SR&ED claims. This blog clarifies several points of confusion in regard to the SR&ED program and provides examples of qualifying SR&ED in industries you would not expect a SRED claim.

SR&ED-ing the Misconceptions: What most Businesses don’t know about SR&ED Tax Credits by James McDermott

The SR&ED program is among the most generous R&D tax incentives in the world, paying in excess of $4 Billion (CDN) to more than 20,000 eligible claimants every year. Based on program criteria, participants can receive significant cash refunds or tax credits to offset a portion of qualified projects. Eligible expenditures include salaries and wages, parts and materials, subcontracts and capital expenditures. In most cases, SR&ED tax credits are fully refundable for small and mid-sized businesses, even if no taxable income is present.

While the program is generous in its application, claimants often struggle with qualification criteria and face a litany of program misconceptions. In dealing with prospective SR&ED participants we regularly encounter intelligent professionals that are utterly baffled by the program. The good news -- nearly all of the collective confusion is based on inaccurate information and a widespread lack of awareness. Businesses that take steps to educate themselves and clarify their eligibility are typically pleasantly surprised by the outcome.

According to CRA’s own statistics, only 25% -33% of SR&ED eligible businesses actually file claims. These estimates, among many things, provide strong evidence that a large segment of eligible Canadian businesses are missing the boat. With overwhelming advantages for claimants (see Mark’s blog of Tuesday), why is the program underutilized? What are the factors that prevent program participation?

In our experience, there are a few recurrent “confusion points” that continue to stand out.

Do we really conduct SR&ED?

Businesses have a difficult time determining whether they actually carry-out SR&ED eligible activities. Without dedicated R&D facilities or labs devoted to research, businesses falsely assume they cannot apply for SR&ED credits. Potential claimants should instead consider time and cost overruns, difficult one-off jobs, recalls or onsite trouble-shooting as strong indicators of qualifying work.

Our work is “not new”

 For work to be considered SR&ED eligible, claimed projects do not have to be “new” to their relative industry. If the underlying technology is not accessible in the public domain and is new to the claimant’s organization, grounds for eligibility exist. Most notably, commercial success or failure is irrelevant so long as technological knowledge is gained. Incremental changes to existing products, methods or processes (regardless of the outcome) can be typically considered SR&ED eligible.

We have $0 in taxable income

Potential claimants often assume that losses preclude them from program participation. This is a myth. For most (small and mid-sized) organizations without taxable income, SR&ED credits are fully or partially refundable.

Outside of the three scenarios listed above, there are also numerous businesses that disqualify their own eligibility based entirely on industry identification. Although some are correct in their assumptions, it is prudent for businesses to fully investigate their eligibility. To support this, below are few interesting examples of often ignored SR&ED eligible work.

Occupational Therapy

While it is recognized by the CRA as an eligible field of science, the SR&ED program remains almost totally ignored by occupational therapy practices. Despite this, opportunities are found (especially in larger practices) where new test protocols, outcome measures and treatment techniques are being developed. Examples include, but are not limited to: Speech-Language Pathology, Orthopaedic Services, Maxilo-Facial Surgery, Audiology and various forms of Physical Rehabilitation.

Insurance industry & Financial Services

Outside of claimed IT projects, SR&ED is typically overlooked within insurance and financial services firms. Potential claimants in this area should also consider efforts in actuarial and mathematical modelling. The development of predictive algorithms or data correlation (through statistical modelling) can be leveraged into a SR&ED claim.

Construction & Civil Engineering

Construction and civil engineering businesses traditionally undervalue their eligibility and often go without filing claims. Most firms in this field incorrectly discount their development efforts due to the fact that a majority of their projects are regulated by “code”. In reality, exceptional value exists in work related to the use of new materials and the creation of more efficient processes. Environmental factors and site- specific conditions, as an example, introduce the type of technological obstacles that can form the base of a strong SR&ED claim.

For further assessment of your SR&ED eligibility, visit http://www.benefact.ca/ or contact James McDermott, Director, Marketing & Business Development at james.mcdermott@benefact.ca

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

The benefits of undertaking Scientific Research and Development in Canada

The Canadian government's Scientific Research & Experimental Development (“SR&ED”) program has been controversial at times, with some pundits calling for action to tighten the program and its eligibility requirements. However, the SR&ED program has been a lifesaver for a couple of my clients. These clients were cash starved in their formative years and were able to soldier on and to grow into substantial companies, thanks in part to the funding from the Federal and Ontario SR&ED programs. These companies now pay income tax and employ a significant number of people.

In this blog, I will not delve into the criteria required to make a SR&ED claim, nor all the machinations of the income tax calculations. However, I wish to draw attention to the substantive nature of the SR&ED claims available to those businesses with qualifying expenditures. These benefits are best illustrated through an example.

Assume Research in Lotions Inc. (“RIL”) a company trying to develop an anti-aging formula for men spends $10,000 in SR&ED wages and has various overhead expenses. Since the tracking and identification of overhead SR&ED costs was problematic for most companies, the government provided an alternative election known as the Prescribed Proxy amount. If a company elects to use the proxy, it does not need to track its SR&ED overhead costs, but can simply multiply the $10,000 in SR&ED wages by a predetermined ratio of 1.65. Thus, if a RIL incurs $10,000 in wage costs, it is actually allowed to claim $16,500 ($10,000*1.65) in qualifying expenditures for purposes of the Investment Tax Credit (“ITC”). The $16,500 is then reduced by approximately $2,320 in Ontario SR&ED incentives as discussed below, leaving a balance of eligible expenditures for the ITC of $14,180.

Generally, a Canadian-controlled private corporation ("CCPC") can earn an annual refundable ITC of 35 percent on its first $3 million of qualified expenditures for SR&ED carried on in Canada, and a 20 percent ITC on any excess amount ( 40% of the 20% ITC is refundable). The ITC would be refundable in cash to RIL, or would be applied against any income tax owing by RIL. Non-CCPC's can earn a non-refundable ITC of 20 percent of qualified expenditures for SR&ED carried out in Canada.

So continuing with our example, RIL would be eligible to claim an ITC of $4,963 ($14,180 x 35%). It should be noted that RIL would have to addback the $4,935 to income in the following year.

In Ontario, most companies are eligible for an additional 10% refundable Ontario Innovation Tax Credit. So again following our example, a further refundable credit of $1,650 would be earned ($16,500 x 10%). In Ontario there is also a research and development tax credit of 4.5% that can be applied against income tax, but is not refundable (this credit can be waived, which in certain circumstances makes sense).

For SR&ED incentives in other provinces see this link.

I have simplified the SR&ED tax credit process, as it is extremely complex. The key take away here is that if RIL incurs $10,000 in SRED cost, it would potentially be entitled to SR&ED refunds by the Federal and Ontario governments totaling $6,613 ($4,963 Federal and $1,650 Ontario), making the net cost to RIL of undertaking SR&ED only $3,387. In my opinion, this is a significant incentive for any company to undertake SR&ED, despite the complexities in filing and tracking expenses.

SR&ED Wages Incurred	$  10,000
Federal Investment Tax Credit	$ (4,963)
Ontario Innovation Tax Credit	$ (1,650)
Out of pocket SR&ED Cost	$    3,387

On Thursday I will have a guest post that clarifies several points of confusion in regard to the SR&ED program and provides examples of qualifying SR&ED in industries you would not expect to be eligible to make a SR&ED claim.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.