About the Scientific Research and Experimental Development Program – Called SR&ED or SRED – Pronounced “SHRED”
What is SRED?
SRED (SR & ED or SR&ED) is the Canadian federal government’s largest industrial incentive program that funds any company resident in Canada for conducting Research and Development activities.
Who is Eligible?
Any company operating in a field of technology which is carrying out experimental work may make an SR&ED claim. Some companies fail to make a SRED claim because they falsely assume that the program is restricted to “high tech” companies. 20,000 companies receive SR&ED credits annually. Many firms in non-high-tech verticals may have “pockets” of SRED activities going on at any given time. In general, if some of your staff are engaged in solving technological problems for which a solution is not available in-house or online, there is a good chance that the work being performed is at least partially eligible for SRED credits. In many cases, the companies who receive SRED credits are in low tech industries such as agriculture, machine shops or light industrial companies.
How Much Can I Receive?
SR&ED tax credits are always a percentage of the amount spent on R & D activities conducted in Canada. Therefore, if your company does not spend very much money, it won’t be eligible for much in the way of SR & ED credits. Entrepreneurs often make the mistake of sacrificing a salary for months, or even years, to help get their company off the ground. This greatly reduces the size of their Scientific Research claim since wages tend to be the biggest contributor to SRED tax credits. Similarly, companies that do most of their work outside of Canada will not be eligible for substantial SRED claims.
The greatest SR&ED tax credits are reaped by Canadian-controlled private corporations. CCPCs can earn SR&ED tax credits for 35% of eligible expenditures up to the first $3 million spent. For eligible expenses beyond $3 million, companies can receive credits of 15%. Other Canadian corporations such as public companies, partnerships, trusts, etc. can earn SR&ED credits equal to 15% of qualified expenditures for SR&ED conducted inside Canada. Each province in Canada, except SR&ED Alberta since January 1, 2020, has a piggyback program which automatically supplements the federal sred credits earned. SRED BC pays for example a 10% refundable tax credit to all businesses in the province who qualify for federal credits.
What Costs can be Included?
SRED costs are comprised of expenses in three different areas. First is SRED Canada salaries. SR & ED salaries are the bulk of most companies’ claims because salaries claimed are uplifted by 55% to account for overhead costs. This 55% uplift for overhead is called proxy. The second expenditure bucket is materials. SRED CRA rules state that expenditures are comprised of both scrap materials, generated during the course of experimentation, or prototype materials. The final expenditure bucket for SRED is subcontracts. Subcontract expenses can be made to business or to individuals. These individuals are often called contract employees. It’s important to note that subcontractors must be Canadian residents to qualify as valid SRED expenditures. The easiest way to determine that SRED Canada status is to be sure to check for HST numbers for corporations and SIN numbers for individuals. This is the same method used by CRA SR&ED auditors.
How are SRED Credits Paid?
SRED tax credits can be either refundable or non-refundable. CRA SR&ED refundable credits are cash. Once approved a company will receive its SRED grant via direct deposit or, failing that, a cheque for the credits they have earned. Large, public and foreign-owned companies receive non-refundable credits.
For CCPCs, it used to be up to 2017 that the prior year’s taxable income was used to determine the extent to which the SR & ED ITCs are refundable. That is no longer the case. ITCs are fully refundable for CCPC’s regardless of the amount of taxable income. The only SRED credit now affected by the small business limit in Ontario is the OITC. OITC is reduced if the company’s previous fiscal year net income exceeds the $500,000 small business limit. If the company’s prior year net income exceeds $800,000, OITC will be reduced to zero. The 3.5% non-refundable ORDTC, like the federal ITC, is not impacted by a CCPC’s net income level. Companies should “bonus down” their profits to keep net income below the small business limit threshold or at least below $800K to maximize your credits.
For public companies, Investment Tax Credits are not refundable but may be used to reduce any taxes payable. SR & ED Credits can be carried back 3 years or forward for up to 10 years to reduce future tax liability. Note that some provinces offer a provincial SRED component that may be refundable even when the federal SR&ED credits are non-refundable.
What Determines an Eligible CRA SRED Project?
At least 95% of all CRA SRED claims involve Experimental Development (as opposed to Scientific Research). In general, Experimental Development projects qualify as SRED projects if they satisfy three main criteria:
1. Must Conduct a Systematic Investigation
In order for a project to be considered SRED eligible, a systematic investigation must be performed in an attempt to resolve the technological uncertainties.
Projects with SR&ED eligibility often hit “roadblocks” or hurdles that cannot be easily overcome. Your company may attempt several different approaches before arriving at an acceptable solution. Trial and error or undisciplined problem-solving techniques are not considered by the CRA to be systematic. Instead, the results from a failed approach should be used to help determine the next solution to be attempted. That is, by applying knowledge gained in a previous attempt at a solution you can usually choose a new course that has the greatest likelihood of a positive outcome.
Luckily, most engineering work and R & D is systematic anyway, since skilled workers tend to be analytical and process-driven. They will generally try to choose a path that has the highest probability of success based on results analyzed from prior attempts.
2. Must Have Technological Uncertainty
CRA SR&ED technical reviewers insist that there must be technological uncertainty involved in the SR&ED project being claimed. Basically, this means that there is no obvious solution to the problem you are attempting to solve and a solution is not readily available through normal investigation.
It is important to distinguish “technological” uncertainty from other types of uncertainty that are irrelevant to SRED eligibility. Market fit, sales and marketing strategies, labour issues, are irrelevant for SRED purposes. Business issues do not have any bearing on SRED eligibility.
In general, if your company is undertaking a project where, at the outset, qualified staff really don’t know how to solve the problem they are being asked to solve, there is a good chance for SR&ED eligibility because technological uncertainty is involved. SRED CRA reviewers assume that your staff are well trained and educated in the field of science to which their skills are being applied. Also, if a solution is readily apparent through a reasonable amount of research, your SRED consultant will likely deem that the work is not SRED eligible.
3. Must Achieve a Technological Advancement
Although this CRA SR&ED requirement seems daunting, it is actually among the easiest to fulfill. This is because there is no requirement to have a successful project outcome in order to realize a technological advancement. For example, let’s say you unsuccessfully attempted three different ways to resolve a technological uncertainty. In this case, your advancement is in proving that these three techniques are not feasible and your work would achieve SR&ED eligibility.
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