Before you apply for the Scientific Research and Experimental Development credit, it’s important to understand its requirements.
If you’re wondering if the SR&ED program can benefit your businesses, if your projects qualify, how the Canada Revenue Agency (CRA) determines eligibility, how this tax incentive program works, or how to claim it, you’re in the right place.
Keep reading — we’ll answer all of your SR&ED questions.
Related: What Is the ERC?
What Is the SR&ED Tax Credit?
The SR&ED tax incentive program is Canada’s single largest source of federal government support that encourages R&D activities.
Every year, the Scientific Research and Experimental Development program provides Canadian businesses and taxpayers with over $3 billion — and the majority of those taxpayers are small businesses.
The R&D tax incentive is a program similar to Canada’s SR&ED credit — Click here to see if your business qualifies.
What Is the SR&ED Program’s Objective?
The objective of this program is to deliver SR&ED tax credits in a consistent, predictable, and timely manner while encouraging taxpayers to prepare their claims in compliance with Canadian tax laws, procedures, and policies.
The Canada Revenue Agency continuously seeks new ways to simplify and improve its service delivery through the SR&ED program and commits to the following:
- Ensuring that businesses know about the program and have easy access to it
- Administering the program with integrity by ensuring every taxpayer gets the amount they’re entitled to
- Applying SR&ED tax policies correctly, fairly, and consistently
How Does the SR&ED Tax Credit Benefit Businesses?
The SR&ED tax incentive program provides financial benefits to businesses to help them:
- Fund technological and scientific advances to keep your company competitive
- Better position your business for future SR&ED projects
In addition, you might be able to deduct your SR&ED expenditures to further reduce your tax liability in either the current year or carry the credits over indefinitely to reduce your future tax liability.
Your business may also receive benefits in the form of a reduction in taxes payable, refundable investment tax credits, or both. You can carry over any of those unused credits forward 20 years or back three years as long as you earned them after 1997.
What Businesses Can Get the SR&ED Credit?
Any business can claim the SR&ED tax credit for operating and carrying out research and development activities in Canada. Plus, specific expenditures outside of Canada for SR&ED purposes are also permitted.
Businesses that are involved in applied or basic research or in advancing technology to develop or improve materials, products, devices, or processes are likely eligible under the program.
The following three groups of businesses can apply for the SR&ED tax credit:
- Canadian-Controlled Private Corporations (CCPCs): CCPCs can get a refundable investment tax credit on their qualified SR&ED expenditures. However, they must first apply those credits against taxes payable during the year of the claim. Then, they receive the remaining balance as a refund.
The rate of refundability for CCPCs is based on their taxable income and capital of the previous year and includes an expenditure limit.
- Other Corporations: For corporations that are not CCPCs, their available investment tax credit is 20% of their qualified SR&ED expenditures. Unlike with CCPCs, this credit can only be applied to taxes payable — it is not refundable.
- Proprietorships, Partnerships, and Trusts: These companies, like other corporations, have an available tax credit of 20% of their current and capital expenditures. However, after applying it against their taxes payable, these businesses are eligible for a refund of 40% of their investment tax credits earned during the tax year.
What Qualifies as SR&ED?
To qualify as SR&ED, a company’s activities must fall into one of three categories:
- Experimental Development: This is any work completed to achieve technological advancement to create new (or improve existing) products, devices, materials, or processes.
- Applied Research: Applied research is any work performed to advance scientific knowledge and must have a specific practical application.
- Basic Research: This constitutes any work done to advance scientific knowledge that does not have a specific practical application.
In addition, SR&ED can include other work that directly supports any of those three categories. This support work can include any of these eight types:
- Operations research
- Computer programming
- Mathematical analysis
- Data collection
- Psychological research
Companies that want to claim this support work must show how it corresponds to the needs of their SR&ED processes.
What Does Not Qualify as SR&ED?
There are some types of work that are not eligible for the SR&ED program, including:
- Sales promotion or market research
- Research in the humanities or social sciences
- Commercial production of materials, devices, or products
- Commercial use of new or improved processes
- Routine data collection
- Quality control or routine testing processes
- Prospecting, drilling, or exploring for petroleum, natural gas, or minerals
- Style changes
What Are the Eligibility Requirements for the SR&ED Tax Credit?
Other than meeting the qualifications listed above, for a company’s R&D work to be eligible for the SR&ED credit must be a systematic search or investigation carried about by analysis or experiment.’
This includes identifying obstacles, formulating objectives, and developing a plan using the method of experimentation or analyzing and testing a hypothesis. In addition, you must undertake this work to advance scientific knowledge or achieve technological advancement.
However, your project does not have to succeed to qualify for the SR&ED credit.
In addition, the CRA uses two questions to help determine whether or not a project meets SR&ED criteria: “Why?” and “How?”
Related: What Is the Payroll Tax Deferral?
What Is the “Why” SR&ED Eligibility Requirement?
As we mentioned, your SR&ED work must be either to achieve technological advancement or further scientific knowledge. Because both are eligible for the credit, it doesn’t matter which category your work falls under — the important part is that your aim is to advance either science or technology.
But how do you identify when new knowledge is needed? When the current information you have isn’t enough to achieve your desired result — this is where the concept of uncertainty enters the chat.
Recognizing this uncertainty is vital for your work to be eligible for SR&ED. In addition, your work must address this challenge; if you use the knowledge you already have to avoid the problem of uncertainty, your work will not qualify.
What Is the “How” SR&ED Eligibility Requirement?
Next, it matters how you perform your work to determine whether or not it qualifies as SR&ED.
Your work must use a systematic approach and search for the advancement of knowledge — not just for the work itself.
That might sound confusing, but let’s clarify what this systematic approach looks like:
- Generate a hypothesis using known facts as your starting point to resolve a problem
- Test that hypothesis through analysis or experimentation
- Develop a conclusion based on your results
- Log the evidence that you create throughout the entire process
What Expenditures Can Businesses Claim?
Companies can claim many of their expenditures incurred for SR&ED activities throughout the fiscal year, including:
- Salaries and wages
- SR&ED contracts
- Overhead costs
- Material costs
- Equipment lead costs
- Third-party payments
How Do You Determine Your SR&ED Expenditures?
Companies can determine their SR&ED expenditures for the tax credit using one of two methods:
- The Traditional Method: If you use the traditional method, you must identify your overhead costs for the tax year and then claim all of your SR&ED expenditures incurred throughout the year.
- The Proxy Method: This method involves calculating a substitute amount for your overhead costs using a formula instead of specifically identifying them as you would using the traditional method.
What Are the Rates for the SR&ED Investment Tax Credits?
The rate at which businesses can have their investment tax credits refunded depends on their business structure:
- CCPCs: 35% with 100% of the credit being refundable
- Other corporations: 15% with no refundable portion
- Proprietorships, partners, and trusts: 15% with 40% of the credit being refundable
How Do You Claim the SR&ED Credit?
To make a claim for the SR&ED credit, you must file an income tax return with the following forms:
- Form T661
- Form T2SCH31
- Form T2038 (IND)
When Do You File Your SR&ED Claim?
When applying for the SR&ED tax incentive, you have to file the applicable forms by your tax reporting deadline.
That deadline is 18 months for corporations and 17.5 months for individuals from the end of the tax year when you incurred the expenses.
If you don’t report your projects or expenditures by that deadline, you cannot include them in your deductible SR&ED expenditures, and you won’t be able to earn investment tax credits on them.
Claiming your tax incentives doesn’t have to be difficult — See how we’re automating R&D tax credits at TaxRobot.
What Happens After Filing Your SR&ED Claim?
When you send in your SR&ED claim, the CRA will determine if they can process it or if it needs further review. If they can, they will process your claim and reduce your taxes payable or issue you a check (if applicable). If they cannot process it as filed, the CRA will likely contact you to discuss the review of your claim or to request more information.
If you qualify for a refund, the CRA will typically process your claim within 120 days. They process 90% of claims accepted as filed within 60 days and claims selected for review or audit within 180 days.
What Happens If the CRA Has to Review My Claim?
Businesses claiming the SR&ED tax credit are subject to financial and technical review to ensure they meet all compliance and eligibility requirements set out in the Income Tax Act.
If they can’t process your company’s claim as filed, they’ll visit or contact you to review your claim’s information to help you get the SR&ED tax credits to which you are entitled.
A technical reviewer will evaluate your work to determine if it meets the eligibility criteria for the SR&ED credit, and a financial reviewer will look at the costs of your project to ensure they are eligible expenditures for SR&ED.
These reviews may involve a visit to your company to review documentation, speaking with technical staff who were involved in your SR&ED work, and talking to financial staff who understand the expenditures claimed under your SR&ED projects.
What Will the Reviewers Need From You?
To make the process of reviewing your SR&ED claim go smoothly, it helps if you:
- Identify a technical and financial contact person that the CRA can speak to regarding your SR&ED work and expenditures
- Speak with the CRA’s reviewers to clarify what information they need from you
- Respond to CRA requests quickly and accurately
- Maintain the financial and technical documents needed to substantiate your claim
What Supporting Documentation Do You Need for Your SR&ED Tax Credit Claim?
It’s important to maintain evidence and documentation to substantiate the SR&ED work you perform and the expenditures you incur to support your claim. If the CRA selects your SR&ED claim for review, they’ll want to see all of the evidence generated by your project.
Examples of financial and technical supporting evidence for your SR&ED claim include:
- Project planning documents
- Experimentation plans
- Project records and laboratory notes
- Records of trial runs
- Project meeting minutes
- Professional publications and final reports
- Samples and prototypes
- Contracts and lease agreements
- Proof of payment and purchase invoices
- Documents regarding the design of experiments
- Technical drawings and design documents
- Source code (for software development projects)
- Project progress reports
- Protocols, data, analysis, results, and conclusions
- Videos and photographs
- Scrap and scrap records
- Payroll and activity records
- Account records
Related: What Is the WOTC?
Have More SR&ED Questions?
If you’ve read through our guide and FAQ and are still unsure if your projects qualify for the SR&ED credit, our tax experts at TaxRobot are happy to help answer your questions. Don’t hesitate to send us a message.