Did you know that the Scientific Research and Experimental Development (SR&ED) tax credit is available to Canadian businesses of all sizes and in all sectors?
Even if you don’t run a tech company, your business may qualify for an income tax deduction, an investment tax credit, or a tax refund in certain situations if you conduct research and development (R&D) in Canada.
What qualifies as eligible research and development for the SR&ED tax credit? Here are a few examples:
- Basic research: conducted in a lab, to advance scientific knowledge without a practical application in mind
- Applied research: advancing scientific knowledge with a real-life, practical application in mind
- Experimental development: work focused on developing or improving materials, processes, or devices.
- Support work: work in direct support of basic research, applied research, or experimental development
Given the strain that current economic conditions are having on many companies in Canada, getting your SRED claim in order sooner rather than later will ensure you receive any credits you’re entitled to faster. In fact, the Canadian federal government has just announced it will proceed with a long-anticipated review and consultation of the SR&ED tax credit program. The stated goal is modernizing the SR&ED program to boost innovation and intellectual property development in Canada.
With that in mind, let’s dig into the accounting side of it.
The Basics of SR&ED Program
Tech companies often claim SR&ED tax incentives (commonly pronounced "shred") and those in the pharma, biotech, or energy sectors, but any business can qualify.
Whether you operate as an individual, a corporation, a trust, or a partnership, you may be eligible for the SR&ED tax incentive program if your organization is carrying out R&D to:
- Advance scientific knowledge
- Achieve technological advancement
- Overcome technological problems or use technologically advanced solutions to develop a new product or process, or improve an existing one
To be clear, SR&ED-related work does not include activities like market or social sciences research, or the testing, quality control, or commercial production of materials, devices, or products.
In general, however, as long as your business is doing a “systematic investigation or search, through experiment or analysis, to advance science or technology,” the Canada Revenue Agency (CRA) says your project falls under the umbrella of SR&ED.
You can read more about the type of eligible SR&ED work, but consulting with an eligibility expert is highly recommended.
How Your Business Can Benefit
If the work you’re doing qualifies (see above), there are two main ways your business can benefit:
- You can deduct SR&ED expenditures against your current or future income
- You can use the SR&ED investment tax credit (ITC) to reduce your income tax payable – and possibly receive a tax refund
According to the CRA, you should expect your ITC to be at least 15% and as much as 35% of your qualified SR&ED expenditures.
Maximize Your Return: Know Who is SR&ED-able
Understanding which expenditures you can claim for SR&ED purposes will ensure you make the most of any return you’re entitled to. In addition to materials, equipment leases, and contractors, the expense category you should pay close attention to is your SR&ED payroll, including time invested by management.
Payroll Expenditures
When it comes to claiming payroll expenses, the good news is that it includes the fully loaded salary, including taxable benefits and bonuses.
For example, let’s say you have an employee who makes $75,000 per year. On top of that salary, they received a $2000 signing bonus, a $50 monthly reimbursement for their cell phone, a $1000 wellness spending account through extended health benefits, and a $5000 year-end bonus. That means their all-in “salary” for that year is $83,600. If 60% of their time is allocated to SR&ED projects, then their payroll claim would be 0.6 x $83,600 = $50,160.
This includes employees who are directly performing the work, those who support the work through administrative duties, and those who oversee the work.
One note of caution, however: only work performed on Canadian soil can be claimed. Therefore, if your business has remote employees or offices elsewhere, even if they’re on your Canadian payroll, their time and salaries will not be eligible for any SR&ED claim.
Time Invested by Management
The time invested by managers, and senior leadership is also SR&ED-able as it relates to guiding and supervising the project. If your CEO is heavily involved in project ideation and strategic direction, the appropriate proportion of their fully loaded salary can be claimed.
To support your expenditures claim, make sure your R&D work – and any related expenses – are thoroughly documented. This is where accounting and expense management software becomes very important as you prepare this documentation.
For example, the CRA will look for such evidence as:
- Planning documents and records of project resources
- Experiment designs, records of trial runs, and progress reports
- Timesheets and contracts
You should also note that your SR&ED expenditures claim must be filed within 12 months of the filing due date of your company’s income tax return – but sooner is better.
5 Tips for Making Your SR&ED Claim Experience Painless
Claiming SR&ED tax credits can be complicated. We’ve collected 5 top tips for making your claims process as painless as possible:
1. Track hours like a lawyer or agency would. To avoid guessing or estimating later, have your team log everything to make it very clear how many hours were spent on SR&ED-able projects. This also makes it clear who was involved and what they did.
2. Keep your books clean and organized. Work with your bookkeeper to set up or adjust your chart of accounts to track your SR&ED-able expenses separately. This will make all the difference when it’s time to put together your claim.
3. Check in quarterly with your team and SR&ED consultant (if you’re working with one). Keep tabs on how your tracking is looking, whether documentation is being completed on an ongoing basis, whether the same employees are still working on a current project, and whether any new projects on the horizon may be SR&ED-eligible work.
4. Make the most of your time & effort. If you’re operating as a Canadian-controlled private corporation (CCPC) and you qualify for SR&ED, you’re likely eligible for other R&D funding programs, for example, the National Research Council of Canada Industrial Research Assistance Program (NRC IRAP).
5. Stay audit-ready. Keep proper records of all the SR&ED qualifying expenditures you claim so that if you do get audited (which may happen every few years), the process will be as seamless as possible.
Remember, SR&ED credits and refunds are essentially free money from the government if you’re willing to put in a little bit of work.
Taking the time to set up and manage your books and accounting practices in a way that lets you easily track and manage your SR&ED-able expenses will ensure your business is ready to go come claim time.At Enkel, we’ve helped tech companies like Acuva Technologies manage their books and track their SR&ED expenses. If you’re not sure where to begin, get in touch with us today to learn more!
