THE SR&ED PROGRAM

OVERVIEW OF THE PROGRAM

The SR&ED tax credit program is a federal tax incentive program that was introduced in the early 1980s to encourage any Canadian business to conduct research and development in Canada that will lead to new or improved technologically-advanced products or processes. Businesses with R&D projects that qualify receive a cheque or a tax credit, depending on their structure and profitability. B.C. also provides a cheque or tax credit, but relies on CRA to administer its program. This program is the largest single source of federal funding for Canadian industrial R&D, serving about 11,000 claimants each year and providing about $2 billion in tax credits.

Qualifying projects must advance the understanding of scientific relations or technologies, address scientific or technological uncertainty, and incorporate a systematic investigation by qualified personnel. Projects may include:

Basic research to advance scientific knowledge generally - such as developing an optical source that emits photons in a coherent beam.
Applied research to advance scientific knowledge for a specific practical application - such as building a laser gun.
Experimental development to achieve technological advancement for the creation of or improvements to materials, devices, products, or processes - such as calibrating a laser gun to cut through piles of cloth without burning the cloth.

The following activities may not be claimed:

Activities involving social science and humanities research, or natural resource production.
Commercial production or style changes.
Market research or sales promotion.
Quality control, routine testing, or routine data collection.
Development based solely on design or routine engineering practice.

CRA administers the SR&ED program, and the Department of Finance is responsible for the legislation that governs it. For B.C., the program is coordinated through the tax services office in Vancouver. More details of the program are available through CRA's SR&ED website, from which this overview has been summarized: http://www.cra-arc.gc.ca/taxcredit/sred. The following sections describe:
1.   Project Requirements
2.   Cash and Tax Credit Benefits
3.   Filing Requirements and Deadlines

A more informal and less detailed summary can be obtained by reading an article that Nick Arden was invited to write for a client’s website. Click here for an article on SR&ED.

PROJECT REQUIREMENTS

For a project to qualify for SR&ED tax credits, it must satisfy all three of the following major criteria:

Technological Advancement or Something New Must Be Learned
The project must involve an attempt to advance the understanding of scientific relations or technologies. (Failure is in itself regarded as a Technological Advancement.) This means finding a method of achieving something that either has never been done before (as demonstrated by internet searches of applicable knowledge databases) or has been achieved by someone who has kept the method proprietary. A Technological Advancement also occurs if there are significantly different methods of achieving something, and the best method, according to the desired specifications or cost targets, is uncertain.
Technological Uncertainty or The Project May Fail
The Technological Advancement cannot be achieved by the application of an established process or methodology. There must be uncertainty whether or not the Technological Advancement can be achieved. (In recognition of the different levels of in-house expertise, the conventional test of uncertainty is applied to a professional skilled in the particular field.) In most cases, uncertainty can be demonstrated if there is no documented way of doing it, no one has been known to have done it, and there is a significant possibility that the attempt to do it will fail. Alternatively, uncertainty may exist only in the selection of which of a number of different methodologies is a feasible option.
Technical Content or a Scientific Method Was Applied
The attempt to achieve the advancement must involve the elements of a formal scientific experiment, i.e. a systematic investigation going from hypothesis formulation, through testing by experimentation or analysis, to the statement of logical conclusions. Such experimentation can include work on the evolution of prototypes or models. (Trial and error is specifically unacceptable.)

There are two additional criteria:

Qualified Personnel
The staff and sub-contractors working on the project must be suitably qualified for the functions they perform. For example, those responsible for designing the possible solutions must have relevant experience, while those implementing the solutions need less experience, and those testing requiring the least experience.
Documentation
There needs to be evidence that the work claimed for the project actually occurred. For large companies with well-established project management, this is rarely a problem. For small companies with no formal procedures, providing documentation of the process (rather than just of the end result) is often a challenge. There is no requirement for any formal documentation - scraps of paper will suffice! For first time claimants, CRA is usually flexible but does require some evidence.

Software projects are typically the most challenging to define correctly, as the boundary between standard software development and experimental software development is difficult (if not impossible) to identify precisely. There is a detailed discussion in Section 6 'Criteria for Identifying Eligible Activities in Computer Science and Associated Technologies' of: IC86-4R3 which is a CRA Information Circular dated May 24, 1994.

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CASH AND TAX CREDIT BENEFITS

Companies can apply for SR&ED investment tax credits for expenditures such as wages, materials, machinery, equipment, some overhead, and subcontractors. There are complex rules relating to these expenditures, and optional ways in which overhead may be claimed. There are different Investment Tax Credits ('ITCs') offered for qualified expenditures for SR&ED carried out in Canada to Canadian-Controlled Private Corporations ('CCPCs'), and to other Canadian corporations, proprietorships, partnerships, and trusts. The breakdown is:

	Federal ITC	BC ITC	Total ITC (See Table Below)
CCPCs	35% for the 1st $2 million + 20% on the rest	10%	28% to 41.5%
Others	20%	10%	28%

Federal ITC	Formula (B.C. ITC is deducted before applying Federal ITC and then added back in)	Total ITC
35%	= 35% x (100% x Claim$ - 10% x Claim$) + 10% x Claim$	41.5%
20%	= 20% x (100% x Claim$ - 10% x Claim$) + 10% x Claim$	28.0%

A CCPC, with taxable income in the immediately preceding year that does not exceed the small business limit, will receive the maximum total ITC of 41.5% as a cash refund, net of any taxes payable. For taxable income above the small business limit, the federal ITC% will be prorated from 35% to 20%, with 20% applied to double the small business limit. Proprietorships, partnerships, and some trusts receive 20% as a cash refund. Other Canadian corporations, including publicly traded companies, receive a tax credit.

CRA has published service standards for processing SR&ED claims:

For cash refunds when the claim is filed with the Corporation Tax Return, the standard is 4 months.
For cash refunds when the claim is filed as an amendment to the Corporation Tax Return, the standard is 8 months.
For tax credits, the standard is 12 months.

CRA claims a greater than 90% compliance with these service standards. CRA has introduced a fast tracking system by which claims are reviewed at their Processing Centre and, if they meet certain unspecified criteria, the refund cheques can be received within a few weeks.

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FILING REQUIREMENTS AND DEADLINES

Filing an SR&ED claim involves completing Form T661 'Claim for Scientific Research and Experimental Development (SR&ED) in Canada'. In addition, a corporation is required to complete Schedule T2SCH31 'Investment Tax Credit - Corporations', and an individual is required to complete Form T2038(IND) 'Investment Tax Credit (Individuals)'.

Claims should be submitted with a T2 corporation or a T1 individual income tax return, within 12 months of the income tax return's filing due date for the year in which the SR&ED expenditures were incurred. This means that the filing deadlines for corporations is 18 months, and for individuals is 17 1/2 months. Late filing is not permitted, even under special circumstances.

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Last Update: 08/22/2008