Tax credits for the innovator
By Christine Hykamp and Richard Weber
What you’ll need to know to cash in on your creativity.
By Christine Hykamp and Richard Weber
Are your margins under pressure?
Are your margins under pressure? Consider your eligibility for SR&ED tax credits. The Scientific Research and Experimental Development (SR&ED) program allows qualifying companies to receive money back in the form of a refund, a reduction in taxes payable, or both.
Canada Revenue Agency’s (CRA’s) SR&ED program provides a valuable tax incentive to companies for eligible expenditures related to the pursuits of a technological advance. Did you know that advancements in your business that result in increased efficiency, reduced waste or new and improved products may be eligible for SR&ED tax credits?
Often this program is underutilized in the ground water drilling and geothermal industries because of the misconception that the technology already exists. For example, SR&ED tax credits were successfully claimed by an Ontario firm who integrated various green technologies into an advanced thermal closed loop system. A few Atlantic Canada companies have advanced technology using coastal aquifers to improve efficiencies of thermal heating and cooling. A key point in each was that the solution was based on analysis, developing a test system and collecting data to determine how to further improve the system. Although there is a strong technological base in the ground water drilling and geothermal industries, it is important to recognize that when traditional design and equipment fails to function or functions with less efficiency than calculated you may have a starting point for an eligible SR&ED project. Another roadblock to the program is the lack of widespread knowledge in how to set up and conduct an eligible SR&ED project.
In very general terms, the federal SR&ED tax credit is 35 per cent of eligible SR&ED expenditures for qualifying small and medium-sized private Canadian companies. The credit may also be refundable.
Refundable credits are either applied against taxes otherwise payable or refunded to the taxpayer when the credit is greater than the tax liability for the year. For larger companies, the federal SR&ED tax credit may be reduced to 20 per cent of eligible SR&ED expenditures and is non-refundable. Non-refundable credits are applied against taxes otherwise payable or they carry forward and can be applied against income taxes in future years (or also carried back) if the SR&ED tax credit is greater than the tax liability for the year.
Most provinces and territories have SR&ED tax credits as well. For example, in Ontario the SR&ED tax credit is generally 10 per cent of eligible SR&ED expenditures for qualifying companies and the credit is refundable. Nova Scotia, New Brunswick, Newfoundland and Labrador have a 15 per cent refundable credit. Refundable credits range from 15 per cent in the Yukon, Saskatchewan, 10 per cent in Alberta and 10 per cent non-refundable credit in British Columbia.
Evaluating whether to pursue SR&ED tax claims
To determine if a SR&ED claim makes sense for your business you need to answer the following questions.
Do you have eligible work? If you are systematically conducting experiments and analysis that involves engineering, design, mathematical analysis, computer programming, data collection and testing in a lab by computer simulations or in the field in order to overcome technological obstacles that you, your suppliers, your customers and the industry at large cannot resolve, then you are likely performing SR&ED. Similarly, if the path to new and improved products or more efficient or environmentally friendly processes is not routine or straightforward, start the clock and keep track of related expenditures.
Do you have eligible expenditures attributable to the technological advance? All labour, materials consumed (or transformed) and contract costs for eligible services that are directly attributable to the SR&ED project can be claimed. A common disappointment with smaller companies can occur if the owner/operator contributes time to the SR&ED work but does not take a salary from the corporation. Labour costs need to be from T4’d employees or eligible contract expenditures. Most claims take advantage of the proxy method in which 65 per cent of the claim labour costs are also added to compensate for overheads. You may have some capital expenditures in order to perform your SR&ED; however these must be fully dedicated or greater than 50 per cent in use for SR&ED and you need to be able to prove there is no cross-utilization by your regular operations.
Do you have acceptable documentation to substantiate your expenditures? The CRA expects that you will have a time log or time sheets for each person on each of the projects claimed. Several manual and electronic solutions exist so ask your advisor for any and all tools they may have. Materials consumed must be substantiated by invoices dated within the fiscal period of the claim. Contract expenditures must be from Canadian suppliers and supported by invoices detailing the eligible service and acknowledging that the SR&ED and Intellectual Property acquired from the work belongs to you. It is important to note that the contract expenditure is claimed in the fiscal year in which the service is delivered, not necessarily paid for. Capital purchases have several rules; the most important is it must be new equipment.
The CRA expects that you will have dated documentation and evidence . Items such as project planning documents, design of experiments, project records and notebooks, records of trial runs, minutes of meetings, test protocols, test data and analysis of test results would be valuable. Evidence such as photographs, videos, samples, prototypes and scrap needs to be dated and initialled at the time it is created. A full listing of acceptable supporting evidence can be found in the CRA’s T661 Guide to SR&ED.
If you wish to conduct and claim SR&ED, identify at least one technical resource and a costing resource and have them trained so that the SR&ED projects are proactively planned (where possible!) and expenditures are continuously tracked throughout the year. Organizing an SR&ED team and detailing the project status at regular intervals during the fiscal year will result in a solid, supportable claim generating a tax credit that you can perhaps roll right back into making the next technological advance.
Christine Hykamp, P. Eng., M.Sc. Eng., is senior engineer, SR&ED Services at Business Improvement Group, Inc. Richard Weber, CA, is tax principal at Fuller Landau LLP. If you would like to learn more about SR&ED, contact the Business Improvement Group at 1-877-541-5551 or Fuller Landau at 416-645-6500 to arrange a no-charge on-site visit to determine your SR&ED eligibility.