The federal and provincial governments use the SR&ED tax incentive to encourage innovation by a wide range of companies
Available to businesses of all sizes, these much-misunderstood innovation incentives can deliver big financial benefits
As economic chaos breeds consolidation, COVID-19 has forced many businesses to shelve their formal research and development work. So the fact that, since the pandemic began, I’ve seen twice as many companies as usual seeking innovation-related tax relief for the first time is perhaps a little counterintuitive.
But that’s exactly what’s playing out right now in B.C., where my tax consulting firm is based. In times of trouble, small and medium-sized enterprises redouble their efforts to ensure they’re claiming all the tax benefits owed to them.
The Scientific Research & Experimental Development (SR&ED) tax incentive happens to be one of the most underclaimed. That’s because SR&ED is widely misunderstood, and it’s common for businesses to be wrongly told by tax consultants and accountants that they aren’t eligible. The tragedy is that over the next 12 months, many companies will go out of business without realizing they were owed tens, maybe hundreds, of thousands of dollars.
So, what is SR&ED?
SR&ED tax credits let companies claim back 35 percent of qualifying R&D expenditures, up to a maximum of $3 million in each tax year, and 15 percent for expenses above that amount. They can take a cash payment or use the claim to offset outstanding taxes.
SR&ED claims are usually split in two because there’s a federal and a provincial component. The 35-percent rate applies to the federal investment tax credit (ITC), while in B.C., the provincial program offers an ITC of 10 percent.
The claims are calculated by working out the provincial component first. B.C. ITC is regarded as government assistance, so it’s offset against the overall qualified costs, resulting in a reduction of the amount that attracts 35-percent relief. The local rate varies between provinces, but SR&ED will typically return about 41.5 percent of a qualifying project’s R&D costs to a business, so it can be extremely beneficial.
For example, if a B.C. company has $1 million in eligible R&D expenses, the 10-percent provincial ITC of $100,000 leaves $900,000 covered by the federal program. At the 35-percent rate, the federal credit is $315,000. Total ITCs: $415,000.
SR&ED, which the federal and provincial governments use to encourage innovation in companies of all sizes, is chronically underused by small and medium-sized businesses. This strikes at the heart of one of the big misconceptions about SR&ED. It isn’t just for larger firms carrying out stereotypical examples of R&D such as pharmaceuticals development or aerospace research.
What kind of work qualifies?
The official definition sounds intimidating. SR&ED is any work that involves “systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis.” A wide variety of work at all kinds of companies qualifies. Crucially, SR&ED covers experimental development of technology that creates or improves materials, devices, products and processes.
To qualify for SR&ED ITCs, a business has to meet three basic criteria. It must:
- Further technical knowledge or create advancement in their industry
- Overcome scientific or technological uncertainties
- Do something by design that other businesses would find hard or not obvious
What costs are eligible?
Most expenses associated with R&D qualify for SR&ED, including staff costs, salaries, payments to contractors and third parties, and materials.
How do I make a claim?
A company must claim SR&ED within 18 months of its business tax year end. This means firms looking to make a claim now could use work done more than two years ago.
You or your accountant can claim SR&ED using the T661 form. Claims can be complex, and many companies and their accountants use consultants to squeeze the maximum value out of them.
The timing couldn’t be better for SMEs that have never claimed before because the program has become a lot more favourable for them in the past two years.
A good year to apply
For SMEs, eligibility for federal SR&ED ITC used to be partly judged on a company’s taxable income from the previous tax year, which could reduce the overall benefit, but that rule was abolished for tax years ending after March 18, 2019. This is important because many more SMEs with inconsistent income will find it easier claim the incentive.
SR&ED is not to be confused with the Industrial Research Assistance Program (IRAP), which offers government-funded grants rather than a tax benefit. SR&ED can deliver a significant, immediate cash-flow benefit and you can claim it retrospect, whereas IRAP grants are for planned work.