SR&ED Tax Incentive Program
The federal government has a longstanding tax incentive program aimed at promoting the advancement of technology in Canada. Companies making qualified expenditures in connection with Scientific Research and Experimental Development (“SR&ED”) activities within the country are entitled to receive an investment tax credit.
The credit reduces tax payable, but for certain entities the credit is fully refundable where there is no federal tax liability. The refunds assist emerging businesses and others that are not taxable in the year. This federal program is administered by the Canada Revenue Agency (“CRA”). Most provinces offer parallel programs with tax credits for qualifying activities in the particular province.
The 2012 Federal Budget proposed several changes to the SR&ED program which will undoubtedly impact most claimants. Our commentary here has been updated for these changes, however, for a detailed listing of the changes; please see our 2012 Federal Budget Highlights page.
Available Tax Benefits
Qualifying current and capital expenditures (as of January 1, 2014, will no longer be fully deductible in the year purchased, instead will face regular capital asset CCA rates) are fully deductible in computing taxable income. The federal credit rate and the availability of a cash refund are dependent upon the nature of the entity and, in the case of a corporation, its tax status and associated group’s prior year taxable income and prior year taxable capital employed in Canada.
A Canadian-controlled private corporation (“CCPC”) is essentially a private corporation that is not controlled by one or more non-residents of Canada or one or more public corporations or a combination of those parties. A CCPC can earn a federal investment tax credit of 35% on up to $3 million of qualified current expenditures and that credit is 100% refundable.
For current expenditures in excess of the $3 million limit, the credit rate is 20% (changing to 15% starting January 1, 2014 under the new budget) and that credit is 40% refundable. The corporation’s expenditure limit will be eroded on a pro-rata basis by the aggregate of its associated group’s taxable income over the threshold amount ($500,000 in 2011) or the aggregate of its associated group’s taxable capital employed in Canada above the threshold amount ($10 million in 2011). Slightly different rules apply for capital expenditures relating to computers, equipment and machinery used in SR&ED.
A corporation which is not a CCPC will receive a 20% credit (changing to 15% starting January 1, 2014) on all qualifying expenditures. This credit can only be applied to reduce taxes payable and is not refundable. Individuals, partnerships and trusts carrying out qualifying SR&ED activities will also receive a non-refundable 20% credit (changing to 15% starting January 1, 2014).
Provincial tax credits are generally at a lower rate than the federal credit. The combined federal and provincial tax credits range from:
- 35% to 48% for CCPCs
- 20% to 32% for non-CCPCs and non-corporate entities (changing to 15% – 27% starting January 1, 2014)
Federal investment tax credits claimed in a particular year reduce the SR&ED expenses used to compute taxable income in the following year. Provincial tax credits and other government assistance generally reduce the SR&ED expenses in the current year. Provincial tax credits on the proxy amount used to substitute for overhead expenses reduce SR&ED expenses in the following year.
Qualifying Expenditures and Projects
From the CRA’s perspective, the particular project must meet three main criteria to qualify for SR&ED incentives:
- Technological advancement or advancement of scientific knowledge
- Technological uncertainty
- Systematic investigation
Work that qualifies for the SR&ED program specifically includes:
- Basic research where there is no specific practical application in view
- Applied research where there is a specific practical application in view
- Experimental development to achieve technological advancement to create new materials, devices, products, or processes, or improve existing ones
- Support work in engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, or psychological research, but only if the work is commensurate with, and directly supports, the eligible experimental development, or applied or basic research
The following activities are specifically not eligible for benefits under the program:
- Market research or sales promotion
- Quality control or routine testing of materials, devices, products, or processes
- Research in the social sciences (psychology, economics, business, law, history, archaeology, literature, philosophy) and humanities research
- Prospecting, exploring, or drilling for or producing minerals, petroleum, or natural gas
- Commercial production of a new or improved material, device, or product, or the commercial use of a new or improved process
- Style changes to an existing product
- Routine data collection
Expenditures incurred for SR&ED may include wages, materials, contract services (only 80% eligible for SR&ED starting January 1, 2013 under the new budget), equipment lease costs (no longer eligible as of January 1, 2014), third party payments (no longer eligible as of January 1, 2014) and certain capital expenditures. Overhead expenses may be claimed either on a specifically identifiable cost basis or by electing to use the simplified “proxy method” which substitutes the actual overhead expenses with a proxy amount determined by multiplying eligible SR&ED wages by 65% (decreasing to 60% on January 1, 2013 and further to 55% on January 1, 2014).
To learn more about how your company can take advantage of the SR&ED program, please contact us today: