Introduced in the 1980s, the Scientific Research & Experimental Development (SRED) is a federal tax incentive program administered by the Canada Revenue Agency (CRA), which issues over $6 billion in tax credits annually for qualified research and development work. The government of Canada supports innovation and entrepreneurship through this program.
What is SRED in Canada?
SRED (or SR&ED) refers to the Canadian Government's "Scientific Research and Experimental Development" program. It is a generous incentive program that encourages and rewards businesses of all sizes and in all sectors for conducting research and development to create new or improve existing products, processes, principles, methodologies, or materials in Canada.
While many other countries have similar programs, Canada’s SRED program is one of the most lucrative tax-incentive programs for businesses performing research and development.
What Is The Idea Behind Introducing the SRED program?
The purpose of the SRED program is to deliver SRED tax incentives in a timely, consistent, and predictable manner while encouraging businesses to prepare their claims in compliance with tax laws, policies, and procedures.
CRA is persistently seeking new ways to enhance and simplify its service delivery. The program commitments are to:
- Ensure that businesses are aware of the program and can access it as conveniently as possible.
- Administer the program with fiscal integrity by applying the legislation correctly, consistently, and fairly, and ensuring that claimants receive the full amount to which they are entitled.
What Businesses are Eligible Applicants for SRED Program?
The SRED program is available to any business conducting research and development in Canada. Certain expenditures for SRED performed outside Canada are also eligible.
Any business that is involved in basic or applied research, or advancing technology to improve or develop new materials, devices, products, or processes may be eligible under the SRED program.
The businesses that are eligible applicants under the SRED program fall into three groups:
- Canadian-controlled private corporations
- Other corporations and
- Proprietorships, partnerships, and trusts.
SRED Program Benefits
Invest in research and development in Canada: It Pays Off! The SRED program can provide both financial and non-financial benefits.
- Eligible companies can recover up to 70% of qualifying expenditures in refundable or non-refundable investment tax credits (ITCs), depending on the province they are in.
- Unused ITCs may be carried back three years or carried forward 20 years if they were earned in tax years ending after 1997 (carried forward ten years if they were earned in tax years ending before 1998)
- Most Canadian provinces offer additional tax credits on qualified SRED expenditures. Depending on the province, SRED claimants can earn additional provincial SRED tax credits.
- It will help to fund the scientific and technological advances that keep your business competitive.
- You can better position your business for future SRED projects.
- You may be able to deduct SRED expenditures to reduce your tax liability in the current year or carry these expenditures forward indefinitely to minimize your tax liability in future years.
What Are SRED Tax Credits?
The Scientific Research and Experimental Development Tax Credits are provided under Section 42 of the Income Tax Act, 2000.
SRED Tax Credits, administered by the Canada Revenue Agency (CRA) and supplemented by the provinces provide compensation to businesses for conducting research and development work in Canada.
These tax incentives come in two forms:
- Income tax deduction
- Investment tax credit, which may be applied against income taxes payable in the current year, in a prior year, or may carry forward to a future year. In some cases, the credit may be refundable.
How to Claim SRED Tax Credits?
SRED credits come in the form of refundable and non-refundable tax credits on expenditures for scientific R&D. To apply, you must complete Form T66, Scientific Research, and Experimental Development
Expenditures Claim. This form will help you prepare the technical reports that will be required to substantiate your SRED claim. While submitting Form T661, you must submit your other federal forms with your income tax return. There may also be provincial forms too.
One of the following two forms must be submitted:
- Form T2SCH31, Investment Tax Credit – corporations.
- Form T2038. Investment Tax Credit – individuals.
Overall, your return forms must satisfy the following criteria:
- Technological Uncertainties
- Technological Advancements
- Scientific or Technical Content
- Proof of documentation supporting your SR&ED claim activities.
If the SRED schedules and forms are incorrectly completed, the CRA may deny your claim. This error is one of the leading reasons SRED claims are denied; therefore, it is important you work with an accounting firm that is well-versed in this area.
Types of Work That Qualify for SRED Tax Credits?
The work must fall into one of the following categories to qualify for SRED tax credits:
- Basic research: work undertaken for the advancement of scientific knowledge without a specific practical application; and
- Applied research: work undertaken for the advancement of scientific knowledge with a specific practical application; and
- Experimental development: work was undertaken to achieve technological advancement to create new, or improving existing, materials, devices, products, or processes, including incremental improvements; or
- Support work: engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, and psychological research.
What Are the Eligibility Requirements for SRED Tax Credit?
Canadian individuals, businesses of all sizes, corporations, and others can qualify for the SRED. If you have developed a new product or improved an existing product, you might qualify as well!
In determining eligibility, you need to address why was the work undertaken (for the purpose of achieving a scientific or technological advancement) and how was the work conducted (systematic investigation or research carried out utilizing experiment analysis).
- Why Was the Work Undertaken?
Technological Advancement– The work must attempt to increase the technology base or level from where it was at the start of the research. The technology base or level includes all the technological resources within the business and all the knowledge on the technology that is reasonably available in the public domain. A key criterion is that there must be technological uncertainty involved in the SRED project being claimed. This means that there is no obvious solution to the problem you are attempting to solve, and a solution is not readily available through normal investigation.
Scientific Advancement– A research must be carried out to generate new scientific information or understanding of scientific relations.
- How Was the Work Conducted?
For a project to be considered SRED eligible, a systematic investigation must be performed to resolve the technological uncertainties.
Most SRED eligible projects hit "Roadblocks" or hurdles that cannot be easily overcome. Your company may attempt several different approaches before arriving at an acceptable solution. Random attempts at a solution do not qualify as SRED since random techniques are generally not systematic. Instead, the results from a failed approach should be used to help determine the next solution to be attempted. That is, by applying knowledge gained in a previous attempt at a solution you can usually choose a new course that has the greatest likelihood of a positive outcome.
This would include identifying the obstacle, formulating an objective, developing a plan of action including the method of experimentation or analysis, and testing the hypothesis. This all research must be carried out in the field of science and technology.
What Expenditures are SRED Eligible?
You may claim many of the expenditures incurred for SRED during your fiscal year. The following kinds of expenditure are eligible under the SR&ED:
- Salary or wages
- Contractor costs
- Materials consumed or transformed
- Lease costs of equipment
- Overheads
How is SRED Tax Credit Calculated?
Your investment tax credit could be at the low end of 15%, potentially, as high as 35% of your qualified SRED expenditures based on the eligible R&D your business is conducting.
Several other factors go into calculating your SRED tax credit, including the type of expenses incurred and the amount of time spent on the project.
You have two calculation methods at your disposal:
- Traditional Method
The traditional method will require you to itemize your overhead and related expenditures.
- Proxy Method
The proxy method involves calculating a substitute amount for overhead expenditures using a formula, rather than specifically identifying, and allocating these expenditures as you would with the traditional method.
How CRA Determines If a Business Qualifies for SRED Claim?
The CRA will assign technology advisors and financial reviewers to examine your SRED claim.
The technology advisors will assess whether your project qualifies under the SR&ED and the financial reviewer will look to see if the costs you claimed for the work are allowable.
You may also get a visit by the CRA reviewers, who will then speak to your technical and financial staff and review your documentation and other supporting evidence.
Does SRED Tax Credit Only Apply to Certain Industries?
SRED tax credits are not restricted to certain industries. However, some industries are generally likelier to qualify for the credit, such as:
- Natural and formal sciences, including physics and chemical studies
- Engineering and technology development, including civil and mechanical engineering
- Medical and health sciences, including basic medicine and clinical medicine
- Agricultural sciences, including animal science, dairy science, and biotechnology
- Software development, including software startups.
What is the Timeline to File SRED Tax Credit Claim?
To apply for SRED tax incentives, you must file the applicable prescribed forms by your reporting deadline. Your deadline will depend on your tax filing type.
- Individuals with a Business Tax Filing: you have 17.5 months from the calendar year-end. So based on December 31, 2020, you have until June 15, 2022.
- Corporate Tax Filings: you have 18 months from when your year ends. For example, if your year ends on June 30, 2020, then you have until December 31, 2021, to file.
- Trust Tax Filings: you have 15 months from where your year ends. If your year ends on June 30, 2020, you have until September 30, 2021.
If your deadline falls on a weekend or statutory holiday, it will be pushed to the following business day.
If you do not report an expenditure or project on the prescribed forms by the reporting deadline. You will not be able to include the amounts in your pool of deductible SRED expenditures to be used to reduce your income, and you will not be able to earn ITCs on these expenditures.
What Happens After SRED Claim is Filed?
When a SRED claim is filed CRA then determines if it can be processed as filed without further review. If the CRA will process the claim that was filed, it will reduce your taxes payable or, if applicable, issue a cheque to you. If CRA decides not to process the SRED claim filed, it may contact the applicant to request more information or to discuss the review of the claim.
If a claim is qualified for a refund, it may be processed within 120-180 days after the CRA receives it. This applies in situations where a complete claim has been filed and the applicant responded to any CRA requests for additional information.
Work Not Eligible for Benefits Under SRED Program
- Market research or sales promotion
- Quality control routine testing of materials, devices, products, or processes
- Research in social sciences or humanities
- Prospecting, exploring, or drilling for, or producing minerals, petroleum, or natural gas
- Commercial production of new or improved material, device, or product or the commercial use of a new or improved process
- Style changes
- Routine data collection
Filing Taxes Can Handle Your SRED Claims for You
Given our technical background and SR&ED experience, we can translate your work into a format understood by the CRA and are able to prepare the claim with minimal time commitment from your end.
In the event of an SR&ED review by the CRA, we defend you in the process and help ensure your claim is successful.
Filing Taxes offers clients a complete host of SRED services that are designed to generate the highest possible tax credits and refunds
Every client engagement is given the same attention; whether you want to engage us to handle your entire claim on a contingency basis, you want us to review and provide feedback on a claim you’ve prepared internally, or you want to engage us on a fixed-cost or hourly basis.
For more information or to find out how we can help your business access the SRED tax credit and other grants, and incentives feel free to reach out to Filing Taxes at 416-479-8532. Schedule an NTR engagement appointment with us and take the first step towards proper management of your finances.