1 - Basics
- SR&ED stands for Scientific Research and Experimental Development. It is often pronounced “shred.”
- Scientific Research means a systematic investigation or search by means of experimentation in the field of science to gain new scientific knowledge. This covers basic research (advancement of scientific knowledge with no specific practical application being sought) and applied research which usually advances the findings of basic research to apply science to a specific problem. Scientific research is a rarity in business, usually carried out by very large companies, research organizations and universities.
- Most clients perform Experimental Development. This can be defined as advancing the understanding of basic or applied research, applying it to the improvement of existing materials, devices, products or processes. It can also be seen as the incremental advancement of knowledge to resolve a specific technological obstacle.
- Most clients encounter SR&ED when they face a problem that cannot be solved simply by applying known techniques, and they have to systematically experiment to find a solution, where the approach, timeline and/or success are uncertain.
These two words, “technology” and “technological” sound almost the same yet they are ever so different in the SR&ED program!
The easiest way to understand technology is to think of it as using existing knowledge and while you may manipulate what it does, you don’t manipulate how it works. This is not really SR&ED.
For example, you buy some equipment (someone else’s technology) and then set it up. Perhaps the setup was not obvious for your application and you have to fiddle with it, but in the end you learned nothing more than how to set up the equipment for your particular needs.
Technological, on the other hand, is really getting into the guts of a technique or mechanism, understanding how it works, its limitations, and trying to manipulate how it works so that you get what you want. You experiment with different approaches, see why they fail, and in so doing, understand the problem and mechanisms better so that you can offer new ways of doing things. Now you have created new knowledge.
For example, after fiddling with the new equipment you have purchased, you find that it is not capable of meeting your requirements, but you think you may be able to modify it to work differently. You try different modifications, and develop a new or modified mechanism that eventually meets your needs. That sounds a lot like SR&ED.
Once you can show some technological involvement, there is almost always technical involvement that can be claimed in association with the technological activities as support work.
- A joint SR&ED filing is when schedule T661, which describes the SR&ED projects, is included as part of the original corporate T2 tax filing. This must be done within 6 months of the corporate financial year end, the filing deadline for the T2.
- An amended filing is when the T661 is filed separately, after the T2 has already been filed. The filing deadline is 18 months from the corporate financial year end.
- A joint filing is much preferred because you get paid much more quickly, and industry experience shows that the chance of an audit is reduced.
2 - Eligibility
- There is a close correlation between patentable work and SR&ED-worthy work. A patent protects the solution to a problem from being exploited by others, where as SR&ED helps to offset the cost of everything that was tried and failed in order to reach the solution to a problem.
- SR&ED claims and patents have some commonalities and many differences. Both patents and SR&ED must cover new technical ground. A patent must be novel, useful and non-obvious; SR&ED must raise the base technology over what is available in the public domain and within the corporation. The work done to advance technology (and which may possibly be patentable) is generally SR&ED-eligible. Unlike a patent, which must be unique, SR&ED could cover the same ground as a competitor providing the competitor or other entity has not made their advances known to the SR&ED filer directly or via the public domain.
Yes, if you perform SR&ED-eligible work, but fail to solve the problem or choose not to pursue the project for business reasons, you can still claim it.
The subject of qualifying expenses can be quite nuanced but here are the basics. You can claim expenses that were expended to perform experimentation, including wages, contractors and materials. Staff and contractors must be in Canada, materials can come from outside Canada. If an employee spends half a year experimenting on the SR&ED project, you can claim half their wages. If a contractor was hired to build a prototype, you can claim that too. If materials were transformed or consumed in the experiment, you can claim the materials.
You can claim support activities including the following
- Operations research
- Mathematical analysis
- Computer programming
- Data collection
- Testing or psychological research
This has to be directly related to the SR&ED work itself, so it is vital that support work is properly understood and applied. It isn’t hard to get confused about such items as data collection, which cannot be claimed if it is routine work.
There are certain activities, such as contracting out welding and electrical work that may be claimed, but it is nuanced and generally cannot be claimed as part of the proxy method.
You can no longer claim capital expenses associated with SR&ED. For example you can’t claim the computers you bought for your software developers and engineers who are conducting SR&ED (you used to be able to but that ended in 2013).
Here is a list of specific activities you cannot claim:
- Market research or sales promotion
- Quality control or routine testing of materials, devices, products or processes
- Research in the social sciences or the humanities
- Prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas
- The commercial production of a new or improved material, device or product or the commercial use of a new or improved process
- Style changes
- Routine data collection
Some of these are obvious, such as market research, on the other hand, technology to aid the process of market research may well be SR&ED. Others, such as style changes and routine data collection are harder to interpret under some circumstances, which is the reason a SR&ED consultant such as SR&ED Clinic is very helpful to guide you towards claiming all legitimate expenses and staying out of trouble.
3 - Documentation
- Documentation is required in case of an audit, in which case having adequate documentation is crucial to the success of an audit.
- CRA expects “contemporaneous documentation”, meaning it is produced at the time the SR&ED took place, not a week before the audit. Therefore you should produce and collect documentation as you go. Daily is perfect, weekly is acceptable, monthly is pushing it and hard to maintain (but far better than nothing!).
- You can keep documentation in any way that suits your employees and your business process. If you have meetings, please at least date and photograph the white board. Use email to summarize key points as they come up, rather than simply discussing them, executing them and forgetting them. A hand-written, dated, bound notebook can’t be beat; electronic notes are just fine as well. Physical artifacts, if you have them, are great. Remember to affix a date to them, and a written description wouldn’t hurt. Time sheets are much appreciated by CRA, failing that, some sort of documentation to show timeline and level of effort is most helpful; copious emails, meetings in your agenda and dated blue prints, are examples of proxies for time sheets.
- As people are busy, don’t aim for perfect documentation, this is unrealistic for most individuals and typical businesses. Instead, choose a few approaches that are solid and support your business goals and stick to them, week in and week out. Five minutes a week per involved staff can go a long way at audit time and is also very helpful when reviewing your SR&ED activities for the year in advance of writing up the reports and costing the claim.
4 - Refunds
- Processing and issuing time varies widely.
- At one end of the spectrum, a joint filing (SR&ED filed with your T2 tax return within the 6 month year end) can be fast, sometimes as quickly as 1 week, more often it takes a month or two. The CRA service standard is 60 days.
- At the other end of the spectrum, a claim that goes into review can delay payment to 180 days (the CRA service standard) or longer (they only have to meet this 90% of the time, whatever that means).
- Amended filings (SR&ED filed after the T2 tax return has been filed) are more likely to be reviewed, if not officially, then in practitioners’ collective experience.
- The moral of the story: make sure your SR&ED filing is done properly (explains your SR&ED activity in a way that CRA can understand so they are less likely to review your claim) and file jointly with your T2 return.
5 - Audits
- There are two reasons why the CRA may call you about your SR&ED claim. If you are a first time claimant, you will almost certainly get a visit from CRA in what is called an FTCAS – First Time Claimant Advisory Service. This is simply an opportunity for CRA to educate your company about the SR&ED program.
- If the CRA is calling to audit your claim, DON”T PANIC! If you have a claim that is legitimately SR&ED and properly prepared, you should do just fine, although some CRA representatives are problematic and unpredictable. Even if the CRA doesn’t agree with you, you won’t be in trouble although they may want some of their money back.
- Proper preparation is the best defense. Sometimes they want to review your claim because they don’t understand the report, and the audit is a chance to clarify what you did. You also have the opportunity to learn how to best present your SR&ED next time. Sometimes it is just a periodic checkup. If you’ve not been reviewed in 5+ years, CRA may want to check in and touch base.