Tax Traps & Tips: SR&ED Credits Now More Accessible
Beyond Numbers · April 2009
By Steve Youn, CGA, and Joanne Hausch, CA
The Scientific Research & Experimental Development (SR&ED) program is a federal tax incentive program that currently provides tax credits of nearly $4 billion a year to approximately 18,000 taxpayers who perform research and development in Canada. Recent changes to the program, resulting from discussions between the Department of Finance and the CRA, have made the program more effective for Canadian businesses—particularly small, Canadian-controlled private corporations (CCPCs).
Expenditure limit increases
The federal income tax incentives for SR&ED include an immediate deduction for all qualifying SR&ED expenditures, as well as investment tax credits (ITCs) on these expenditures. These ITCs either reduce taxes payable dollar for dollar or, for certain corporations, provide a cash refund. ITCs are earned at a basic rate of 20%, with an additional 15% for CCPCs that meet certain thresholds for taxable income and taxable capital. There is an additional 10% provincial credit available in BC.
As part of the recent changes to the SR&ED program, the Department of Finance instituted the following increases to the thresholds governing refundable ITCs for taxation years that end after February 25, 2008:
- The expenditure limit increased from $2,000,000 to $3,000,000. The net effect of this change is to increase the maximum annual refund from $700,000 to $1,050,000 for qualifying CCPCs.
- The upper limit for taxable income increased from $600,000 to $700,000.
- The upper limit for taxable capital increased from $15 million to $50 million.
Whereas the taxable income limit (which was tied to the annual business limit) had been increasing prior to the recent changes, the expenditure and taxable capital limits had remained fixed since the introduction of the SR&ED program in 1985. The recent changes to the program, which give small and medium-sized CCPCs greater
access to refundable ITCs, were long awaited, and many CCPCs will now welcome the influx of refundable ITCs to fund ongoing research and development.
However, despite requests to the Department of Finance to increase access to refundable credits, the 2009 budget did not offer additional benefits for large or publicly held entities.
SR&ED activities carried on outside of Canada
The rules regarding foreign SR&ED activities are very restrictive. In the past, foreign expenditures for labour did not qualify for the benefits awarded for Canadian work, and these rules were confirmed by the courts in several cases and appeals. However, there is now limited relief for employees of Canadian corporations who conduct SR&ED work outside of Canada that supports eligible SR&ED projects carried on within Canada.
For example, an engineer working on a Canadian SR&ED project may be required to collect data at a foreign site. Pursuant to the recent changes, the salary and wages related to the engineer’s time outside of Canada may now be included in the calculation of qualified expenditures, provided the work on foreign soil was conducted solely in support of SR&ED carried on in Canada by the employer. However, as described in new paragraph 37(9)(b) of the Income Tax Act (ITA), the salaries and wages claimed cannot exceed 10% of the total Canadian SR&ED salaries and wages claimed in that year, and remuneration based on profits or bonuses or wages subject to foreign tax are not eligible.
New ITA subsections 37(1.4) and (1.5) are effective for expenditures dated after February 25, 2008, and apply to the salaries and wages of a claimant’s employees, including specified employees. Payments made to subcontractors and other amounts that are not classified as T4 salary and wages are not eligible for ITCs because this kind of work is not “directly undertaken” by the taxpayer.
Alberta refundable tax credits
Another welcome change to the SR&ED program was the introduction of a new provincial credit in Alberta. For taxation years ending after December 31, 2008, Alberta taxpayers are entitled to a 10% refundable credit on up to $4 million per year of SR&ED eligible expenditures in that province. As with the federal expenditure limit, the $4,000,000 Alberta expenditure limit must be shared among all associated corporations in a group. However, the Alberta expenditure limit is not reduced by either the taxable income or taxable capital of the corporations in the associated group. This means that the refunds are available to all companies carrying on SR&ED in Alberta, including large public companies.
To be allowable, expenditures must be incurred in Alberta; these expenditures include salary and wages, materials, capital, contract payments, lease costs, and qualifying third-party payments. The election to use either the traditional or proxy method for overhead must be the same for both the Alberta and federal claims.
New Form T661
The CRA released a new version of Form T661 (Claim for SR&ED) in November 2008 to simplify the filing requirements for all SR&ED claimants—particularly small businesses. The new form, which applies to all fiscal years ending on or after January 1, 2009, is a “prescribed form” for all taxpayers; this means claimants must ensure that they use and complete the correct form to avoid their claims being denied.
E-filing and the requirement to file for all projects
The new version of Form T661 introduces the concept of e-filing project descriptions. Prior to the introduction of the new form, taxpayers who filed their tax returns through the CRA’s e-filing system were still required to file technical project descriptions separately. This essentially made the e-filing process somewhat inefficient. As the new version of Form T661 directly incorporates the technical descriptions within the form, claims filed through the e-filing system should now be assessed more quickly, as no separate manual submission is required. Of course, all SR&ED claims may be reviewed by the CRA—this has not changed.
While the new form is a benefit for taxpayers who opt to e-file, there is another major change to consider. Under the previous policy, taxpayers only needed to submit project descriptions for their 20 largest projects; this reduced the amount of information that had to be submitted, although all other projects were open to review if requested by the CRA. Under the new policy, however, companies must file a project description in the prescribed form for every project claimed in the year. This signals reporting changes for companies that undertake numerous projects; these companies may also need to adapt their claiming systems to ensure that they retain detailed technical and financial information in the required format.
Limiting the number of words
The new version of Form T661 limits the number of allowable words for technical descriptions; a maximum of 350 words is permitted for each of the technological advancement and technological uncertainty sections, and a maximum of 700 words is permitted for the description of work section. As the form is now prescribed, no
exception will be made for larger or more complex projects. Due to the restriction on the number of words for the project descriptions, claimants must describe eligibility clearly and concisely, and must retain supporting documentation for the work performed in the event of a subsequent CRA review.
New format and instructions
To clarify the requirements, the line descriptions on Form T661 have been reworded using plain language. Legislative and policy references have been removed. Emphasis on understanding the CRA requirements of the SR&ED program has been incorporated into the form, and taxpayers must now complete a checklist of prescribed information.
The filing deadline for SR&ED claims is 18 months after the end of the taxation year. Claimants must file a complete claim on or before that deadline, as no appeals or extensions are permitted under the law. Therefore, it is critical to ensure that claims filed under the new format are completed, meeting all of the new requirements regarding prescribed information. Improperly filed or incomplete claims will be rejected.
The recent changes to the SR&ED program should help ensure that the program continues to be an important source of funding for Canadian businesses, particularly small CCPCs seeking cash to fund their development activities.
Steve Youn, CGA, is a tax manager with Deloitte & Touche LLP in Vancouver. Joanne Hausch, CA, is an associate partner with Deloitte & Touche LLP in Vancouver, where she leads the firm’s SR&ED practice in British Columbia.