Complex in detail, daunting to deliver and the occasional target of legal challenges, Canada’s Scientific Research and Experimental Development (SR&ED) program is nonetheless one of the most generous research and development (R&D) tax incentive programs in the world—a fountain of funding so generous that no business can ignore its promise of financial windfall.

Canadian business is fortunate to operate in a nation where governments understand that companies must leverage technology and innovation—not cheap labour or dwindling resources—to remain competitive in the global marketplace. The SR&ED program encourages businesses of all sizes and in all sectors to conduct R&D that will lead to new, improved or technologically advanced products or processes. While the Department of Finance is responsible for developing SR&ED tax policy in general, as well as the fiscal measures that encourage R&D, the program is administered through the Canada Revenue Agency (CRA).

11,000 claimants are issued more than two billion dollars in investment tax credits annually through the SR&ED program. Among them are savvy executives and entrepreneurs who realize that “scientific research” does not necessarily mean white lab coats and bubbling test tubes, or that the CRA definition of “experimental development” is as generous as the program’s incentives: “to achieve technological advancement to create new materials, devices, products, or processes, or improve existing ones.”

Under the CRA definition, certain business activities do not qualify for incentives—but virtually every business sector does. As one of the best-kept secrets of the CRA, the program is not only beneficial to the business sector in general, but beneficial for individual businesses. Potential claimants, however, should take the time to learn the benefits, qualifications and strategies to maximize one’s claim.

Claim Complexities

There are numerous businesses that could claim SR&ED tax credits but do not, because they believe their projects either do not qualify for incentives or the claims process is too complex. Such businesses should seek professional advice—they may be missing out on money—but let’s address some of the typical issues surrounding claims and see if we can simplify the process. For example, how can the structure of a business help optimize a claim?

Both individuals and corporations can apply for SR&ED credits, but for the cost of the legal setup of a corporation, earned credits can be raised by 15 per cent and credit status moved from non-refundable to refundable. Individuals earn at a rate of 20 per cent that is not fully refundable. Comparatively, for a Canadian-controlled private corporation (CCPC) that earns below the business limit for the year in question, the entitlements, on the face, are 35 per cent and refundable. Non-CCPCs also earn credits at a 20 per cent rate and are non-refundable, but the credits can be used to reduce both current and future taxes. There are also yearly spending limits in place to reduce the rate on earned credits when SR&ED qualified expenditures are over $2,000,000 in any year.

It is important to note that all provinces, with the exception of Prince Edward Island and Alberta, offer additional provincial credits that piggyback the federal program. Though the provincial rate and availability of a refund may differ between provinces, the programs are generally similar and usually require little more than an additional tick of the tax form box to accompany the federal form rather than any additional or onerous filing requirements.  As an added bonus, there is generally only one federal audit process with which to deal, thus minimizing the time and trouble spent to earn the credits.

The SR&ED program requires no pre-approval and claimants have 18 months from their fiscal year end to make the claim and identify all expenditures. Identification of a potential claim is critical at the outset, as the 18 month limit is not negotiable; therefore, even if the CRA does not begin the audit until after the 18 month period, no additional expenditures can be identified at that time. 

Does 18 months really mean 18 months? What 18 months are included? The answer is simple: the CRA requires that expenditures for a fiscal period must be identified to the CRA before the end of 18 months after the fiscal year end. This means that for a claimant with a year end of December 31, 2005, all expenditures made for SR&ED from January 1, 2005, until December 31, 2005, must be identified and claimed on prescribed form T661 by June 30, 2007. No exceptions apply and there are no relieving provisions in the Act. The CRA auditor can always reduce your claim after audit past the 18 month limit but there is no mechanism for the CRA to upwardly adjust your claim should you have missed any expenditure. 

In addition, a claim filed on time with the initial filing of a return has the fastest track to earning the credits. The CRA has a three-tiered system for processing claims and thus three service levels for claims. For refundable claims that are filed with their initial T2 the time is 120 days from complete claim receipt. If the same CCPC waits and files an amended claim, the CRA’s mandated time jumps to 240 days. For non-refundable claims, the CRA has 365 days to approve the credit, which does not change whether filing an initial or amended claim.

The best way to ensure you are able to claim your complete entitlement is to be proactive and file your SR&ED forms as part of the yearly tax return. In doing so the basis for a claim is the filing of Form T661 Claim for SR&ED carried out in Canada along with a Schedule 31 Claim for Investment Tax Credits for corporations or T2038 for individuals. An SR&ED filing must always be accompanied by an original or amended tax return, be it a T1, T2 or T3.

Service Standards

While the SR&ED program has received much praise for its contribution to Canadian competitiveness, it has also undergone periodic cycles of significant criticism concerning its administration, primarily for the backlog of its unresolved claims. A number of recommendations have been issued over the years, most notably by the federal auditor general and the federal standing committee on public accounts—chaired by John Williams, CGA and member of Parliament for Edmonton-St. Albert—that have resulted in significant service standard improvements.

The entire SR&ED program was removed from the audit directorate of the CRA and became its own directorate with its own director general. SR&ED program employees received a greater independence as a result, and became more responsible for the direction of the program. The directorate also established sector-specific expertise, a new communications strategy and, most importantly, an informal process for resolving disputes.

Part of the communications strategy was an ongoing SR&ED claimant survey developed to provide feedback on SR&ED service standards by claimants of the program. The latest survey from 2005 suggested that most respondents were satisfied with the program, the staff and the results of their review. However, it was noted that the claimants were less than satisfied with the time it took to complete the review. In addition, many claimants were less than satisfied with the usefulness of CRA SR&ED publications. The final criticism coming from the survey was that only 40 per cent of survey respondents said that the primary SR&ED claim form (T661) was easy to understand. Only 46 per cent stated it was easy to complete.

This is significant. The purpose of the program is to promote R&D through financial assistance, yet claimants report significant difficulties in completing claims. As mentioned, the CRA has a timed service standard, but the clock only starts ticking after a complete claim is received, and the CRA’s definition of a complete claim is one with a complete T661—including both financial data and all project descriptions for which a financial claim has been submitted.

Legal Challenges

The dispute process, although improved, cannot resolve every situation encountered. Take the case of Alcatel Canada, for example, which dates back to 1994 and was not resolved until 2005.

In calculating its 1994 SR&ED expenditures, Newbridge Networks (the predecessor of Alcatel Canada) included the value of stock option benefits derived by those employees who were directly engaged in SR&ED. The value used for calculating the expenditure was the benefit included in the employee’s income per section seven of the Income Tax Act, which was calculated as the difference in market value of the shares on the day the option was exercised and the exercise price.

The CRA denied the inclusion. It contested that the expenditures should not be included, because “in allowing its employees to buy shares for less than market value as contemplated by the option program, [Newbridge] conferred a benefit on them without making any outlay and therefore did so without making any expenditure.”

An appeal was granted to Alcatel (which acquired Newbridge in 2000) because the Tax Court noted that the stock option benefits in question fell within the meaning of salary or wages as defined in section 248 of the Income Tax Act. Indeed, it’s hard to see how salary or wages can flow from employer to employee without expenditure on the part of the employer.

In February 2005 the Tax Court of Canada held that employee stock option benefits, although not deductible for Canadian income tax purposes, were expenditures of the employer that qualified for income tax credits under the Act. The CRA did not appeal, and in November 2005 the minister of finance released a notice of ways and means motion to amend the Income Tax Act, the purpose of which was to clarify that “no expenditure will be considered to have been made by a taxpayer except to the extent of an actual outlay or expense incurred by the taxpayer.” In other words, a limiting of stock options issued or exercised on or after November 17, 2005. Options exercised before that date are eligible.

One of the reasons that the Tax Court allowed Alcatel’s appeal was that the Act must be applied in a way to ensure that the SR&ED remained an incentive program. Given the daunting complexities of administering a multi-billion dollar program with a multitude of claims annually, it is perhaps not surprising that administrative and legal challenges occasionally arise that obscure the mandate of the program: an incentive to keep Canadian businesses competitive in the global marketplace. Nevertheless, the SR&ED program is one of the most generous funding programs in the world, and the opportunity to tap that fountain of funds is one that no business should ignore.

If you’re in the right kind of business, SR&ED tax incentive programs may give you access to money you didn’t know existed

In the midst of the current economic turmoil your business may have access to money you never imagined, in the form of tax credits for research and development you are involved in or contemplating for the future. Complex in detail, Canada’s Scientific Research and Experimental Development (SR&ED) program is nonetheless one of the most generous research and development (R&D) tax incentive programs in the world. In this time of a credit crunch, businesses should be aware of all possible opportunities to self fund.

Canadian businesses are fortunate to operate in a nation where governments understand that companies must leverage technology and innovation to remain competitive in the global marketplace. The SR&ED program encourages businesses of all sizes, and in all sectors, to conduct R&D that will lead to new or improved technologically advanced products and processes. The program is administered through the Canada Revenue Agency (CRA), and claimants who qualify will receive the credits.

An extra benefit befalls Atlantic Canadian businesses operating in New Brunswick, Nova Scotia, and Newfoundland and Labrador where provincial governments offer an additional 15% refundable credit based on the federal program. Though Prince Edward Island has its own R&D incentive programs, they are not directly aligned with the federal SR&ED program and are subject to different rules and regulations.

Last year approximately 18,000 claimants were issued over $4 billion in investment tax credits through the SR&ED program. Among them were savvy executives and entrepreneurs who realize that “scientific research” does not necessarily mean white lab coats and bubbling test tubes, and that the CRA definition of “experimental development” is as generous as the program’s stated intention: “to achieve technological advancement to create new materials, devices, products, or processes, or improve existing ones.”

Under the CRA definition, not all business activities qualify for incentives—but virtually every business sector does. Despite not receiving the wide promotion it deserves, the program has proven not only beneficial for individual businesses, but to the business sector in general. Potential claimants are well advised to take the time to learn the benefits, qualifications, and strategies in order to maximize their claims. A case in point is that claims must be filed with an original or amended tax return within 18 months from the fiscal year-end to which expenditures were made, or be disqualified. No exceptions to this filing date are available.

The tax credits are earned on expenditures related to the project, such as:

•  Wages
• Materials consumed
• Sub-contracted services
• Overheads
• Certain capital items (refundable only at 40%)
  (This is not an all-inclusive list)

For every $100 in qualified expenditures by a claimant who is a Canadian Controlled Private Corporation (CCPC) and operating in either N.B., N.S., or N.L., that company can expect to receive a $15 credit from its province and another $29.75 from the federal government. The credits may be fully refundable subject to income being within the small business limit and providing no offsetting taxes are owed.

For non-CCPCs, the federal rate drops to 20% and is non-refundable. However, the provincial credits remain fully refundable at the 15% rate.

There are other complexities that are associated with the program. One example is the requirement that qualified expenditures be reduced by grants and certain loans arrangements. This will include amounts that the claimant has received, is entitled to receive, or can reasonably be expected to receive in respect of SR&ED performed in the tax year. Each method of assistance must be reviewed to determine if: (i) it applies to the SR&ED project and; (ii) if it is considered assistance or a bona fide loan. Grants and loans that are deemed assistance will serve to offset the amount of SR&ED expenditures that are claimed while a bona fide loan will have no impact on the claim. It is imperative to know what type of funding you have received or have agreed to receive.

With regards to what qualifies as a project; CRA provides the following definition:

SR&ED is a systematic investigation or search carried out in a field of science or technology by means of experiment or analysis. It must be

(a) Basic research
(b) Applied research
(c) Experimental development
(d) Support work for (a) (b) or (c) above.

Qualifying work must be performed in Canada, though as of February 2008, there is an allowance for some work conducted outside of Canada.

Claimants can expect projects to be scrutinized for the presence of:

• A technological advancement
• Overcoming a technological uncertainty
• Completed using a systematic method of analysis by qualified personnel

Claims must be supportable not only with financial backup, including T4s, invoices, and cancelled cheques, but also with technical documentation to show the claimant’s work on the project and how it meets the definition of SR&ED conducted in Canada.

Readers should ask themselves, what are current claimants doing that I am not? If you already use the program, are you sure that you have done, or are doing, everything possible to maximize your claim?

Bill Pitre, Phillip Rafuse, and Craig Mulcahy are principals of Pitre, Rafuse and Mulcahy Inc., a Charlottetown-based consulting firm specializing in SR&ED tax credit claim preparation.

The Conference Board report, which graded Canada on six components (economy, innovation, environment, education, health and society) compared to 16 other major industrialized countries, was released Wednesday.

The research body ranked Canada fourth from the bottom in terms of innovation, saying Canada's "failure to innovate" largely explains "a mediocrity that is hampering what we can do and what we can be."

Fewer scientific articles are published in Canada, fewer patents are granted and even though the government provides subsidies for research and development, the take-up by companies is low, the authors of the report said, calling it a "stunningly poor" showing. It all falls in line with what Conference Board CEO Anne Golden called Canada's "culture of complacency."

"We're not a risk-taking country because of our history, because of our nature, whatever," Golden said. "We just don't have the same drive."

Canada placed 11th out of the 17 countries on the economy, but that also falls short of the country's potential, given its educated workforce and the richness of its natural resources, the blunt assessment said.

"We're not a low-wage economy, we're a high-wage economy. We're never going to be able to compete just on price," Golden said. "We have to compete on innovation, on new technology, on new products, high-level services in unique niches. And we're not doing that." The Conference Board also gave poor marks to Canada for its record on the environment, noting the country has not yet enforced curbs on greenhouse gases and also generates more waste than comparable countries. And when it comes to health care, the report says we're not prepared for the strain that aging baby boomers will place on the system.

Although Canada performed well in education, scoring an "A," the report card said our universities were not turning out enough post-graduate students in the fields of science and technology in fields that boost innovation.