How to Claim the Canadian R&D Tax Credit
Navigate the Canadian SR&ED tax credit program by learning how to define eligible work, track qualifying costs, and follow the correct CRA filing procedures.
The Canadian Scientific Research and Experimental Development (SR&ED) program is a federal tax incentive encouraging businesses to conduct research and development in Canada. It is the largest source of government support for industrial R&D, providing billions in tax credits annually. The program fosters innovation by reducing the financial risk of developing new or improved products, processes, or materials, enhancing the global competitiveness of Canadian companies.
Determining SR&ED Eligibility
Eligibility for the SR&ED program depends on the claimant and the work performed. The program is open to corporations, individuals, and trusts conducting R&D in Canada. Canadian-controlled private corporations (CCPCs) receive the most favorable tax credit rates, while other corporations can claim the credit at a lower rate.
Work must meet three criteria from the Canada Revenue Agency (CRA). First is the pursuit of a scientific or technological advancement. This means the work must generate knowledge that advances the understanding of scientific principles or technologies, pushing beyond the company’s current knowledge base.
The second criterion is the presence of scientific or technological uncertainty. This implies a genuine unknown must exist at the project’s outset that cannot be resolved by routine engineering or standard industry practices. For example, creating a new algorithm for a previously impossible function involves uncertainty.
Finally, the work must involve a systematic investigation. This requires a structured approach to addressing the uncertainty, including formulating a hypothesis, executing experiments to test it, and maintaining records of the work and results. This demonstrates a deliberate R&D effort.
Identifying Qualifying Expenditures
A significant category is the salaries and wages of employees directly engaged in hands-on SR&ED activities. This includes their time spent on tasks like experimentation, analysis, and technical project management.
Materials consumed or transformed during the SR&ED process also represent a qualifying expenditure. This includes raw materials and components physically used up or changed during the investigation. For instance, the cost of metals to build a prototype destroyed during testing would qualify.
Payments to third parties for conducting SR&ED on the claimant’s behalf can be included. These SR&ED contracts must be for work that would have met the eligibility criteria if performed by the claimant. Distinguish these from payments for services that merely support a project.
Overhead costs are calculated using one of two methods. The traditional method involves tracking specific overhead costs attributable to the SR&ED project, requiring detailed record-keeping. The simpler proxy method allows claimants to calculate a Prescribed Proxy Amount (PPA) by applying a 55% rate to eligible SR&ED salaries, eliminating the need to track individual overhead items.
Calculating the Investment Tax Credit
After identifying qualifying expenditures, the Investment Tax Credit (ITC) is calculated. The rate varies by claimant. Canadian-controlled private corporations (CCPCs) benefit from an enhanced, refundable ITC rate of 35% on qualifying expenditures, while other claimants receive a non-refundable ITC at a 15% rate.
For CCPCs, the 35% rate applies to an annual expenditure limit of $3 million. This limit is gradually reduced for CCPCs with taxable capital between $10 million and $50 million and is eliminated once taxable capital exceeds $50 million. Expenditures surpassing this limit are eligible for the 15% rate.
A distinction exists between refundable and non-refundable ITCs. A refundable ITC can result in a cash payment to the claimant, even if the company has no income tax payable. A non-refundable ITC can only be used to reduce income tax owed.
In addition to the federal program, most provinces and territories offer their own R&D tax incentives. These provincial credits are calculated separately and can be claimed on top of the federal ITC, enhancing the financial benefit of conducting R&D.
Required Documentation and Forms
A successful SR&ED claim requires meticulous documentation and specific forms. The central document is Form T661, the Scientific Research and Experimental Development (SR&ED) Expenditures Claim, which details the project’s technical and financial aspects. Schedule T2SCH31, Investment Tax Credit – Corporations, is used to calculate the final credit.
Part 2 of Form T661 is the technical narrative. Here, the claimant must describe the work for each project, addressing the three eligibility criteria. This involves explaining the scientific or technological advancement sought, the uncertainties encountered, and the systematic investigation undertaken.
The financial sections of Form T661 list and categorize qualifying expenditures. This includes costs for salaries, materials, and contracts, and calculating the Prescribed Proxy Amount if that method is used. Totals are then carried to Schedule T2SCH31 to determine the final ITC.
Maintaining contemporaneous documentation is vital for a strong claim, meaning records are kept as work is performed. This evidence is the primary means of supporting a claim if it is selected for a CRA review. Examples of valuable documentation include:
- Employee timesheets tracking SR&ED hours
- Project planning documents
- Technical drawings
- Test protocols and results
- Meeting minutes discussing technical challenges
- Invoices for materials or contract work
The SR&ED Claim Submission Process
The completed SR&ED claim forms must be filed with the corporation’s T2 income tax return for the fiscal year the R&D expenditures were incurred. This integrates the tax credit into the company’s annual tax filing.
There is a firm reporting deadline for SR&ED claims. A corporation must file its claim within 12 months of the filing due date for its T2 return. Since a T2 return is due six months after the fiscal year-end, this gives a corporation an 18-month window from its fiscal year-end to submit the claim. Missing this deadline results in automatic denial.
After the claim is submitted, the CRA issues a notice of assessment. The claim may be accepted as filed or selected for a detailed review. A CRA review can be financial, to verify costs, or technical, where a Research and Technology Advisor assesses if the work meets SR&ED eligibility criteria.