There is a quote that I really like from Bill Gates. He said, “I believe innovation is the most powerful force for change in the world.” It’s a very simple quote, but it rings true. Human history is infinitesimally small compared to the life of our planet, but we’ve achieved so many groundbreaking scientific revolutions in that tiny speck of time. The Canadian government recognized this early on.
Almost 80 years ago, even when our tax system was still very young and simple, the federal government started to allow companies to fully deduct all expenditures incurred in pursuit of scientific research. Over the years, as more and more taxpayers began to take advantage of the generous tax benefits provided on research and development, our tax rules surrounding it have also grown. It’s now referred to as Scientific Research and Experiment Development. (SR&ED)
Come 2022, Canada has approximately 20,000 applicants annually who file SR&ED tax forms to take advantage of the financial benefits that the federal government provides. Of these applicants, around 75% of SR&ED claims come from small businesses. It really emphasizes the fact that small business owners are significant pillars of society, sometimes overshadowed by the achievements of large corporations. Unfortunately, many small business owners either misunderstand what SR&ED is or are too intimidated to pursue it.
Zenbooks welcomes, Christopher Young a veteran SR&ED consultant with Emergex and Bruce Smith the Director of Growth with Invision Edge. Albert Park, Tax Manager from Zenbooks also joined the conversation to share his knowledge and experience having dealt with the SR&ED tax compliance for various large public corporations, as well as small businesses.
What is SR&ED and what are the incentives?
SR&ED refers to the various types of applied and basic research that companies invested time and resources in. If the Canada Revenue Agency (CRA) approves of the SR&ED activities, the taxpayer is provided incentives in the form of tax refunds or tax credits that reduce the taxpayer’s tax liability once the project is completed. Generally for small businesses, one can expect to receive back 35% of what was spent for qualifying SR&ED activities. Depending on which province the taxpayer does the SR&ED work in, the magnitude of the benefit can change significantly.
What qualifies as activity for SR&ED?
Despite this tax program containing “research and development” in the name, any technical field can in principal be eligible for the SR&ED program. Chris emphasizes that one must consider what specific part of the research and development procedures are experimental in nature since that is what qualifies the activity for SR&ED. Simply put, when you are faced with a scenario where you become uncertain as to how to approach an issue or problem and you work towards a solution for it, that may start to enter into the realm of being experimental development. This uncertainty being faced assumes that the person is an expert in the field and has good knowledge about the standard practices in the industry. So trying to develop a solution for a problem that could be easily resolved with knowledge in that field will not qualify for SR&ED activity.
As an example, assume a scenario where a barber is trying to develop a solution to cutting hair on a sailboat. Learning how to balance would not be technological enough to fulfill the SR&ED criteria. However, developing a razor with a safety device for use on unstable grounding or inventing a platform that keeps the barber stable on a sailboat would be technological instantiations that would qualify for SR&ED.
What if my technological development fails? Will it still qualify for SR&ED?
Fortunately, the SR&ED program does not distinguish between whether the final product is a fully functional technological development or not. The key component of eligibility is that the research and development procedure is experimental in nature.
What can you do to become an organization that will qualify for SR&ED?
It’s less about the corporate or internal organizational structure, but rather more about meeting the SR&ED criteria, which is about the research and development itself.
If a person develops technology that is eligible for SR&ED, but that person works for an organization, who is the owner of the SR&ED benefits?
One of the first things that should be looked into is whether there is an agreement or contractual clause that specify who the owner of the experimental development is. If there is no agreement or clause, one should look towards who is directing the SR&ED qualifying project. Even if a subcontractor may provide services that qualify for SR&ED to a business that hired them, since the work itself is being directed by that business, the benefits will ultimately be claimable by the business.
Typically, employees would never be able to claim SR&ED directly, but sometimes subcontractors can.
Can SR&ED be claimed in case an employee or subcontractor is providing services from outside Canada?
The SR&ED program is for work done in Canada. However, up to 10% of total Canadian salaries or wages claimed for SR&ED may be claimed for work done outside Canada. Generally, the Canadian salaries or wages amount are substantiated by the T4 slip issued.
How can organizations change the mentality of the group to be come more innovative?
From a strategic perspective, it’s essential for organizations to have a roadmap of where they want to end up. For innovativeness, it’s important to be ready and have a proper foundation in place to be able to innovate in the first place (e.g. proper education, innovative leaders, etc.). Further, having a process that can be followed to innovate systematically at a larger scale is necessary. Lastly, a supportive culture must be in place. This includes having proper compensation and incentives in place for the employees to have the motivation to innovate. Overall, the qualities of innovation readiness, having a system in place, and fostering the right culture must work together to create an innovation ecosystem in the organization.
Can the SR&ED claim be filed by the taxpayer, or should they hire a tax professional?
Technically, it is possible. However, there are multiple layers of complexities behind filing a SR&ED claim that an ordinary person would not know about:
- SR&ED claims must be accompanied by an income tax return. Without the filing of an income tax return, it is not possible to calculate how much SR&ED tax credits can be refunded or recovered upon filing.
- There are specific wordings and vocabulary that must be considered when writing the technical explanation of the experimental development done. Without the necessary experience or expertise, the write-up will not contain proper information for the CRA to determine that the project qualifies for SR&ED, increasing the chances of it being denied. Utilizing SR&ED experts helps the taxpayer create their write-up that follows best practices and helps include information that the CRA is generally looking for.
- Often, applications for SR&ED are accompanied by CRA information reviews or audits. Utilizing a tax professional increases the chances of those reviews or audits being completed successfully on a timely basis.
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