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Article Archives >> Income Tax - Advanced IssuesSR and ED Tax Credits
(Thursday, January 21, 2010)Summary
SR&ED activities are carried out in many businesses – not just in large corporations with research laboratories and “high tech” industries. Many businesses may be eligible to claim investment tax credits and not realize it.
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The Income Tax Act provides incentives to encourage expenditures on scientific research and experimental development (SR&ED). One such incentive is an investment tax credit on certain qualifying expenditures of a taxpayer. Under subsection 127(5) of the Act, a taxpayer may deduct from the tax otherwise payable by the taxpayer for a taxation year the amount of the investment tax credit.
The basic investment tax credit rate is 20% of qualifying expenditures, with some corporations entitled to 35% of the first $2,000,000 of qualifying expenses. The tax credit can be applied against taxes owing, or a cash refund of from 40% to 100% of the investment tax credit. Any unused investment tax credit can be carried back for 3 years or forward for 20 years and applied against taxes owing. Qualifying expenses can be claimed as an expense for the year, or carried forward indefinitely and claimed in future years.
Qualifying expenses include wages, materials, equipment, some overheads, contracts and third party payments that relate to SR&ED activities. Overhead expenses can be allocated between SR&ED activities and other activities, or it is possible to claim 65% of qualifying wages as the overhead expense (the “proxy method”).
Qualifying activities are:
· Experimental development – work done to achieve technological advancement to create or improve new materials, devices, products, or processes. Businesses may be doing this work without realizing that it can qualify for SR&ED tax credits.
· Applied research – research to advance scientific knowledge with a specific practical application in mind.
· Basic research - pure research without a specific practical application in mind.
· Support work – work that directly supports experimental development, applied research, or basic research. This consists of: Engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research.
The basic criteria for eligibility is that the activities generate information that advances scientific or technological knowledge, that the outcome is not certain when the project is started, and that the personnel doing the work are qualified in the field of knowledge.
Generally, this means that work to improve an existing product, add new features, improve quality control, or increase production efficiency is not eligible. If the end product is essentially the same as other products already available on the market, the work is unlikely to qualify for SR&ED credits.
Research in the social sciences or humanities, accounting, management reporting systems, market research or similar activities do not qualify because advancements are not technological in nature.
Even if the end product in itself does not qualify for SR&ED credits, work done to create or improve new materials, devices, products, or processes used in producing the end product may qualify by themselves.
The claim forms for SR&ED credits is complex and it can be time consuming to comply with all the documentation requirements Canada Revenue Agency requires, but if a business is investing significant amounts of money in research and development, the time and effort can be well worth it. An accountant knowledgeable in SR&ED credits and claims can help you claim for credits.
