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What is SR&ED?


The Scientific Research & Experimental Development (SR&ED) is a tax incentive program offered by Canada Revenue Agency (CRA) to support R&D and innovation conducted in Canada. SR&ED funding is the government largest source to support innovation among Canadian companies. In fact, government gives away over $4 billion per year on SR&ED tax credit. 


The SR&ED program will rebate up to 68% of direct research labour expenditures. The federal government gives away over $4 billion dollars each year in funding claims made under the SR&ED tax credit program. Despite of these efforts, there are still many Canadian companies that do not capitalize on this opportunity. In fact, it is estimated that there is almost $2 billion dollars in funding that goes unclaimed, because companies are not aware of this program.

How it works


In order to qualify, a claimant must engage in work which meets all three of the following criteria:

The project has advanced the knowledge base of the company in manner that could only be achieved through experimentation.The project had a legitimate risk of failure.

In order to receive SR&ED incentives, claimants must complete a detailed technical report:

  • Project Description

  • Technological Objectives

  • Technological Uncertainty

  • Knowledge Base Level

  • Technological Advancement

  • Description of Work

  • Supporting Information

 

A comprehensive expenditure analysis


The report must differentiate between the technological and technical content of a given project, in addition to efficiently communicating the technological uncertainty, the technological advancement and the technological content of the projects identified as SR&ED. The completed reports are submitted with the corporate tax return. The submission must be precise, and conform to the exact standards set out in the legislation.

  • Salaries for relevant employees

  • Materials consumed

  • Sub-contractor

  • Incidental

The report must differentiate between the technological and technical content of a given project, in addition to efficiently communicating the technological uncertainty, the technological advancement and the technological content of the projects identified as SR&ED. The completed reports are submitted with the corporate tax return. The submission must be precise, and conform to the exact standards set out in the legislation.



IS YOUR COMPANY ELIGIBLE?


We have developed a powerful process to quickly and effectively help you decide if your business qualifies for an SR&ED refund.

If you answer "yes" to any of the following questions, you should move to the next stage of receiving your SR&ED refunds - contact us to receive details of Saccade's proven SR&ED Qualifier package - our no risk, no-cost confidential process to determine eligibility.

 

  • Have you undertaken a project which allowed or will allow you to expand your product line(s) ?

  • Have you developed a new product, or are you are in the process of developing one?

  • Are you improving an existing product or process to meet new criteria (e.g. to meet new cost constraints, new industry standards, etc.)?

  • Are you improving the methods by which an existing product is produced?

  • Are you investigating new materials to use in an existing product?

  • Are you exploring new uses for an existing product, process or piece of equipment?

  • Are you spending money on improvements which aim to minimize the environmental impact of your manufacturing process?

  • Does your business create customized products?

 

INDUSTRY SPECIFIC EXAMPLES


Examples of industry specific projects that typically qualify for SR&ED refunds include:


CHEMICALS INDUSTRY


  • Developing a full-scale chemical manufacturing process to produce a final product with unique viscosity, colour, turbidity and purity specifications (from the products they have previously created).

  • Changing the blowing agent used in the manufacturing of insulated foam boards from CFC-11 (a chemical known to damage the ozone layer)  to a safer but functionally similar one.

  • Developing a new catalyst.

  • Examining the use of CFB gas-phase technology to produce polyethylene

 

SOFTWARE INDUSTRY


  • Determining the best of several possible architectures for a given problem

  • Determining the most efficient algorithm(s) for a given problem

  • Determining the most effective techniques or constructs for a given problem

  • Examining the interoperability of software entities which were not originally designed to work together

  • Developing software entities to meet unique end-user criteria

  • Re-designing existing software entities to meet new criteria

 

TEXTILE INDUSTRY


  • Developing a new garment

  • Creating or using a new fibre or dye type

  • Applying a new chemical or mechanical finish

  • Applying or developing a new spinning or printing process

  • Incorporating different basic chemicals, filaments or yarns into existing designs

  • Modifying an existing product to have new unique properties (e.g. less shrinkage)

 

PLASTICS INDUSTRY


  • Creating a mould using a new material or new tooling methods

  • Creating a mould with special mechanisms or instrumentation

  • Creating a mould to produce a part that - even if made as designed - may not function as intended

  • Creating a geometrically unique mould

  • Creating a new polymer formulation

  • Substituting new materials for existing ones (e.g. attempting to use recycled materials)

  • Utilizing new/different equipment


FOOD AND BEVERAGE INDUSTRY


  • Developing a new food or beverage product

  • Reformulating an existing product with different raw ingredients

  • Modifying an existing product's stability, consistency, flavour, texture, form, shelf life and/or safety

  • Modifying an existing process to meet new efficiency standards

 

PULP AND PAPER INDUSTRY


  • Developing a new paper utilizing wood species which have not been evaluated under the company's mill conditions before.

  • Modifying any or all of the integrated mill stages including the digester, bleach plant, paper machine and calendar to meet new efficiency standards or accommodate raw material changes.

  • Developing a new coating formulation.

  • Modifying an existing product or process to meet new specifications (e.g. increasing the brightness of paper from 30% ISO to 90% ISO)

 

MORE INFORMATION ON SR&ED


SR&ED stands for "Scientific Research and Experimental Development". It's a government incentive program to encourage Canadian businesses to develop new or improved products or processes. Below are the five SR&ED requirements:

  • Uncertainty

  • Hypothesis

  • Work history

  • Advancement

  • Records & Documentations

 

The federal government provided close to $4 Billion dollars in funding under the SR&ED tax credit program. It is estimated that there is almost $2 billion dollars in funding that goes unclaimed, because many companies are still unaware of the program, or are unaware what types of expenditures are eligible for funding.

A common misconception in the industry is the belief that the SR&ED tax credit program applies exclusively for the high-tech sector. SR&ED is not performed in laboratories only. It can happen in an office behind a computer or on the shop floor. It can be applied from a small mechanic shop to a large recycling facility, from a dental lab to construction site and from print shop to a chemical processing plant and everything in between.

Modifying a product to reduce its manufacturing cost or altering a process to increase the output rate or improving a product performance is another example of R&D activities. Government clearly states on the CRA website that every business performs some portion of their daily activities in R&D without knowing that their activities could be qualified for SR&ED Tax Credit. Obviously, these R&D activities can vary from one company to the next or from one industry to the next.

The critical key, that most companies fail to see, is not just filing for this program, but being able to maximize their claim expenditures, which they are legally eligible to claim. There are many expenses that are eligible for an SR&ED claim. Some of these costs include:

  • Training

  • Materials consumed

  • Salaries or wages of your staff

  • Overhead and other direct costs

  • Contract and subcontract expenditures

  • Scrap generated during experiments and test runs

  • Third-party payments to organizations such as universities lease costs

 

How much refund can you get?


Canadian-controlled private corporations (CCPCs) with less than $500,000 in taxable income can receive an investment tax credit (or ITC) of 35% of SR&ED expenditures. This means that you get up to $0.35 back in CASH from the federal government for every dollar spent on research. In addition to this refund, you are also eligible to receive Ontario Research and Development Tax Credit (ORDTC) and Ontario Innovation Tax Credit (OITC) for the total amount of 44.1% of your research investment.

There are many activities that are eligible for an SR&ED claim, regardless achieving the desired goal. Some of these activities can be eligible:

 

  • Designing and developing a custom machinery

  • Developing a new e-commerce, software or telecom application

  • Developing a new product

  • Improving an existing product (i.e. making it lighter, stronger, cheaper, better etc.)

  • Developing a new process

  • Improving an existing process

  • Lean Manufacturing Implementation

  • Six Sigma

  • Plant Expansion and Move

  • Robotic/Automation Systems Implementation

  • ISO – Quality Improvement

  • Cost Reductions, ie:

    • Reduction of waste

    • Reduction of manpower

    • Reduction of set-up time

    • Reduction of cycle time

 

How do you apply for SR&ED?


Any Canadian taxpayer,either companies or individuals, can apply for this program using T661-part 2 in their annual T1 - Form T2038 (individuals) or T2- Form T2SCH31 (corporations) income tax return. Also, the applicant is required to file schedule 566 to claim OITC, schedule 508 to claim ORDTC, schedule 31 to claim ITC. Despite of tax filing requirement, the vast majority of the sred filing is technical and about 10% is financial reporting. It is absolutely critical to prepare the technical as accurately as possible, as it can easily trigger a CRA review. The key elements in the technical reports are that the technological obstacles and advancement must be visible. Also,the reports should be free of any routine activities and/or off the shelf solutions and focus on the steps, which were taken trying to rectify the technological obstacles. The great thing about this program is that the applicant is not required to reach their project objective in order to receive this grant. In other words, even if the project was a complete failure, the applicant is still eligible to receive the sred grant. To be eligible to claim this government grants, a corporation will have up to 18 months after the end of the tax year to apply for the sred program. If they miss this deadline, CRA will disqualify their application. Another hurdle in filing for the sred program is a current documentation system.

CRA performs a review on the submitted claim to ensure the SR&ED funding is wisely and effectively distributed among Canadian industries in attempts to foster innovation and R&D. But, the question is, what really triggers an audit? And what can you do to prevent a CRA visit?

Quite often, companies assume that a thorough documentation system is the key to avoid a CRA audit. But, the truth is, there is no correlation between a proper documentation system and a CRA audit. A thorough documentation system helps to defend a claim, but it does not prevent it from getting a review. The most common reasons triggering a CRA audit are as follows

 

  • The biggest reason for a CRA audit is inadequacy or inconsistency within the submitted reports. There are cases where claimants submit an obviously overvalued claim. For example; a small machine shop with seven employees submitted a SR&ED claim containing eight projects. They provided full technical and financial reports for their claim, hoping their claim will be accepted. It might initially seem rational, but a question arises; if the claimant spent 65% of their time on R&D activities, how can they perform their regular duties within the remaining 35% of their time?

  • Technical reports that are heavily focused on new features and benefits that a new product brings to the company. These reports would describe in a detail how a new product line helped the claimant achieve a competitive edge and increase their market share. The reports were presenting a business project rather than a sred project. Although, these projects might look similar, there is a big difference between them. The reports should have been constructed to address technological obstacles and the advancement that the company achieved in developing their product.

  • Inadequate correlation between the technical reports and financial reports could also initiate a CRA review. Even though both the technical reports and financial reports are strong, they can lead to a CRA visit if they do not match. For example, a client should always have a sufficient evidence to support start/end of each project.

  • The recent changes in the CRA guidelines, which require the breakdown of each reporting structure, as well as the disclosure of the employees for each project, arecreating another layer of CRA scrutiny on a claim. If an unqualified employee performs sred activities, it will cause an audit. For example, a claimant submitted a claim stating that their controller or general support office staff was involved with their sred projects. Although, it might seem logical, it doesn't comply with SR&ED guidelines.

  • Experience of your sred consultant plays the most important role in preparation and development of a claim. Your consultant's work ultimately impacts whether the claim will pass the CRA desk or will trigger a CRA review. Therefore, choosing a seasoned consulting firm by far plays an important role regarding a successful claim.

 

How to handle a CRA audit?


Although CRA has well established guidelines to follow to process each claim, the outcome of a review can drastically vary depending on a CRA reviewer. Defending a claim canbe very time consuming and exhausting experience not to mention that it can generate a significant delay, which in some case, can take several years, before the claimant receives their refund check.

If you disagree with the decision of a CRA reviewer / auditor, before taking your case to the Tax Court, you can request for an Administrative Second Review. In this case, the Assistant Director of the SR&ED program will assign a second staff to review your case and provide a second opinion, which, in most cases, will support the initial reviewer's viewpoint just to maintain the CRA's credibility. After the decision is made by the Administrative Second Review, if you still disagree with its outcome, you can file for a Notice of Objection, which you have 90 days to file.

Remember, the best way to handle an audit is simply to avoid it rather than trying to defend it in the boardroom. You can prevent an audit by doing your due diligence while developing reports, especially the technical reports, to ensure that they accurately describe the five SR&ED criteria; technological obstacles / uncertainty, formulated hypothesis to overcome the technological uncertainty, procedures used were aligned with the principles of systematic investigation, technological advancement and detailed supporting documents.

 

Additional tips to avoid a CRA audit:


  • Clearly state the technological obstacles (not routine activities) and the technological advancements

  • Ensure the systematic investigation is visible in the project description

  • Project start/finish dates are actual and consistent with CRA guidelines

  • Ensure all schedules and forms are filled out correctly and completely

  • Avoid a sudden increase in a claim value from the previous year, unless it is justifiable

  • Keep detailed records of project activities

  • Don't put through a huge claim, especially if you are 1st time SR&ED claimant

  • Leave out weak activities from the project description

  • If possible, don't continue a project into the next fiscal year

  • Avoid using audit triggering words

  • Ensure the time invested by owners, shareholders and management on a claim are actual

  • Include detailed description of the subcontractor's contribution to the project

  • Ensure the material expenditures are reasonable and accurate

  • Avoid resubmitting a claim to CRA with an increase to its expenditure

  • If your last year claim was rejected, don't file another claim unless it meets all SR&ED guidelines

  • Don't claim high subcontractors' expenditures without adequate explanation of the nature of their work

 

How to develop a documentation system?


  • Keep all engineering drawings to show each design iteration

  • Maintain job listings or task lists

  • Make voice recordings of issues and progression of work

  • Store internal emails to capture the chronology of the work

  • Maintain dated digital records (i.e. photos/video)

  • Document concurrently for best results

  • Provide quarterly reminders from management to employees that they should document their work

  • Accumulate evidence using existing application software (i.e. MS Office, Outlook)

  • Identify and organize the existing documentation

  • Develop a document folder for each project

  • Maintain logbooks of activities and hours for ease of linking with costs

  • Perform good project management practices, including time tracking

  • Use setup sheets to record trial runs and results

  • Maintain project meeting minutes

  • Use work orders or other existing "business" system documentation

  • Utilize tracking software

  • Provide documentation to support claimed metrics, specifications, and benchmarks

  • Keep all iterations of source code

  • Maintain emails citing current knowledge/understanding of the problem from the project launch

  • Utilize notebooks, personal employee records

You don't need to implement a complex computerized system to keep track of your SR&ED activities. In fact, a paper tracking system or just a simple spread sheet would be sufficient to keep track of SR&ED activities and comply with the CRA requirements. At Kingsway Consulting, we help our clients to develop a complete and easy-to-use tracking system. We then provide a complete training followed by an ongoing support to ensure the tracking system is effective and fits clients' recording structure.

 

Please contact Kingsway Consulting for a FREE, no obligation consultation with one of our SR&ED experts.