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Small Business Deductions: Scientific Research and Experimental Development (SR&ED) Tax Credit

As a small business owner, you’re likely to be pleased with any tax credit that reduces your taxes. One program that may benefit you is the federal Scientific Research and Experimental Development Program, which offers a refundable tax credit to all types of small businesses, including sole proprietors, partnerships, and corporations. While the title makes it sound as if this tax credit applies only to high-tech businesses, you may be surprised to find out just how many businesses can qualify for this tax credit. The SR&ED tax credit program offers generous tax incentives for individuals and corporations that do certain types of research and development, covering a wide range of activities. If your business qualifies, this program can lower your tax liability and potentially result in a refund.

What Is the SR&ED?

The refundable tax credit through the SR&ED program uses the amount you spend on scientific research and development as the basis for the calculation. Any taxpayer can claim the credit, regardless of incorporation status. Even if you do business as a sole proprietor or use an unincorporated business model, you may still qualify. Since it’s a refundable tax credit, you can receive a tax refund even if you don’t owe taxes.

Another provision with the SR&ED program lets you fully deduct the amount of certain equipment that you normally have to capitalize. Most provinces also offer incentives for research and development, which can give you even more tax breaks on those activities.

Who Qualifies for SR&ED?

Individuals, trusts, and corporations can all qualify for this program. If you run your business as a partnership, you can also qualify, but you have to apply on your individual tax return using your portion of the partnership’s eligible expenses.

Which Projects Qualify for SR&ED?

As the name suggests, this program focuses on tax credits for activities related to scientific research and experimental development. This includes basic and applied research. Any work you undertake regarding engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, or psychological research can qualify. You can include research you do purely for the advancement of science, but you can also include research you do with a practical application in mind.

Do you participate in experimental development, working on technological advancements to improve materials, devices, products, or processes? For instance, developing new materials to fill potholes could fit into this category because you’re trying to improve the materials used. If your work falls into one of the eligible categories, you can include salary, materials, overhead, capital expenses, and various other costs related to your research or development activities.

The definition is broad-ranging and can apply to many different types of businesses, but the law specifically excludes certain activities from SR&ED tax incentives. Among the activities that don’t qualify are the market research you do before you start your project, promotions, social science research projects, humanities research projects, and style changes. You also can’t count routine tasks such as testing, quality control, data collection, commercial production activities, or commercial use of your new and improved products or ideas. And if you work in the minerals, petroleum, or natural gas fields, you can’t include any expenditures related to prospecting, exploring, or production.

It’s also important to note that your project doesn’t have to end in success. Your efforts just need to be a legitimate scientific or research project, even if the results aren’t what you expect.

What Does the Program Offer?

The program offers a twofold tax benefit. You can deduct the eligible expenses from your income, and you can claim a tax credit based on your eligible expenses, which reduces your income tax payable so you owe less. For example, if you have $100,000 in income and $5,000 in eligible SR&ED expenses, the tax deduction lowers your taxable income to $95,000. You also get 35% of the expenses as a credit, assuming you meet the Canadian-controlled private corporation (CCPC) qualification. That means you qualify for a tax credit of $1,750, which directly lowers your tax liability. While this example provides a very basic look at what you might save, your specific numbers depend on several factors. For instance, you must deduct any assistance for qualifying expenditures that you receive from the government, your provincial government, or other sources. This deduction can lower what you’re eligible to receive as a tax incentive. Working through the form and consulting with your accountant helps you determine the exact amount you qualify for.

How Much Is the SR&ED Tax Credit?

The amount of the tax credit depends on the type of business you run. Some of the specifics include:

  • CCPCs can qualify for a credit that’s worth 35% of your eligible expenditures up to $3 million.
  • The part of the credit that’s based on capital expenses is only 40% refundable, but the rest of the credit is completely refundable.
  • If your qualifying expenses exceed the $3 million mark, you can claim a non-refundable 15% credit on those costs.
  • If your corporation isn't a CCPC, your credit is 15% of your eligible expenses, and it’s nonrefundable.
  • As an individual or a trust, you can also earn a 15% credit. If some of the credit is left over after you cover your income tax due, you can get a refund of 40% of the remaining amount.

How to Claim the SR&ED Tax Credit

To claim the SR&ED tax credit, you need to fill out Form T661 (Scientific Research and Experimental Development Expenditures Claim) along with either Form T2SCH31 (Investment Tax Credit – Corporations) or Form T2038(IND) (Investment Tax Credit – Individuals), depending on how you run your business. If you’re claiming the tax incentives as a corporation, you have 18 months from the end of the tax year to claim the expenses. For individuals, the deadline is 17.5 months after the end of the tax year.

You have the option to use a traditional or a proxy method for calculating the expenses. With the traditional approach, you calculate your actual expenditures for the year. If you choose the proxy option, you use the prescribed proxy amount, which comes from a percentage of a salary base. When calculating your credit, be sure to include expenses related to salaries, materials, overhead, third-party payments, and capital expenditures.

The Canada Revenue Agency (CRA) may ask to inspect all of your supporting technical and financial documents to determine that you are carrying out your project in a serious and documented manner, so it’s important to have those documents available. For example, you should have project-planning documents, design documents, technical drawings, and minutes of project meetings, along with photographs, videos, or other means of illustrating your project. That way you’re ready to provide supporting evidence if the CRA requires it.

What Are Upcoming Changes to the Program?

The SR&ED program is popular. About 24,000 individuals and businesses submit a claim every year. Between 2016 and 2019, the CRA plans to overhaul the program to speed up and streamline the application process. As part of that effort, the program started offering a pre-approval process to businesses in early 2016. That makes it easier to include the credit in your financial plans without having to wait for a formal approval. The government also plans to extend outreach so that more people know about the program. The CRA is implementing a quality assurance program to improve consistency across the board. All these planned changes promise a faster, easier process for individuals and business owners. If you think your work may qualify, you may want to start gathering receipts and descriptions of your work in preparation for the filing process.

Taking advantage of the SR&ED tax incentives can lower your tax obligations for activities you’re already doing. QuickBooks Online can help you maximize your tax deductions. Keep more of what you earn today.

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