In the competitive Canadian landscape of innovation and development, companies constantly seek incentives and funds for their research and development (R&D) activities. In this light, many turn to various sources of financial assistance, such as government grants, tax incentives, and private investments.
Among these, the Canadian Scientific Research and Experimental Development (SR&ED) program stands out. It offers substantial non-dilutive funding through tax credits to support research and development.
However, while the SR&ED program is a valuable resource, many companies face challenges in navigating the complexities of funding. Especially when trying to maximize their Investment Tax Credits (ITCs) without overlapping or compromising other forms of assistance.
In this article, we will explore some common misconceptions about how the SR&ED program interacts with other funding sources. And provide strategies to ensure that companies can maximize their ITC benefits effectively.
Types of Financial Assistance
In the context of the Canadian SR&ED program, we can categorize financial assistance into government and non-government types.
According to the Income Tax Act, Government assistance encompasses various forms of support provided by governmental bodies, municipalities, or other public authorities. Non-government assistance refers to support from sources other than public authorities.
Government assistance reduces both the deductible SR&ED expenditures and the qualifying pool for ITC purposes.
In this context, assistance may be in the form of:
- Grants
- Subsidies
- Forgivable loans
- Tax deductions or allowances
- Any other inducement or support
The classification of received amounts as assistance rather than loans or other forms of financial support depends on two factors:
- Absence of firm terms of repayment: If the terms of repayment are unclear or are highly flexible, the received amount may be classified as assistance rather than a traditional loan. This lack of firm repayment terms suggests that the amount is intended as support rather than a repayable debt.
- Absence of a business motive: When the payer does not have a clear business motive for providing the financial support, it may indicate that the recipient is receiving assistance. If the support is not aimed at advancing the payer’s business interests or does not create a business relationship, it is more likely to be classified as assistance.
Avoiding Double-Dipping, Why It Matters
Double-dipping refers to the practice of receiving multiple financial support for the same expenditure or activity. This can result in an overlap and potential duplication of benefits, leading to an overstated financial benefit.
While it might seem advantageous in the short term, double dipping can result in significant compliance issues, including:
- CRA audits
- Penalties
- The need to repay improperly claimed credits
- Delays or issues with future SR&ED claims
This can leave the company in a difficult position and compromise its ability to receive funding from future SR&ED claims.
To avoid these risks , it is crucial to adopt a granular approach to tracking and categorizing projects and expenditures. This method helps companies apply assistance accurately, minimize overlap, and strategically plan to maximize funding.
Structuring SR&ED Claims for Strategic ITC Maximization
SR&ED claims should be first divided at the project level. Each project can contain multiple subprojects that share the same technological objectives, and technical uncertainties.
Next, divide at the subprojects level, so that for each the following can be clear, and readily accessible:
- Main motivation, and technological objective of the subproject.
- Timeline of the subprojects, start date, and end date.
- Employee allocations/timesheets for each subproject in a monthly basis.
- Subcontractors, or third-party services that were employed in the subprojects in a monthly basis.
- Materials used in each subproject in a monthly basis.
Tracking Financial Assistance
Companies should carefully track the following regarding the assistance received:
- Determining which subprojects or employees are covered by the assistance received.
- Timing of assistance received over the funding period.
This tracking allows companies to leverage assistance without conflicting with SR&ED eligibility. To maximize ITCs:
- Align assistance to non-eligible periods or activities
- Avoid overlap with SR&ED timelines or core expenses
- Consider all categories of claimed expenditures
A Common Scenario: IRAP vs SR&ED
Many companies combine IRAP and SR&ED because the two programs serve complementary purposes:
- SR&ED offers tax credits for eligible subsets of R&D expenditures
- IRAP provides direct funding to cover a portion of the R&D project costs and other business development expenses.
This combination helps companies maximize their financial support for innovation activities.
When using both:
- IRAP doesn’t cover overhead, so SR&ED proxy or traditional overhead claims won’t overlap.
- IRAP covers 80% of labour costs, leaving 20% eligible for SR&ED if the employee works on SR&ED eligible activities.
For maximization purposes, a granular and clear classification of expenses will facilitate the distribution of funding across subprojects. This allows IRAP to cover ineligible portions of the SR&ED subprojects, such as marketing and business development. While SR&ED can fund eligible R&D activities.
Additionally, companies can leverage other funding sources or IRAP, for periods that fall outside of SR&ED eligibility, particularly during due diligence phases.
Common Misconceptions
In navigating the SR&ED program, businesses often encounter various misconceptions that can lead to missed opportunities or compliance issues. Understanding these is crucial for maximizing benefits and ensuring accurate claims.
The following are some of the most common misconceptions:
The Proxy Method Includes Overhead
If a claimant elects to use the proxy method, there would not be any overhead expenditure included in the pool. Therefore, no amount of assistance related to overheads will reduce the pool.
Excess Assistance Is Lost
The excess assistance that is not applied to a given SR&ED project in the current tax year will be carried forward to reduce the future period qualified expenditures.
Assistance Can’t Be Shared Among NAL Parties
Assistance can be transferred amongst NAL parties via form T1145, this can allow for strategic moves to streamline the claiming process through a single claim, and balance tax liabilities. So that if one party has a higher tax liability and is not able to fully utilize the SR&ED credits, transferring the assistance to a party with a lower tax liability or one that can utilize the credits more effectively can optimize overall tax benefits.
Always Use SR&ED First
When claiming SR&ED subprojects where assistance greatly overlaps, or even surpasses SR&ED expenditures, it is better to use alternative founding sources instead of SR&ED, or only waiver the provincial portion of the credits when larger amounts of provincial assistance is leveraged.
You Can Claim Paid Contracts
Contract payments also reduce the claimable amounts, so that both parties can’t claim the same amount twice. However, if the contract payer is outside Canada, there can’t be double dipping, and the work can be claimed even thought a payment has been received. Although both received contracts and assistance both reduce the claimable amounts, contract payments do not reduce the pool of deductible expenditures.
Repaying Assistance Has No Effect
When assistance is leveraged in a given period and reduces the eligible expenses, any repayment of that assistance in future periods entitles the taxpayer to a return of ITCs at the same rate by which the eligible expenses were originally reduced.
All Provinces Apply the Same Rules
In Newfoundland and Labrador, eligible provincial expenditures are not reduced by government and non-government assistance.
You Only Report Assistance Once Received
Assistance should be reduced and reported in SR&ED before its receipt if it is entitled to be received for the specific filing period. A claimant is considered entitled to receive assistance when a specific event has occurred or when the claimant has met certain conditions that qualify them for the assistance.
Failure to report such assistance during the appropriate period can be contested during an audit.
What should I do to minimize overlap?
In conclusion, to maximize funding and minimize overlap, companies should :
- Adopt a granular view of their R&D operations
- Understand each funding source’s rules and coverage
- Maintain detail and real-time records of all financial assistance received and all SR&ED subprojects and expenses
This will facilitate the separation of portions of expenditures under different programs or assistance types without any overlap.
Consult with SR&ED experts to help navigate grey areas, ensure compliance, and develop a long-term, optimized funding strategy.
Contact us to get help on overlapping your financial assistance strategically!
