A discussion of scientific research & experimental development (SR&ED) tax incentives for Canadian businesses.
Overview
To sustain competitive advantage, many companies engage in scientific research & experimental development (SR&ED).
The Canadian income tax act defines SR&ED as “systemic investigation or search that is carried out in the field of science or technology by means of experiment or analysis…”
Under Canadian tax rules, SR&ED program provides tax incentives to encourage Canadian businesses to conduct R&D in Canada. The three forms of tax incentives available are an income tax deduction, an investment tax credit (ITC), and in some circumstances a refund. (source: Canada revenue agency).
SR&ED pool and deduction
Qualifying SR&ED expenditures can either be deducted in the current year or added to the SR&ED pool. SR&ED pool is the total of SR&ED expenditures not deducted in previous years and expenses incurred in the current year, netted against current year deductions and previous year’s SR&ED ITCs (discussed below). The year-end SR&ED pool calculation is as follows:
| SR&ED pool calculation (source: CPA Canada) |
| Balance in pool, beginning of year |
| Add: Current-year SR&ED expenditures added to pool |
| Minus: SR&ED expenditures from in come in the year |
| Miuns: SR&ED ITC claimed in previous year |
| Balance in pool, end of year |
By adding expenditures to the SR&ED pool, companies have the flexibility to carry them forward indefinitely.
Alternatively, if a company deducts the expenditures which consequently results in a non-capital loss, then the non-capital loss can only be carried forward 20 years.
The decision on whether to take a deduction in the current year with little income or carry forward the deduction should be based on an analysis of future years’ taxable income. If taxable income is expected to be higher in future years, then carry forward might be a better option.
SR&ED ITCs
Under the general rule, companies can claim a non-refundable ITC equal to 15 percent of eligible SR&ED expenditures.
However, CCPCs (including their associated groups) are eligible for an enhanced refundable rate of 35 percent. This enhanced rate and refundability is available on the first $3 million of eligible SR&ED expenditures. Expenditures in excess of $3 million are eligible for ITC at the general rate of 15 percent.
The expenditure limit is phased out when taxable capital employed in Canada by the CCPC and its associated group is between $10 million and $50 million.
Carrybacks, carryforwards and refundability of SR&ED ITCs
Like SR&ED deduction, a company can deduct all, part, or none of its SR&ED ITCs against its tax payable. However, the maximum deduction is limited to the amount by which tax payable can be reduced to zero. For any ITCs left over in the current year, the company can carry them back 3 years or forward 20 years.
In contrast, SR&ED ITC is refundable to a CCPC for an amount left over after tax payable is reduced to zero. This alleviates the need for a CCPC to carryback or carryforward the SR&ED ITCs.
The portion of SR&ED ITCs that can be refundable for CCPCs are calculated as follows:
For a “qualifying CCPC” (company with taxable income not in excess of $500,000 in the previous year):
100% of the ITC earned at the 35 percent rate is refundable, and
40% of the ITC earned at the 15 percent rate is refundable
For a “non-qualifying CCPC” (company with taxable income in excess of $500,000 in previous year):
100% of the ITC earned at the 35 percent rate is refundable, and
0% of the ITC earned at the 15 percent rate is refundable
For professional advice contact Alpha Accountzy, Accounting & Tax Solutions.
