SR&ED vs CDAE: Everything You Need to Know

For innovators in Canada, investments in research and development (R&D) are vital; however, funding innovation often proves challenging, especially for growing companies with limited resources.

The Canadian and Provincial Governments have several programs to help propel investment in R&D in firms across the country. Among them are the Canada Revenue Agency’s Scientific Research and Experimental Development (SR&ED) tax credit and Revenu Quebec’s Tax Credit for the Development of E-Business (TCBE), often referred to as “CDAE,” its French-language abbreviation.

We will explore the key similarities and differences between the two programs so that you can get a better idea of whether the programs are the right fit for your firm. Keep in mind that CDAE and SR&ED are not necessarily mutually exclusive—we will explore this later.

Nature of funding

Both the SR&ED and CDAE programs are tax credits.

A tax credit is an amount of money that a firm can subtract from the taxes they owe the CRA and their provincial agency or it can be a direct refund regardless of taxes paid or owing.

In the case of a refundable tax credit, a firm will receive a cash reimbursement at the end of the year, deducting any taxes due. Meanwhile, non-refundable tax credits are capped at the firm’s tax liability—even if the credit exceeds the owed taxes, the firm will not receive any additional reimbursements and the full value of the credit will not be used. Having said that, non-refundable tax credits can often be carried forward or back.

SR&ED is generally a refundable tax credit for Canadian-controlled Private Corporations (CCPCs). When claimed by non-CCPCs, the program generally offers a 15% non-refundable tax credit. On the other hand, CDAE offers a combination of refundable and non-refundable tax credits.

Eligibility Criteria

Eligible Firms

Most significantly, SR&ED supports firms across Canada, while CDAE only offers credits to firms in Quebec.

The CDAE requires that eligible companies are focused on developing and selling software licenses or services. Your company’s gross revenue must be at least 75% derived from IT sector activities; 50% of these activities must be related to a core subset of the IT sector, as defined here.

Additionally, to qualify for CDAE credits, your company must have at least 6 full-time, eligible technical employees for the entire fiscal year of the claim.

This minimum requirement is more flexible for startups that have existed for less than 2 years. For these firms are eligible once they have 6 eligible technical employees.

The SR&ED credit does not have revenue requirements, nor does it require a minimum number of employees.

Beyond the eligibility of the firm, there is a second level of eligibility for CDAE: the eligibility of employees and their salaries.

Eligible Activities

SR&ED supports R&D activities in any industry. R&D activities must demonstrate a systematic approach, an attempt at technological advancement, and technological uncertainty. As such, projects related to technology that have already been validated and for which there is readily accessible information cannot be claimed.

Contrarily, the CDAE covers innovation activities in E-business, SaaS, and B2B software companies. While CDAE’s revenue requirements are more restrictive, its eligible activities are less rigid and can include routine development.

It is important to note that CDAE does not cover programs that involve software that controls hardware or is built into hardware. As such, projects in the IoT or robotics are essentially ineligible because they involve software that controls mechanical elements.

Additionally, projects that rely on external data sets, such as AI or AI-adjacent projects, are ineligible for CDAE as well. To be eligible, data used in the project must be internally owned and generated—for instance, inventory data would be permitted under CDAE.

Interested in learning more about SR&ED Eligibility? Read our guide here.

Eligible Expenses and Amounts

Both tax credits cover salaries; however, they have different requirements and credit amounts.

CDAE covers only the salary of employees in technical roles—mostly front-end or back-end developers. The CDAE offers a refundable tax credit of up to 24% and a non-refundable tax credit of up to 6% of each eligible employee’s salary. These credits are applied to the total salary, regardless of the portion that is directly related to the CDAE activities.

Note, however, that the CDAE only covers salaries up to $83,333, meaning that firms can only receive up to $20,000 in refundable credit and up to $5,000 in a non-refundable credit per employee salary. There are no restrictions on the number of employees that can be covered by CDAE; however, a fee must be paid to Invest Quebec for each eligibility certificate requested.

Unlike CDAE, companies applying to SR&ED can only claim tax credits on expenses related to R&D activities—salaries, wages, materials consumed or transformed, subcontractor expenses, and overhead.

The SR&ED tax credit covers only the portion of employee salaries and subcontractor expenses that are related to the eligible R&D activities. In other words, the SR&ED refundable tax credit is based on the percentage of time spent on R&D activities relative to the employee’s salary. However, there is a tradeoff: this program also covers the salaries and wages of support employees, such as HR or payroll employees who specifically spend time recruiting engineers for the SR&ED project or handling payroll for project employees. This is known as indirect SR&ED and is claimed in different manners federal and provincially.

Note that unlike CDAE, SR&ED tax credits are not restricted by a maximum eligible salary amount for non-owners.

Application Process

The CDAE’s application process is done in two levels: first, you must apply to Invest Quebec within 15 months of the fiscal year-end in which the expenses were incurred to receive an eligibility certificate for each employee for which a tax credit is being requested. Then, you must submit an application to Revenue Quebec within 18 months of the same fiscal year. These CDAE applications automatically get reviewed—the process is standardized and systematic.

Meanwhile, SR&ED applications are only reviewed by the CRA and do not always get audited, but there should be at least a first-year visit.

SR&ED vs CDAE

So, we’ve discussed the two programs and their differences. Now, which one will be more beneficial to your firm?

CDAE can help firms that are more advanced and are looking to scale up. Many firms receive more SR&ED tax credits in the early days of their innovation projects, and then move towards increasing their CDAE funding amounts as SR&ED covers fewer of their activities.

Because routine development activities are covered under CDAE, firms that are looking to maintain or improve existing technology will benefit. Meanwhile, these activities are not covered under SR&ED.

CDAE is also more beneficial to large or foreign companies, since its tax credits are fixed, unlike SR&ED which offers lower, non-refundable credits to non-CCPC.

Stacking SR&ED and CDAE

If both programs seem like they’d benefit your firm, how do you choose which one to claim? There’s good news: it is possible to claim both SR&ED and CDAE.

A few options exist if you want to benefit from both programs. Claiming federal SR&ED tax credits and provincial CDAE tax credits is a great combination. It is also possible to optimize both CDAE and SR&ED on the provincial level to maximize the tax credit amount, but this is tricky.

If you like to learn more about how to stack SR&ED and CDAE or need some help, speak with our experts to find the best option for your firm’s specific needs.

Still Have Questions?

Read what our experts have to say in our SR&ED FAQ and CDAE FAQ articles.

If you’re considering submitting a CDAE claim or combining credits, don’t hesitate to contact R&D Partners at 1-800-500-7733 for more information or to schedule a meeting with one of our expert consultants.

Disclaimer: The views expressed in this article are provided for informational purposes only. It is not intended to nor can it replace the evaluation of your specific SR&ED or e-business tax credit claim by a dedicated professional.

SR&ED vs IRAP: Everything You Need to Know

The National Research Council of Canada Industrial Research Assistance Program (NRC-IRAP) and the CRA’s scientific research and experimental development tax credit (SR&ED) are two programs of major importance for Canadian innovators.  

In this article, we will examine the key similarities and differences between SR&ED and IRAP and how these programs can work together to maximize your government funding for your innovative technology project.   

Nature & Timing of Funding 

The first fundamental difference between SR&ED and IRAP is that the former is a tax credit, while the latter is a grant. This mainly affects when the funding is received from each program, but also the administrative overhead necessary to access funds, as well as the reporting requirements that come with the funding.  

A tax credit – like SR&ED – provides funding after the expenses are incurred. For Canadian Controlled Private Corporations, the SR&ED program offers a refundable tax credit disbursed after the CRA receives the claim. Therefore, SR&ED is typically less useful in cases when a business is looking to sustain their cash flow as they undertake a project.  

This is especially true when a business submits their first SR&ED claim, since the retroactive funding will not arrive until after the end of the fiscal year. However, when claiming SR&ED every year, the refund from the previous year helps sustain the cash flow for the next period.   

IRAP, on the other hand, requires monthly refund requests after the initial application is received and accepted. This means that a grant program such as IRAP is naturally more apt at sustaining a business’ cash flow while a specific project requires it. This is especially true for first-time applicants.  

Funding Amounts 

Once the federal and provincial tax credits are combined, SR&ED typically offers a refundable tax credit ranging from 54% (no provincial tax credit) to 74% (Quebec, beyond the threshold) of eligible salary expenditures to Canadian controlled private corporations. The exact tax credit rate depends on the size of the claimant company and a few other factors.  

IRAP on the other hand is a grant and its funding is allocated on a discretionary basis. A certain amount is approved with the initial application when a budget is submitted. Therefore, the final funding amount will vary depending on  the project, but typically goes up to 80% of salaries expenditures.  

Eligible Expenses 

IRAP and SR&ED share salaries as eligible expenditures, but treat them very differently. Since IRAP is a grant program and must be applied for before the project starts, applicants submit a budget which will end up dictating the amounts of funding they are entitled to receive, if accepted into the program.  

For example, ABC Corp plans to assign 2 employees to work on a project they wish to fund through IRAP. They include this in their application, and the NRC agrees to fund up to 50% of those 2 employees’ salaries. Three months later, they realize they will need an additional team member to complete the project. The additional employee who ends up working on the project will, in this example, not be covered by the initial agreement, and therefore, their salary will have to be paid by ABC Corp, with no additional support from the NRC.  

Since SR&ED is a refundable tax credit, it is able to account for all the actual costs incurred for a given project for the past fiscal year. Those costs are eligible salaries, subcontracting expenses, and other eligible expenditures related to eligible R&D activities for the SR&ED project. This may also include certain overhead expenses. 

This level of specificity is why time tracking is important for a company planning to claim SR&ED.  

Let’s consider ABC Corp again. Say they decide to forego IRAP funding altogether for simplicity’s sake – we will return to stacking IRAP & SR&ED later. They decide to attempt to claim SR&ED for their project at the end of the year instead and are tracking their employees’ time as it is spent on different tasks and projects.  

We will assume, for simplicity sake, that ABC Corp is eligible for the maximum 74% refundable credit and have 5 employees in total. 2 of them begin working on the SR&ED project, but at some point during the year a third employee joins the project. When the time comes to submit the SR&ED claim, their eligible expenses would be as follows, assuming they did not receive any other overlapping funding for the project:  

First, because they did not work on the R&D project at all, 0% of the salary of the 2 employees who did not do any experimental development work would be eligible for SR&ED.  

For the 3 remaining employees who did do eligible experimental development work, the amount of time spent on the project needs to be taken into account in order to determine which portion of their salary is eligible for SR&ED. 

According to their timesheets, at the end of the year it can be concluded that: 

  • Employee #1 worked on eligible experimental development work 75% of their time.  
  • Employee #2 worked on eligible experimental development work 50% of their time. 
  • Employee #3, who joined the project much later, worked on eligible experimental development work 25% of their time. 

Therefore: 

  • 75% of Employee #1’s salary for the claim year is eligible for a 74% refundable tax credit.  
  • 50% of Employee #2’s salary for the claim year is eligible for a 74% refundable tax credit. 
  • 25% of Employee #3’s salary for the claim year is eligible for a 74% refundable tax credit. 

Of course, SR&ED claims are never this straightforward, but this example seeks to illustrate the basic principles that guide how the eligible salaries are determined.  

SR&ED can also fund materials necessary for the project, something IRAP does not do.  

Evaluation Criteria 

While there is some overlap when it comes to the eligibility criteria of SR&ED and IRAP, there are some important differences to note. 

First, neither SR&ED nor IRAP have industry specific criteria – therefore, any company could theoretically be eligible as long as they are conducting eligible experimental development activities. 

Experimental development can look drastically different depending on the industry. Find out how to determine if your project is eligible in our blog post all about the topic here.   

This does not mean either program funds anything or everything. For example, IRAP excludes any clinical trial activities from their eligible project costs. This does not exclude pharmaceutical companies altogether but is still important to keep in mind when applying for funding.  

Furthermore, neither program formally requires a minimum number of employees or years in business in order to be eligible. That said, while SR&ED can be claimed by an individual – there is no incorporation requirement – IRAP does require the company to be incorporated, and the company generally needs to be revenue-generating as well. Businesses with more than 500 employees are not eligible for IRAP, as the program is purposed to support small and medium businesses.  

While IRAP does not require a minimum number of employees, the program’s monthly reporting requirements make it more complicated to handle for small businesses with little administrative staff. A business entirely run by its two co-founders or an otherwise very small, specialized technical staff are rarely awarded IRAP funding. Therefore, the size of the team does have an impact on the usefulness of IRAP to a specific company.  

SR&ED is usually more advantageous for such smaller teams because, while it requires diligent time tracking of all activities related to the project throughout the year, the claim is only submitted once for the whole year. 

A key difference to note between SR&ED and IRAP’s evaluation criteria is that the CRA has no return-on-investment considerations when they fund a SR&ED project. On the other hand, IRAP’s mission is to advance technology in Canada and stimulate Canada’s growth as a science and technology leader on the world stage. Therefore, eligible projects are selected much like investments. Only those with the greatest commercialization potential and that advance science and technology in a way that the NRC considers significant enough will receive funding. In this way, NRC IRAP is a competitive program – not all applicants, even if they may be eligible, receive funding.  

SR&ED is not subjective. As long as a project and related corporation/individual meet the criteria according to the lawit will be accepted – assuming the claim is submitted correctly and on time.  

Stacking  

It is perfectly possible for a company to benefit from both SR&ED and IRAP for the same project. However, a few things must be kept in mind.  

Since some eligible expenses could both be covered by SR&ED and IRAP, having received IRAP funds throughout the project would necessarily reduce the amount of the future SR&ED refund. Of course, the difference here is the timing of when the funds are received. As mentioned earlier, IRAP is better designed for supporting cash flow because of its monthly reimbursement structure, so it makes sense to apply for IRAP if increasing cash flow during the project is a primary concern. It will still be possible to submit a SR&ED claim and receive the refundable tax credit amount, but it will almost certainly be reduced by the amounts that overlap with NRC IRAP funded activities.  

Want to find out more about the best practices related to stacking funding programs? Read our dedicated blog post here.   

Stacking funding programs requires paying extra attention to the stacking limits of each program and how they interact with each other. Double-dipping – covering the same expense twice – can come with its fair share of trouble.  

This is particularly true when using IRAP as the NRC conducts a systematic audit of every application, whereas SR&ED claims do not automatically get audited.  

Have questions about the SR&ED audit process and how to prepare for it? Find out more here.  

Whether you get audited or not, you should always be ready by preparing your claim carefully and having all the necessary documentation. 

 

Disclaimer: This article is intended for informational purposes only and does not constitute professional advice.

To know more about SR&ED, IRAP and any other funding program and how your business can benefit from it, contact Mike Lee at:  1-800-500-7733, 110 mlee@rdpartners.com.  

Enhancements to Quebec’s University Research R&D Tax Credit

Two major changes to the University Research Tax Credit were announced in the latest Quebec budget in March 2021. These changes will make the credit more accessible and advantageous for startups and smaller research projects.

In this article, we will go over the tax credit basics, changes recently announced, and the impact on your next university research tax credit claims.

You can also read this previous article for more details on incentives found in the 2021 Quebec budget.

University Research Tax Credit Basics

The Tax Credit for University Research or Research Carried out by a Public Research Centre or a Research Consortium – more commonly referred to as the University Research Tax Credit – is one of the four components of Quebec’s provincial research and development tax credit. The other three components are the Tax Credit for Salaries and Wages (R&D), the Tax Credit for Private Partnership Pre-Competitive Research, and the Tax Credit for Fees and Dues paid to a Research Consortium.

Eligible expenses for the University Research Tax Credit are limited to cash payments made to a university or research center acting as a first-level subcontractor. To be considered a first-level subcontractor, the university or research center must undertake the research themselves, meaning they cannot subcontract the research activities.

The reimbursement rates for all four components of the Quebec R&D Tax Credit were standardized in 2014. The maximum rate now varies between 14% and 30% depending on the status and size of the company. The maximum rate of 30% is for Canadian Controlled Corporations with less than $50 million in assets. This article describes the changes announced in 2014 in more detail.

The advantage of the University Research Tax Credit is a higher inclusion rates for subcontractor expenditure (80%) in comparison to the inclusion rate under the more traditional Tax Credit for Salaries and Wages (50%). For a company at the 30% refundable tax credit rate, this can make quite the difference.

Finally, the work undertaken must be eligible R&D work.  Moreover, the main researcher on the project cannot be named as a party in the contract and the company that subcontracts the research work must hold at least some rights to the research undertaken.

University Research Tax Credit Changes

First, the 2021-22 Quebec budget abolished the requirement to obtain a favourable advanced ruling (“décision anticipée”) from Revenu Québec regarding the eligibility of the research contract to claim the tax credit. This requirement was removed primarily to reduce the administrative burden on firms looking to benefit from the measure.

Previously, the need to obtain a favourable advanced ruling cost $318 plus tax in application fees paid to Revenu Québec. Besides the direct fees, the time invested in preparing all the documents required for the advanced ruling was considerable. For some prospective applicants, after all the fees, the time spent preparing the documentation, the excluded amounts, and their effective refund rate, the cost of the application outweighed the benefits.

While the reduction of the administrative burden for applicants is a net positive – especially for smaller firms and earlier stage companies – the eligibility criteria previously verified at the advanced ruling stage have not been lifted. The same documentation will be required in event of audit.

Second, Revenu Quebec has also abolished its exclusion limit when it comes to the University Research Tax Credit for fiscal years beginning after March 2020. The exclusion limit previously made the first $50,000 spent on otherwise eligible R&D expenditures ineligible for tax assistance from Revenu Québec for companies with assets below $50 million. The threshold limit could be as high as $225,000 when the company’s assets were $75 million or more.

This exclusion previously applied to all four components of the Quebec R&D tax credit. With this change, it no longer applies to the University Research Tax Credit, but remains in place for the other three components of the Quebec R&D Tax Credit. This provides an even further incentive to claim the University Research Tax Credit in comparison to the other Quebec R&D tax Credits.

This change is also beneficial for businesses claiming other Quebec R&D Tax Credits in combination with the University Research Tax Credit. This is due to the fact that the total exclusion amount remains proportionately divided among the Quebec R&D Tax Credits the business claims, and then the portion associated with the University Research Tax Credit effectively gets discarded.


 

How R&D Partners can help

If you have any questions about this or other tax credit programs, do not hesitate to contact Dominik Klein at dklein@rdpartners.com, or at 1-800-500-7733 ext. 103.

Further reading:

2021-2022 Quebec Provincial Budget (in French only): http://www.budget.finances.gouv.qc.ca/budget/2021-2022/fr/documents/Budget2122_RenseignementsAdd.pdf

Quebec’s Tax Credits for Scientific Research and Experimental Development: https://www.revenuquebec.ca/en/citizens/tax-credits/tax-credits-for-scientific-research-and-experimental-development-rd/

 

Disclaimer: This article is for informational and general guidance purposes only.

SR&ED Frequently Asked Questions, Answered by R&D Partners Experts

Introduction

The federal scientific research and experimental development (SR&ED) tax incentive program (ITC) is one of the most generous in the world. As the largest federal funding program in support of business R&D in Canada, it awards more than $3 billion annually to companies that conduct eligible R&D activities. Compared to other programs, SR&ED is particularly accessible since it is industry agnostic and does not require businesses to be revenue-generating to be eligible for funding. However, its application process can often seem daunting – especially for new claimants – and its requirements are not always clearly understood.

We get questions about SR&ED all the time, so we decided to round up some of the more common ones and have the experts on our team answer them.

The Experts

Debbie Frail, P. Eng., MBA

Debbie has spent her professional career managing engineering, operations, and project teams in several technology fields. For over 20 years, she has successfully worked with clients ranging from entrepreneurs to multinational corporations to prepare and defend SR&ED tax credit claims. Debbie works primarily in the manufacturing, automation, and transportation sectors.

Patrick Campana , P. Eng., MBA

Patrick has been managing engineering and project teams in several technology fields for over 18 years. Patrick specializes in preparing and defending SR&ED tax credit claims for companies of all sizes operating in the telecommunications, software, and manufacturing sectors.

The Questions

How do I know if my project is eligible for SR&ED?

Patrick: SR&ED eligibility is based on a fundamental question: are you solving a technological uncertainty? If the current state-of-the-art technology available to you does not allow you to reach your technological objectives with a straightforward and known approach, your project is likely eligible for SR&ED tax incentives. However, the answer may not be that easy to ascertain depending on the situation.

Beyond technology specific criteria, the company’s size and experience in the field must be considered. Companies with extensive proprietary knowledge may have to push their experimental development efforts further than a less experimented company might need to do to qualify for the SR&ED program.  Conversely, a small company entering an unfamiliar area of technology for them may need to first go through a learning curve before reaching the state-of-the-art level of competency from where they can start working with the SR&ED program.

Ultimately, there is no one-size-fits all answer here, and each project still has to be evaluated on a case-by-case basis to determine eligibility.

Want to know more about how to evaluate your eligibility for SR&ED? Read one of our previous articles all about the topic here

What is the key to a successful SR&ED audit?   

Debbie: First, proper documentation is key. Keeping accurate time sheets and recording material and sub-contracting expenses is essential to a successful SR&ED claim.  Additional substantiating documentation to demonstrate the work done is also important. This can include records of tests carried out, analysis of results and conclusions made, meeting minutes, invoices, correspondence, modifications made to prototypes, and other contemporaneous information that can support the claim.

Additionally, it is important to be well prepared and knowledgeable as to the SR&ED program technical and financial tax requirements. For example, you can only claim the portion of an employee’s salary that is proportional to the amount of time they spent on eligible SR&ED activities – and not their entire salary for the year – unless they spent at least 90% of their time on activities that are eligible for SR&ED.

Want to know more about SR&ED audits and how to face them? Read our article dedicated to the subject here. 

What is the best way to track my project activities?

Patrick: The CRA doesn’t ask for any specific ways to track the project. The most important thing is to always have dated documentation, and there are a few ways to make it as simple and useful as possible.

Tracking individual tasks with a project management tool like Jira is not always the most helpful: this keeps the focus on low-level individual tasks and often lacks linkages to claimed SR&ED activities. Using an overall project map that gives a bird’s eye view of the project – its stages, who is assigned to which tasks and the general timeline – can be a simple and very useful tool. It can help anyone who is not familiar with your project – like a CRA auditor – understand it as a whole.  It is also a valuable resource to identify and justify which expenses can be claimed.

How should SR&ED program time be tracked? 

Debbie: You can only claim the salaries directly related to SR&ED eligible activities. This would exclude work that does not directly support experimental development, such as routine software development and routine quality control testing. It is important to track both eligible and non-eligible SR&ED program time to ensure you can demonstrate full work periods, and also to enable you to reclassify time in the event eligible SR&ED program time was improperly classified.

The worst way to track your time is of course to not track it at all: it often leads to either a refusal or underestimation of the time spent on eligible SR&ED work. This means that you are potentially losing money you could have been entitled to.

We recommend and work with three different kinds of time tracking systems: 1) intelligent spreadsheets we have developed for very small R&D teams; 2) our very popular, automated pull time tracking solution (contact us for a demo!) that requires very little training or work; and 3) established, customized web and ERP time tracking tools. This last option works best in large enterprises with well installed systems and methods.

How do I differentiate between SR&ED hours and non-SR&ED hours in my timesheets? 

Patrick: In most cases, it is not productive to ask individual contributors to classify their work as SR&ED or non-SR&ED in their timesheets, unless a project can be clearly circumscribed and identified as SR&ED work ahead of time.

Often, when a project encompasses both SR&ED and non-SR&ED activities, the final distinction can only be made retroactively, once one can determine what work went beyond the current state-of-the-art in an attempt to solve a technological uncertainty. Therefore, the important thing is to consistently label activities so they can later be easily retrieved and included in your SR&ED claim.

Artifacts naturally generated throughout the duration of the project – if they are dated and identify contributors and associated labels, will efficiently corroborate timesheet data down the road.

What is the best way to track my material expenses? 

Debbie: We often suggest that clients set up specific G/L codes for material and sub-contracting expenses that are related to a SR&ED claim in their internal accounting system. Tagging them and keeping track for when the claim is filed – and in case of audit – is crucial.

What should I do if I already received government funding for the project? Am I still eligible for SR&ED?

Debbie: Yes, you are still likely eligible for SR&ED even if you received other government funding – a grant, for example – for your project. However, you have to be aware of the stacking limits and of how the government aid you received or are expected to receive could reduce your eligible SR&ED expenses – or even your ability to claim the SR&ED tax credit.

The important element is understanding the stacking limits of every source of government funding, as well as the allowable interactions between these sources of funding.  Generally, more funding and funding programs are preferable. However, the cost of applying for, tracking, and reporting on the funding programs should be taken into consideration, as at some point additional funding programs will have diminishing or negative net funding returns.

Want to find out more about what to keep in mind when you apply for potentially competing government funding programs? Read our blog post all about it here. 

 

If you have any questions about SR&ED that this blog post left unanswered, or if you are considering submitting a SR&ED claim, don’t hesitate to contact our team at:  1-800-500-7733, ext.2

 

Disclaimer: The views expressed in this article are provided for informational purposes only. Iis not intended to nor can it replace the evaluation of your specific SR&ED claim by a dedicated consultant. 

The Dos and Don’ts of Grant Stacking

Entrepreneurs looking for funding in Canada have access to a large number of government programs that can support many of the costs associated with running a business: from R&D salaries and subcontractor costs to export-related expenses like market research and advertising to name only a few.

Despite the variety of programs in existence—whether they be tax credits, grants, low-interest government loans or other—many end up having overlapping eligible costs. Meanwhile, “double-dipping”—the practice of covering the same expense twice with two or more programs, under certain conditions and scenarios—is not allowed, for obvious reasons.

In fact, governments often put out multiple grants and tax credits intentionally focused on the same expenditures. Therefore, the number of programs available explodes. However, the expenses that can be covered are finite and to what extent they can be funded is generally capped at a certain percentage. This creates two problems:

1) The government is inefficiently and independently managing applications, claims, and audits for two or more programs that could be just one since they essentially cover all the same expenses.

2) Entrepreneurs need to apply for several programs rather than one. They try to maximize government funding but often do so without realizing that there are restrictions on the amount of funding a project or an expense can receive. This often ends up being less than the combined maximum offered by the programs the entrepreneur applied to, and the programs essentially “cannibalize” each other.

Over the last year, we have seen the second issue reach new heights as several—albeit very important—COVID-19 support programs, like the Canada Emergency Wage Subsidy (CEWS), became available to businesses. Since both the CEWS and the CRA’s Scientific Research & Experimental Development tax credit program (SR&ED) fund employee salaries, businesses claiming SR&ED in 2020 that benefited from the CEWS see a layer of complexity added to their SR&ED claim—they essentially need to remove their CEWS funding from their eligible expenditures for SR&ED when calculating their tax credit.

This process is further complicated by the changing funding rates of the CEWS—a subsidy that offered varying rates of financial support depending on the calculated revenue loss—as well as the SR&ED’s eligible activities and time tracking requirements. The CEWS / SR&ED cannibalization scenario was previously documented here, but this problem is not exclusive to emergency COVID-19 support.

Here is an example to illustrate the grant “cannibalization rate” concept more broadly. Take an imaginary company headquartered in Quebec with annual salary expenditures of $50,000. They develop innovative products and are eligible for the SR&ED tax credit. They find a grant to cover 50% of their payroll expenses for the year. Should they go for that grant?

The quick, obvious answer might seem to be “yes”. If they apply to the grant program and are accepted, they will ultimately receive more money from the government to cover the year’s salary expenses. But is that extra money worth it? When we break it down further, we quickly find that it might not be as advantageous as it first appears. This fictional company would benefit from running the following scenarios before making a final decision:

Note that in this example, we assume that the company is a Canadian Controlled Private Corporation (CCPC) where the incremental expenditure is above the minimum QC threshold. We can see that 54% of the grant ($13,625) is cannibalized before you even get to the cost of applying for or managing the grant, or the expected success rate. This leaves our example company with an $11,375 possible grant that is further reduced to $5,688 when we take typical success rates into consideration.

The cannibalization rates are generally between 35% and 55% for the situation above across other provinces prior to grant management costs. These cannibalization rates increase even more when dealing with other grants competing for the same expenditures until a ceiling is reached. In many cases, the cannibalization rates can reach 100% as early in the process as the second grant because the stacking ceiling has already been reached.

The simulation above is also interesting because we notice that the cost of applying for, managing, monitoring, and—heaven forbid—supporting the audit for, a grant is important to understand as well. It is estimated to cost $5,000 in the example.

When we add everything up, this fictional company only has a weighted incremental benefit of $688 if they go for the grant. However, the grant also may also provide this business with greater cash flow as it is received before the SR&ED tax credit. The value it can bring is not exclusively in terms of the total contribution received from the government; the timing is also important when considering this added cash flow.

In the end, always make sure you understand the success rates, cost, cash flow needs, net benefit, and what is important to you in a grant application before you pursue it. If you are planning to access competing government programs, then make sure you understand the cannibalization rates associated with combining them as well.

There are some excellent government grants that we use regularly for our business, but make sure you are informed before devoting time, energy, and money to applications that may not yield the return on investment you hoped for.

If you have more questions about grant stacking and cannibalization rates or want to find out how R&D Partners can help you maximize your government funding and simplify your life, please contact Mike Lee at mlee@rdpartners.com 1-800-500-7733, ext 110.

COVID-19 Funding and SRED: Best Practices for Canadian Companies

Over the past few months, we’ve seen various levels of government create many new funding programs for Canadian companies that were hit hard by COVID-19 or the necessary lockdown measures. This has affected nearly every industry, from the biggest industrial manufacturers to our favourite local restaurants and independent coffee shops. However, receiving this funding is not the end of the journey. For many innovative Canadian firms, getting ready to file a SRED claim for 2020, the influx of government subsidies and other supports brings confusion about how these funding programs interact with the SRED claim.

As a general rule, any government funding that a company receives and that goes towards their R&D expenditures must be deducted from the amount they include in their SRED claims. This is to avoid what is commonly called “double-dipping”, which happens when the same expenses are covered by two or more different sources of government aid. Moreover, stacking rules as specified by each funding program must also be adhered to. As your company prepares its SRED claims, forgetting to deduct non-repayable COVID-19 pandemic support from your SRED-eligible expenses could end up costing you time and money, especially if an audit is conducted. Below, you will find important information about two of the most important Federal Government coronavirus relief programs and how they may interact with your SRED claims:

1. Canada Emergency Wage Subsidy (CEWS)

This wage subsidy has already seen a few different iterations in its short existence. This corner stone of the federal COVID-19 support strategy has distributed over $60 billion to Canadian companies to date and will continue to approve applications until at least June 2021.

You may have accessed the full 75% wage subsidy in its early months, and then, depending on your industry and how much it was affected by COVID-19, seen your subsidy rate go up or down with the introduction of the base and top-up subsidies system that allowed some businesses to cover up to 85% of their eligible salaries.

When it comes to R&D expenditures, the principle of how to treat the CEWS funds remains the same, regardless of the claim month and exactly which proportion of your employees’ salaries was subsidized. However, individual calculations will vary greatly. You will need to keep a few key things in mind:

  • You only need to deduct the amounts of the wage subsidy that apply to employees that are actively engaged in research and development activities; and
  • You only need to deduct the amounts of the wage subsidy that are proportionate to the amount of time your employee actually spent on research and development activities in a given month.

Here is a practical example: Let’s consider a company that has 10 employees and benefited from a 75% wage subsidy from CEWS in April 2020. Each employee’s salary amounts to $1,000 a month, bringing the total CEWS amount the company benefited from for April to $7,500.

10×(0.75×$1,000)=$7,500

However, that month, only three employees spent time on research and development activities the company can include in their SRED claim. Therefore, only $2,250 would need to be deducted from eligible SRED expenses at most, and that is if all three employees spent 100% of their time on eligible R&D activities that month.

3×(0.75×$1,000)=$2,250

Say two of these three R&D employees spent 50% of their time that month on eligible activities, with the last spending 75% of their time on eligible SRED work. For our first two, you would only need to deduct $375 each, and for our last eligible employee $562.5.

50%×(0.75×$1,000)=$375

75%×(0.75×$1,000)=$562.50

(2×$375)+$562.50=$1,312.50

In total, you would have to deduct a total of $1,312.5 from April expenses from your total SRED claim to account for the monies received from CEWS that month and avoid any double dipping. Repeat this process for every month you received CEWS and conducted eligible R&D. This will give you the total amount you need to deduct from your claim for the financial year. Do not forget that your CEWS rate will vary from month to month and make sure to adapt your calculations accordingly.

(2×$375)+$562.5=$1,312.50

2. Canada Emergency Business Account (CEBA)

This program was initially introduced as a $40,000 interest-free loan with the possibility of up to $10,000 of that loan amount being forgiven if the remainder is repaid by December 31, 2022. On December 4, 2020, the total loan amount was increased to $60,000, with now $20,000 eligible for complete loan forgiveness.

While it is officially a government loan administered by various local financial institutions across Canada, the potentially non-repayable portion of CEBA should generally be treated like a grant at this time for tax accounting and purposes (this can be reversed if the loan is not repaid on time and the grant portion is thus lost). This grant portion is a form of government funding that should be deducted in the year it is expected to be received and could impact other government funding. The R&D tax credit expenditures are reduced by government aid that is associated with R&D activities and this may include both grants and loans with “noncommercial” terms, as long as the government aid is directly associated with these R&D expenditures.

The important element to keep in mind with respect to interaction of financial aid and the SRED tax credit program is that any government or non-government aid your business benefited from that is directly associated with the SRED expenditures must be taken into account. Complex and often competing stacking rules for each program must be considered as well. This includes the programs mentioned above and the many other COVID-19 and other government incentives, even if we did not specifically mention them in this short overview.

How R&D Partners can help:

If you have any questions about SRED or COVID-19-related government funding, or if you are considering submitting a SRED claim, do not hesitate to contact me, Mike Lee, at R&D Partners:

1-800-500-7733, 110

mlee@rdpartners.com

Determining SR&ED Eligibility by Industry and Project Type

Introduction:

Prior to the COVID-19 pandemic, Ibis World predicted that, over the next five years, the engineering services industry in Canada would begin to grow once more, having contracted following a drop in the price of crude oil in 2015. The field of biotechnology was similarly expected to expand. Though government assistance programs will help offset the impact of the COVID-19 pandemic, it’s unlikely that either industry will meet their original projections. Nevertheless, programs like SRED still exist to support activities within these industries, provided businesses know how to claim them.

Resources that describe general SR&ED eligibility criteria are abundant, but it is more difficult to find information related to specific industries or project types. For example, if you are in the aerospace industry and qualification testing takes up most of your fiscal period, how eligible is this activity? In this simple guide, we break down some key concepts and questions that may help you discern between eligible and non-eligible activities in certain industries.

 

Aerospace:

Often, the recipe for R&D and technology uncertainty in the aerospace industry comes from the fact that the field is stringent, regulated, and competitive . Technological objectives are constantly changing and becoming increasingly challenging to meet. Further, these objectives are often competing (e.g., reduced costs with increased performance) and demand experimental development to determine whether or not they can be met.

If your project is fairly mature and undergoing various rounds of certification testing, determining eligibility can be trickier. However, it is also worth noting that uncertainties can often be rooted in the sensitive nature of engineered goods and services being directly utilized by humans with serious safety implications. In the aerospace industry, durability and safety are typically expressed and certified under the following terms: 1) airworthiness (flight has been certified to be operative in air with passengers) and 2) flight availability (expressed as the probability of a fault occurring every flight hour, which must meet federal standards). As such, if there are uncertainties related to flight performance and safety that have yet to be understood and resolved, SR&ED continues, and related project activities could be eligible.

If you are able to answer “yes” to any of the following questions about your project, then related activities could be SR&ED eligible:

– Are there remaining tests required to prove the flight availability of your newly developed aerospace component (e.g., engine control software) in several flight and environmental scenarios?

– Is there still technological uncertainty that requires experimentation to determine whether objectives defined at the outset can be achieved?

– Are you still learning about interactions between control laws and flight performance in various flight maneuvers and environmental scenarios?

In addition to these scenarios, unexpected failures may arise during any stage of development and certification, necessitating further experimental investigation and SR&ED eligible activities.

Electrical Engineering, Electronics, & Control Systems:

Many widely-known theoretical tools have been established to explain and model phenomena in the areas of electronics, control systems, and electrical engineering . However, novel application of these theoretical tools in various devices and contexts may uncover complexities that necessitate experimental development, as modeling tools alone cannot accurately predict outcomes. What’s more, certain modeling efforts may be too computationally intensive, implying large costs and extensive development times. From these limitations, an opportunity for SR&ED occasionally arises as newer algorithms and modeling methodologies are developed, or as assumptions are made that must be experimentally evaluated. When developing new material systems and structures for semiconductor devices, antennas, and flexible transmission lines, for example, and subjecting these to uncommon signal frequencies and extreme environmental conditions, characterization activities that attempt to fill in gaps in the available knowledgebase could be eligible.

If you answer “yes” to any of the questions below, you could recover some of your R&D costs through funding programs like SR&ED.

– Are you developing new tools and algorithms to model otherwise complex and computationally exhaustive phenomena?

– Are you attempting to advance the state-of-the-art in microwave theory, signal processing, or non-linear control theory?

– Are you exploring new materials, processes, and leveraging quantum and electromagnetic theories to build next-generation semiconductor devices?

– Have you presented the theoretical basis to your current development at an IEEE conference?

– Does your project also add new knowledge to the fields of sensing, physics, chemistry, or signal processing?

 

Biomedical & Pharmaceutical Sciences:

Drug development and medical device development can be an expensive, multi-year process, but the good news is that many of these costs can be offset by several government-backed funding programs in Canada. From a SR&ED point of view, research and development in the life science sector is eligible on many fronts, compared to other technological sectors. For example, it is often clear what the established state-of-the-art is due to a vast collection of up-to-date publications concerning syntheses and clinical trials, the systematic, scientific approach demanded by SR&ED, and the uncertainty at different stages of development related to the efficacy, safety, and performance of chemical compounds and devices that interact with the human body. Given this, if you answer “yes” to the following questions, you’re likely eligible for SRED:

– Are you developing chemical compounds that interact with the human body?

– Are you dealing with scalability issues in large-scale synthesis?

– Are you building in vivo medical devices?

 

AI/Machine Learning:

Growth in the AI/Machine Learning industry has been rapid and widespread over the past few years. Accordingly, research institutions and industries alike that leverage AI/Machine Learning continue to be rewarded with lucrative funding opportunities. Naturally, the competition for securing these funds is also growing, and the bar continues to rise, especially where SR&ED eligibility is concerned. Nonetheless, if you are advancing the field of AI/Machine Learning or utilizing it to supplement your products or processes, we identified a few questions below that may help you better understand how eligible your AI/Machine Learning based project may be. If you answer “yes” to any or all of these questions, your projects are likely eligible:

– Would some of your work be potentially publishable in top-tier conferences in machine learning or directly advances a specific machine learning topic from a published resource?

– Are you dealing with strict performance requirements that, for example, encourage you to develop scalable and untested models and algorithms that can work with less data?

– Would your AI efforts and advancements impact another field of science like biology, chemistry, or agriculture?

 

Manufacturing:

Though SRED eligibility may be less common where traditional manufacturing is concerned, opportunities could arise when significant improvements to a product or existing process are sought, especially if artificial intelligence or advanced 3D printing can be leveraged.

If you answer “yes” to any or all of these questions, your manufacturing projects may be eligible:

– Are you attempting to increase production efficiency or adhere to more strict environmental regulations by applying technologies or materials that would not be conventionally used for your application?

– Additionally, does this require extensive experimental iterations?

– Are you adding new knowledge to other fields of science and technology, for example, processing advanced thermoplastics?

 

Conclusion:

It is important to examine both the experimental tasks and industry in which they are being undertaken to evaluate the eligibility and risk of a potential SR&ED project. Certain industries lend themselves well to SRED claims, while others are less obvious and more problematic. Having said that, we have successfully claimed SRED in some of the most unlikely industries, and there are a number of elements that can be incorporated into the process of filing a claim that will increase its chance of success. Please reach out to us if we can help you navigate the eligibility of a potential claim and ensure that all the possible steps are taken to maximize it and reduce the related risk.