Accountants and businesses have a difficult time understanding Canada’s complex Scientific Research & Experimental Development (SR&ED) tax credit legislation. Here, in the first of a series of expert articles, Richard Hoy, our President of Catax Canada, tackles some of the pitfalls to watch out for.
When you’re looking to make a claim for R&D tax incentives in the form of Scientific Research & Experimental Development (SR&ED) tax credits, the focus is inevitably on what you or your client have been investing in.
However, it’s also important where that money came from in the first place.
One of the biggest blindspots in SR&ED circles is how grant funding can heavily impact a claim.
This is because tax relief can’t usually be claimed on SR&ED expenditure that has been funded by grants. This rule applies even if the funds have come from a non-governmental source.
On the one hand, government or non-government grants only affect qualifying SR&ED expenditure on a project-by-project basis. This means that funding directed at one project can’t reduce the qualifying SR&ED expenditure of another.
However, the total amount of deductible SR&ED expenditure for each project is reduced by the value of any assistance given to a project in respect of R&D. Crucially, not all expenditure related to R&D is eligible for SR&ED tax relief. This means there’s a danger that grant-funded spending on things that don’t qualify for SR&ED tax credits still reduce a company’s overall claim.
Beware of vague wording
The way to avoid this is to ensure that the wording of each grant explicitly states what the funding is for. If it’s only intended to cover activities that don’t qualify for SR&ED, then the grant award needs to make that clear.
For example, if a grant was awarded to fund capital expenditures, which are not eligible for SR&ED tax credits, then make sure this is clearly stated so it can’t be misinterpreted as funding intended for wages (which are eligible).
If a grant is only intended to partially cover ineligible expenses, then it should be made clear what portion of the assistance applies to those activities.
Wiggle room — is it a grant or loan?
It’s not possible to avoid this trap by simply reclassifying the grant as another form of funding. For example, if a condition was included that meant the money would be repaid in the form of royalties if profits were earned from a project, then the CRA would interpret that as assistance rather than a business loan of some kind.
Arrangements like this are often referred to as ‘forgivable loans’, because the recipient may never have to pay any of it back.
An example of one of these has come about as a direct result of the pandemic — the Canada Emergency Business Account (CEBA). This is a key plank of Canada’s Covid-19 Economic Response Plan. It consists of an interest-free loan of up to $40,000, 25% of which will be written off if 75% of the loan is repaid by December 31 2022. Companies can therefore save themselves up to $10,000 by repaying by this deadline. The loan itself does not qualify as ‘assistance’, but the written off amount does. So it would be this forgiven debt of up to $10,000 that reduces a company’s SR&ED claim rather than the original CEBA loan itself.
The cost of inaction
A second major trap to avoid — which often surprises businesses and accountants alike — occurs when a company is entitled to a grant or financial assistance but doesn’t take it. You might think the company can still claim SR&ED on the full eligible expenditure — but this isn’t true. This will still count against the claim.
If a firm is entitled to receive assistance but chooses not to take it, its total claimable SR&ED costs will be reduced by the value of the unexploited grant.
The CRA rules are clear about the fact that “the pool of deductible SR&ED expenditures is reduced by any amounts of government assistance or non-government assistance that a claimant has received, is entitled to receive, or can reasonably be expected to receive on or before the income tax return filing-due date for a tax year for SR&ED current expenditures”.
This will affect even those companies who aren’t aware of the assistance available to them so it’s essential any business claiming SR&ED, or their accountant, stays up-to-date with the grants landscape and what is available.