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Not all innovation is born equal when it comes to SR&ED

Date: January 24, 2023

Businesses undertake innovation all the time but when it comes to the tax incentives they are eligible for, not all activity is judged the same.

It’s often assumed that all research and development qualifies for tax incentives but dubious claims are still frequently received and rejected by the Canada Revenue Agency.

In fact, separating the innovation that qualifies from that which doesn’t is one of the hardest things companies have to overcome when first making a claim. It often takes a while for a business to learn exactly what kind of innovation the CRA is looking for. The Scientific Research and Experimental Development (SR&ED) program is unique and R&D activity must match specific criteria.

In this article, Richard Hoy, President of Catax Canada, highlights a common misconception.

Breaking down the difference

One misconception we often come across is that testing of existing solutions forms qualifying activity. This is likely to be because prototyping and testing is usually considered part of the R&D process.

Let’s take an example. We once came across a bicycle manufacturer that was not happy with the reliability of its painting process for red bicycles. High ambient temperatures in the shop during the summer and variable humidity levels meant adhesion was poor. Testing showed that having an even thickness over the bike frame is also important to prevent paint chipping and fading.

Having searched for industry solutions, they chose some promising techniques and began to test whether they would solve the problem. This work was certainly R&D but it wasn’t SR&ED. They were simply trialling solutions that already existed and weren’t contributing to greater technical knowledge within their industry. This is how product selection, even if testing is involved, differs from experimental development.

Then the company realized they still couldn’t apply the paint evenly in all seasons and began testing modifications to the conveyors, which rotate the bike frames through multiple axes as they go through the paint shop. They needed to be able to apply the paint properly within two passes otherwise productivity would suffer.

After experimenting with sacrificial coatings where the paint was still too thick, the company opted to trial targeted sprayers on the final stage of the conveyor’s final pass to add paint precisely to undercoated areas. Testing showed they’d finally solved the problem. This experimental development project taught the client something new and, therefore, did qualify as SR&ED.

How this impacts your claim

It is normal for a company to present a portfolio of different projects to the CRA, knowing some elements could be rejected. The CRA is used to going through claims with a fine-toothed comb to assess what is rewarded with tax incentives, but determining what could qualify beforehand is key to ensuring your claim goes through quickly and smoothly.

Delays can be common but it pays to get your affairs in order to help speed up the process. Hiring a specialist in SR&ED, or asking your accountant to get clued up on what qualifies, can help with this.

Accountants will often come to us looking for advice on how their clients can claim SR&ED because, even after years of working in the tax arena, understanding what qualifies for this program can be challenging.

The benefits typically outweigh the cost of hiring a consultant, though, and we regularly process claims worth tens of thousands of dollars, which can prove absolutely game-changing for smaller firms.

If you are a business or an accountant interested in hearing more about the different types of innovation that qualify for tax incentives, set up a discovery call by emailing Richard Hoy, president of specialist tax consultancy Catax Canada, at Richard.Hoy@catax.com.

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