Spring is a crucial time for tax filers and, by proxy, their advisors and consultants. In my years of helping clients file their SR&ED claims, I’ve seen all the mistakes imaginable.
I’ve made a list of the most costly ones and divided them in 3 main areas: preparing your SR&ED claim, filing your SR&ED claim and defending your SR&ED claim.
PREPARING YOUR SR&ED CLAIM:
CCPC or not to CCPC: There are different types of corporations and, for tax purposes, it’s important to select which one applies to you. Canadian Controlled Private Corporations (CCPC’s) are eligible for refundable tax credits with an enhanced Investment Tax Credit (ITC) tax rate. Determination of CCPC status can be complex but a good place to start would be shareholder residency. This is particularly important for companies who are undertaking new, non-Canadian individual or institutional investors, as this may trigger non-CCPC status. Furthermore, you need to ensure that your company is not a partnership structure or other type of corporation in which the treatment and utility of ITCs earned is ambiguous.
SR&ED expenditure limits and associated corporations: Companies with associated corporations for tax purposes can share the SR&ED expenditure limit to maximize refundability of ITCs at the enhanced rate. Companies who have expenditures near or exceeding the $3M limit and multiple associated companies need to investigate this further. Refer to Schedule 9 of your Corporate Tax return to determine any associated and related companies. Schedule 49 can be used to allocate their SR&ED expenditure limits. As this determination can be quite complex, your best option is to consult with a tax professional.
Taxable Income and Taxable Capital: There are numerous tax planning opportunities associated with companies who file SR&ED claims. The most obvious involve the amount of taxable income and taxable capital. When a company gets to a certain size it may face possible reductions in both its eligibility for refundable tax credits as well as its SR&ED expenditure limits. For smaller companies who have no taxable income or very large profitable companies, the treatment is pretty obvious. However, larger profitable companies that generate taxable income near or in-excess of the business limit of $500,000 and/or taxable capital greater than $10M should consult a tax professional to optimize their SR&ED ITC refunds.
FILING YOUR SR&ED CLAIM:
The 18-month deadline: This is a big one. The 18-month deadline is a statute barred deadline that even the Minister of Revenue cannot overturn. Also, if your file is incomplete, the CRA is within their right to refuse any additional information past this deadline. The deadline can change depending on the year-end changes associated with company transactions and reorganizations. So check your year-end. Then double-check it. And to be safe, don’t wait until your 18 months are up.
Project Descriptions: The project description is the heart of any SR&ED claim. I’ve seen way too many shoddy and incomplete project descriptions. Although it’s not necessary to divulge any ‘trade secrets’, it pays to exercise basic common sense. Can you really justify a mere 7 lines of “Work Performed” when you are claiming 2 man-years of effort? It’s also smart to describe your project in the simplest technological terms possible. Keep in mind that word limits imposed by the CRA are strict, as any excess words are simply truncated by their automated system. Carefully study the published CRA guide to fully understand what content you are expected to provide.
Documentation, documentation, documentation: Documentation is the key to both defending your claim and assessing eligibility. Without a contemporaneous record of the SR&ED work the chances of a project being deemed ineligible rises substantially. The more your claim is worth, the more documentation you need to provide. The gold standard of documentation includes a link between the activity, the time involved and the performer. Keep in mind that SR&ED is about the “how” or the “process” of experimental development rather than the “what”. Showing a working product does not prove you undertook SR&ED. Read our Step-by-Step guides on how to document SR&ED better.
Government Assistance: Line 429 of your SR&ED claim form T661 is where “provincial/territorial government assistance” is claimed. Many don’t realize that this also includes any provincial SR&ED or R&D tax credits you expect to receive in the tax year. This may also include other forms of provincial government assistance such as grants and subsidies. Although most tax preparation software fills this line automatically, in almost all cases this line should be filled (by hand) if you have a provincial SR&ED claim. If this line is missing, it may trigger an incomplete flag by the CRA’s automated systems (see below).
Check it out: The CRA provides a complete checklist of what is needed when you file your SR&ED claim. As many companies rely on 3rd party tax preparers or accounting firms, it’s important to check the entire claim for completeness and that all information is correlated. For example, if you claim SR&ED contractors make sure you fill in the contractor line(s) with the necessary information. The CRA assesses your claim with a combination of automated and human processes. The more errors and omissions in a SR&ED claim, the more likely it is to get picked up for further human review.
DEFENDING YOUR SR&ED CLAIM:
Respect thy CRA: Did you know that around 1 in 20 CRA letters go unanswered? I once received a frantic call from a CFO about a multi-million dollar claim had been denied because their new R&D Director, a recent hire from overseas, did not know anything about SR&ED and thus, completely ignored an audit request from the CRA. It’s important to acknowledge reception of any CRA Request for Information letter and to communicate any questions directly to the assigned auditor. If you have yet to hear back about the status of your SR&ED claim after a few months, always follow up, starting with the 1-800 CRA business enquiries line. If you do get selected for an audit, keep reading.
Audit Preparation: The Boy Scout motto “Always Be Prepared” also holds true for SR&ED audits. Although they are officially called “reviews”, don’t be deceived by the euphemism. Plant tours, product demos and free donuts will not sway the auditor’s assessment. Being prepared means 1) proving science eligibility and 2) presenting employees who possess “hands on” experience with the work being claimed and who understand the program requirements. The tone of the review should be professional and productive, not confrontational and adversarial.
I hope the tips above help you avoid costly mistakes during the busy tax season.