SRED Facts

Information about Canada's SR&ED Tax Credit Program

Arm’s Length vs. Non-Arm’s Length Contractors

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When you claim contractors on your SR&ED project, you will need to classify them as being either arm’s length or non-arm’s length.

So how do you determine which category your contractors fall into, and what are the advantages or disadvantages between these two types of contractors in terms of SR&ED?

Arm’s Length

Contractors that are independent from you and your company will fall into the category of arm’s length contractors. Being independent means that you (or any other shareholders of your company) don’t have any blood ties (e.g., marriage, family, common-law partnership, adoption) with the contractor or have control in the contractor’s company. In terms of the Tax Act, control is defined as “owning enough shares to have the majority of the votes in the election of the board of directors.”

Non-Arm’s Length

A non-arm’s length contractor is simply the opposite. You (or any other shareholders of your company) will have either a blood relationship with or control over the contractor.

For example, a business owner that hires a contractor who is a family member or a business owner that subcontracts work to a business in which he owns shares would NOT be dealing at arm’s length with each other.

Note that the Income Tax Act also contains a specification on associated companies, which would also fall under the category of non-arm’s length. Associated companies are typically created to take advantage of tax breaks (e.g., to reduce the amount of tax payable or to benefit from increased ITCs) and are defined as being two (or more) companies that are closely related in terms of business activities but are controlled by different people. For example, a software firm might have a development company and create a separate company to handle the sales of the software it creates.

For further details on the meaning of arm’s length and non-arm’s length, you can view the CRA’s official Tax Information Bulletin, “Meaning of Arm’s Length” at :

Arm’s Length vs. Non-Arm’s Length in SR&ED

In terms of SR&ED, arm’s length contractors have a greater advantage because they qualify for the investment tax credits (ITC), whereas non-arm’s length contractors do not qualify for ITC. If you look at the T661 form, Part 4, you’ll notice that on line 541 you need to deduct non-arm’s length contractors before calculating the ITC in the T2′s Schedule 31.

Since non-arm’s length contractors reduce your potential ITC, you may want to evaluate whether you can adjust this status at the start of your SR&ED project. For instance, if your non-arm’s length contractor is a family member, you could evaluate whether putting them on your company’s payroll as an employee is feasible; this would maximize your claim because they would not only be eligible for the ITC, but they would also qualify for the additional 65% overhead allowance (PPA).

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