Flow Ventures recently ran a workshop for startup CEOs who were participants in Founder Fuel, the startup accelerator from Real Ventures. The workshop covered the basics of the SR&ED financing program tailored for entrepreneurs. The top 10 questions from that workshops are reprinted here.

1. Is my project eligible for SRED?

It depends. SR&ED does not finance software development or product development. The program finances well-structured research and development activities undertaken by you to solve difficult problems. Most people mistakenly assume that a great product idea or lengthy engineering process means they will get a refund. This is not the case. That said, most technology companies, especially startups, have many legitimate R&D projects. They have to be described and documented properly.

2. What types of employees can be claimed?

Job functions that are directly involved in R&D can be claimed. The amount of their salary you can claim depends on how much of their time was devoted to R&D. Eg a developer can be claimed at 100% if they spent all their time on an eligible SR&ED project. Some supporting activities, like management or QA, can be claimed if they directly support R&D and again, you can prove that time was spent on the project(s) you are claiming. Non R&D employees, like graphic designers, copywriters, customer support and marketing people are not-eligible .

3. What types of expenses can we claim?

For the most part, you’ll be claiming the salaries of employees engaged in R&D. This includes outside contractors, though at a lower rate. Materials used/consumed in the course of R&D can be claimed. If you’re a software company, that might apply to dedicated hardware or software you require for testing. The program also allows you to claim an overhead amount (65% of eligible salaries). This benefits startups with little overhead and saves you from having to itemize every lightbulb in your office. See our post on a detailed discussion on the proxy method versus the traditional method and which method you should choose to maximize your claim.

4. How much can we get back?

The amount of your refund will vary depending on several factors, such as how many eligible employees you have (and what percentage of their time was on SR&ED activites), whether you have taxes owing from current or past years (SR&ED refunds are first applied to any taxes owing), your company’s structure, the province where your company is located or how much taxable income your company has. In Quebec, it is possible to get over 80% of your R&D labour expenses refunded. In Ontario, it is slightly less.

5. How much do consultants charge?

Different consultant charge different fees, though most if not all are structured as a success fee. If you don’t get your refund, the consultant doesn’t get paid. Generally, if your consultant is charging more than 20% you’re probably being overcharged. A good consultant will not just write your claim, but work with you throughout the year to gather documentation and help you prepare.

6. If we keep timesheets and use a code repository like subversion or git, is this good for backup documentation?

Yes, this is a good start. Keep in mind that since you are claiming research and development, you should also be documenting details regarding the challenges you have along the way, what worked, what didn’t work (this is valuable to SR&ED because it demonstrates that you had to experiment and that it wasn’t easy to arrive at a solution to your problem) and any relevant statistics. For example, if your SR&ED project involves trying to reduce page load latency, then you should also be documenting the statistic of how many seconds page loads are taking for each experimentation. Documenting bug fixes and features is not sufficient documentation.

7. How long does it take before we get our money?

It can take between 3 – 6 months after you file your tax return to get your refund cheque. If you’re claiming a large refund, it is  advisable to file your corporate taxes as soon as possible. CRA normally processes files within 90 days. In Quebec, the provincial government has its own processing which can add months even after you’ve been accepted.

8. How can we finance our tax credits?

First ask yourself if it is advisable to finance your tax credits. Doing so may put you under pressure as you aren’t guaranteed to get your refund, and it may take much longer than you expect. The ideal lender is your bank as their fees will be reasonable. Specialized lenders can be another option but be prepared to pay up-front fees as well as monthly interest than can be as high as 2.5% per month. Your investors may also be willing to finance your SRED refund. Talk to your SRED consultant about your options.

9. What if I outsource work to a non-Canadian contractor?

Unfortunately, that expense would not be eligible for SR&ED.

10. What if I get audited?

First off, a technical audit of your SR&ED claim is not a full audit of your company. If you’re well prepared, an audit can be a routine meeting during which you answer questions and present documentation. It can add months to the process but if you have a strong claim you have nothing to fear.

Getting selected for a SR&ED audit can send many claimants into a state of panic, especially if it’s their first audit. The fact is that there is an element of randomness in CRA’s audit selection process. It’s impossible to predict whether you’ll be audited and your claim can get selected no matter how well your technical narrative is written or how much documentation you’ve produced.

Nonetheless, there are ways you can anticipate and prepare for an audit and be confident that you’ll pass.

Large Claims Are Common Targets

The larger your claim, the more likely it is you’ll be audited, especially for first time claimants. If your claim is less than $100,000 you may not be reviewed. Over $500,000 it’s reasonable to expect it will be audited to allow the claim reviewer to learn more about your company, the types of projects you develop and provide any feedback on your SR&ED processes such as how you document your projects and your expenses. Bottom line: the bigger your claim the better you should prepare for an audit.

Issues with your Technical Narrative

Another reason that increases your chances of getting audited (or even rejected!) is writing an ineffective technical narrative that doesn’t focus on answering SR&ED criteria (i.e., technological advancement you were trying to achieve, obstacles and a description of the systematic experimentation you had to do to overcome those obstacles). If your answers to the questions on lines 240,242 and 244 of the T661 are unclear or don’t address the SR&ED program’s criteria, your claim risks getting rejected (even if it’s a valid project) or selected for an audit.

Don’t wait for the audit interview to try to explain why your projects are eligible.

Lack of Supporting Documentation

The lack of documentation might also provoke an audit. It’s not uncommon for CRA’s technical reviewers to ask for some supporting documentation to help them understand your project better and to verify the quality of the documentation. This can happen before an audit and an audit may not necessarily follow; however, if the documentation you send upon a reviewer’s request is inadequate or non-existent, it can increase your chances for an audit.

See our post on Common Types of Documentation Requested by Auditors

NOTE: On lines 270-282 of the T661, there is an area where you must indicate the types of documentation you have available for each project. It’s important to be able to back up each claim you make here; in other words don’t pretend you have more documentation than you do. The best strategy is to think about what documentation you should be keeping throughout the year.

Summary

So, while no one wants to be selected for an R&D audit, there is no cause for alarm if you have a well written claim and a well prepared set of backup documentation. Even if you claim is small to mid sized, it’s always important to write your technical narratives by answering the specific SR&ED criteria (e.g., leave out ineligible activities like graphic design and user features) and properly document your project.

We’ll have more tutorials coming up in the next few months that will help you with these last two areas, so keep an eye out for those and subscribe to our feed.

With the restructuring of the SR&ED program in recent years, project documentation is playing an increasingly important role in the success of a claim.

Ensuring that your team regularly documents the time spent, challenges faced and how those challenges were resolved will provide detailed data to write a strong technical report and reduce the risk of having your claim rejected due to lack of supporting documentation.

Here are 8 types of supporting contemporaneous documentation that auditors typically ask for.

1. Time Tracking

Time tracking for each employee and contractor you are claiming is one of the most important documentation practices you can implement to support the financial portion of your SR&ED project. (See “Do I need to keep timesheets for SRED?“)

There are many time tracking applications available but here are 2 free examples

Grindstone: A free Windows desktop application. They’ve recently added a paid cloud-based version.

ClockingIT: A free web-based application with lots of features.

2. Project Planning

Project planning documentation is important for validating start and end dates for the project, milestones, who worked on the project and when. Auditors want to see project planning documents because they provide the big picture of your project.

You can use a dedicated project management tool like Microsoft Project or simply use an Excel spreadsheet to define the major tasks, resources and time estimates.

3. Project Documentation

Traditional project documentation such as specifications, analysis, architecture, database diagrams, test plans and user stories will demonstrate to the auditor that you followed a systematic approach as you developed your project.

It’s important to maintain your documents and revise them accordingly as you progress through your research and development. Keep each version and label them appropriately so you can demonstrate the evolution of your project. Having to modify your approach or design can help prove that the problem wasn’t easy to solve and required experimentation and multiple iterations.

4. Research

You should also create a document or folder to store preliminary research that was done at the start of your project or during the course of development. SR&ED is compared against the standard practice or common knowledge available for the problem you are trying to solve. This can include for example, discussions with peers, third party research, communications with developers of third party components you are working with, forum discussions, whitepapers or academic research.

Having this research on hand will prove that limitations exist with current solutions and that you are attempting to achieve a technological advancement.

5. Versioning

An auditor will likely verify your version control system, such as Subversion or Git, to evaluate whether your project had to undergo multiple iterations; this demonstrates that your project’s challenges required experimentation and were not easy to solve.

6. Iteration Analysis

Evaluating each iteration can help you remember the problems you had, the different approaches you tried to solve them and any qualitative measurements applicable to your research project (e.g., how many seconds to load a web page) while it is still fresh in your mind.

You can use any tool to do this, either a simple document, wiki or project management tool like Red Mine that has different tools that can be used (e.g., wiki, forums, bug tracking).

7. Digital Communications

Email communications, text chats (MSN, Skype) between team members or with third parties, forum discussions (by your team or by peers) and blog posts where you discuss the technological problems you’re having and how you’re trying to solve them are all excellent ways to validate the problems you are trying to solve in your research project.

8. Written Notes

Auditors can also request informal documentation. This can include developer notebooks, hand-drawn diagrams or photographs of white boards diagrams/discussions.

Implementing these types of documents as you progress through your project will save you time when writing your technical report (whether you write it yourself or hire consultants), will increase your chances of getting your eligible project accepted and will reduce the time it takes to prepare for an audit.

Not all companies will have all of the above types of documentation and you do not necessarily need to have all 8 to pass an audit. The important thing to keep in mind is that you need to help the auditors to help you. That means you need to show a minimum amount of diligence in your record keeping as well as an understanding of R&D best practices. Doing so not only helps with your SR&ED refunds, it may help you in your business.

Timesheets are always a contentious subject especially when it comes to smaller businesses who do not have the same documentation resources of larger enterprises. Companies often ask if having timesheets will significantly bolster their chances of passing a SRED audit.

First of all, you do not need to submit timesheets with your T661 form. If you are not audited, no one will look at your record keeping. However, there is a new checklist (currently lines 270 – lines 282) that asks you to check off all the evidence you have to support your claim. Many unwary companies check all of the boxes in an effort to make their claim look better. This immediately sets off a red flag to reviewers and may result in an audit. If there is an audit and you are unable to produce the evidence, eg timesheets, you will have a problem.

The bottom line is: don’t check off items unless you are prepared to back it up.

With respect to timesheets, where they can help is proving that the employees you are claiming for R&D tax credits actually worked on the projects you claimed. This is especially important when the employees were not 100% dedicated to R&D. You need to show that you had a method of tracking their R&D and non-R&D time.

There are many commercial, Open Source and Web-based timesheet systems out there. Whichever one you choose, make sure that the time of each employee is properly categorized and labelled so it’s easy to tell which R&D project they worked on. The more detail you have the better, so breakdowns of work within a project are even better, eg analysis, architecture design, testing. There is no particular timesheet format that is SRED eligible so use your judgement. Auditors understand that smaller companies will not have the same level of documentation as larger companies (though don’t use this as an excuse to present shoddy documentation).