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.

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.

Today we’ll look more closely at the labour expenditures and what’s eligible.

Deduct Other Grants or Tax Credits

Before you calculate labour expenditures, it’s important to deduct any amounts received from government or non-government assistance from your eligible expenses. For instance, if an employee. who earns $75,000, was claimed at 60% of his salary for the SR&ED tax credit, then the portion of his salary that you could claim for the Multimedia tax credit would be 40% or $30,000. This rule applies to employees, shareholders and contractors.

Eligible Employees

After you’ve deducted any other assistance you’ve received from the salaries or wages of employees, you can claim the remaining expenditures for any employee who is directly involved in producing the multimedia title, such as designers, programers, writers etc. You’ll notice this list includes people not normally eligible for SR&ED, so the Multimedia Tax Credit is a nice compliment to R&D focused subsidies. Employees involved in the promotion or distribution of the title, such as marketing or sales, are ineligible.

Non-Arm’s Length Contractors

Like employees, you can claim the full amount of a non-arm’s length contractor’s fees, once you’ve deducted any portions that have been claimed in other government or non-government assistance programs. The contractor must be based in Quebec and be directly involved in producing the multimedia title.

Arm’s Length Contractors

For Quebec based arm’s length contractors, 50% of the eligible portion of their fees can be claimed.

The Quebec Multimedia tax credit is definitively worth looking into if you produce multimedia titles such as video games and interactive software as it provides a generous refundable tax credit of up to 37.5% on labour expenses. To apply or find out more about this credit that is managed by Investissement Quebec, you can visit their website at: http://www.investquebec.com.

Alberta

Calgary: General Information Seminar in English on January 10, 2012. REGISTER HERE

Edmonton: General Information Seminar in English January 31, 2012. REGISTER HERE

Quebec

Laval: General Information Seminar in French on January 18, 2012. REGISTER HERE

Ontario

Ottawa: Seminar on SR&ED Financial Issues in English on January 17, 2012. REGISTER HERE

This credit is primarily aimed at video game developers, but other multimedia titles can qualify if they meet the criteria that they are interactive and contain at least three of the following four types of data: text, sound, still images, moving images. Video is counted as one data type, and not two (i.e., sound and moving images). Some examples of eligible titles include video games, simulators and educational software.

What’s an Eligible Multimedia Title?

Eligible titles fall into two categories. The first category (Category 1) is defined as being a multimedia title that was produced without an order (i.e., not commissioned) and that is intended to be marketed to a wide audience using a structured marketing plan. Category 1 titles are eligible for a 30% refund on eligible labour expenditures.

An example of a category 1 title could be a video game development company that develops a new game on its own, without receiving an order for it from a third party.

Startups working in mobile gaming or online/casual gaming should not overlook this tax credit. You can fund some expenditures not covered in SR&ED for example. It’s true that this program was created back in the day when companies were publishing CD-ROM games (remember those?) but with the right application you should be receiving this tax credit.

Category 2 titles include other types of multimedia that don’t fall into Category 1. These titles are eligible for a 26.25% refund on eligible labour expenditures.

Some examples of a category 2 title include a title that was developed with an order (e.g., a movie producer hires a development company to produce a video game based on the movie), or a title that was developed for a specific purpose and that is meant to be marketed to a smaller or targeted audience (e.g., a company hires a developer to create a multimedia title for educational purposes within the company or for its clients).

So if you do contract work for clients that involves building a game or a multimedia educational training tool, you should be eligible for this tax credit. As with all client work, make sure it is clear whether you or the client has the right to apply.

Note that multimedia titles intended to promote a company’s products or services are ineligible in either categories, as are any titles that encourage violence, sexism and discrimination.

French Version Bonus

Category 1 titles can benefit from an additional 7.5% bonus on labour expenses if a French version of the multimedia title is produced. This can bring the total refund for a Category 1 title to 37.5%.

In our next post, we’ll elaborate on what labour expenditures are eligible. In the meantime, you can learn more about the Quebec tax credit for multimedia titles by visiting the Investissement Quebec website.

Since places are limited, it’s important to register in advance for these events to reserve your place.

Quebec

Montréal

: December 14, 2011 in French

Location:

Time: 9:00 a.m. to 12:00 p.m.

Location:

Revenue Quebec

Complexe Desjardins

Montréal, QC

Rooms 3.2 and 3.3

For more information or to register call (514) 496-1317.

You can register online here.

Ontario

Waterloo

: December 7, 2011 in English

Location:

Waterloo Memorial Recreation Complex

Lions Room 200

101 Father David Bauer Drive

Waterloo, ON N2J 4A8

Time:

8:30 a.m. Registration

9:00 a.m. – 4:00 p.m. Seminar

You can register online here.

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 : http://www.cra-arc.gc.ca/E/pub/tp/it419r2/it419r2-e.pdf.

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).

Alberta

Calgary
T661 Workshops (English): November 15, 2011

Ontario

Mississauga
Public General Information Seminars (English): November 9, 2011

Ottawa
Public General Information Seminars(English): November 22, 2011

Toronto Centre
Public General Information Seminars (English): November 22, 2011

Quebec

Laval
Public General Information Seminars (French): November 16, 2011

Montréal
Public General Information Seminars (English): November 9, 2011

Québec
Public General Information Seminars (French): November 9, 2011

Saskatchewan

Saskatoon
Public General Information Seminars (English): November 16, 2011

To register for any of the seminars or workshops, visit the CRA website.

To register for any of the seminars or workshops, visit the CRA website.

Here is the upcoming schedule for seminars in October:

Alberta

Calgary
Public General Information Seminars (English): October 4, 2011

Ontario

Hamilton
Public General Information Seminars (English): October 27, 2011

Mississauga
Public General Information Seminars (English): October 12, 2011

Ottawa
Public General Information Seminars (English): October 18, 2011
Public Seminars on SR&ED Financial Issues: October 25, 2011

Toronto East
Public General Information Seminars (English): October 18, 2011

Quebec

Chicoutimi
Public General Information Seminars (French): October 12, 2011

Gatineau
Public General Information Seminars (French): October 19, 2011

Montreal
Public General Information Seminars (French): October 27, 2011

Pointe-Claire
Public General Information Seminars (English): October 26, 2011

In this post, we’ll look at the factors that make up a strong technological advancement statement that conforms to the SR&ED program’s eligibility criteria and then look at an example.

Keep in mind this isn’t a guide to guarantee that your project will pass. That’s dependent on the actual R&D you’re doing as well as the CRA’s judgement. The goal here is to help you avoid explaining aspects of your technology that may be great for your customers and your business, but not eligible for SR&ED.

1. Focus on the technology behind your product.
While it’s alright to mention your product and some business features in the introductory paragraph to give your reader context, it’s important not to focus on the features when you state what your planned technological advancement is. Most features are solutions to business problems, not technological problems.
2. What problem are you trying to solve?
Speaking of problems, if you’re having trouble isolating and describing the technology you’ve created, look at the problems you had to solve during development. Were there any problems that required you to experiment with different approaches? Was the solution not just applying standard practice to solve it?
3. Compare what the industry’s standard practice is and what limitations there are with it.
This will help the reader understand what the existing industry knowledge base is and provide them with a comparison to measure the advancement you’ve made. If you show you’re advancing the state of technology not only for yourself, but for your industry, that’s a good thing (for everyone).
4. State how you will measure success.
Include any concrete metrics (estimates are acceptable) such as time (e.g., we sought to achieve page rendering in 25 ms), percentages (e.g., performance was improved by 30%), or any other units of measurement (e.g., we reduced total application size by 500MB). This type of information strengthens the claim and demonstrates that a “systematic approach” was followed as you measured progress through each experimental iteration. This also allows you to show failures (assuming you had some). You’ll have data that shows the outcome was uncertain because some of the time you didn’t get the result you wanted.

Let’s see how we can apply these tips to improve a poorly stated technological advancement. CAVEAT: we’re assuming here that the 2nd statement is what you actually did, and the 1st statement just doesn’t properly capture it. We aren’t suggesting you make it up.

First, here’s the bad example:

We developed a mobile game called Car Racing that allows users to race against each other on different phones.

Now, here’s a better way to describe your work:

We sought a technological advancement that allows bi-directional communications in real-time ( < 1 second latency) on 3G networks by developing ways to minimize memory usage on the limited 256 MB memory available on mobile devices. The current practice is to compress graphics but the available tools add metadata to graphics thereby causing our high resolution graphics to be too large and memory intensive.

Again, we’re not saying the improved description is perfect. But it does focus on the technological advancement at play in your application, not the features. If your project descriptions don’t sound like your product, that’s ok. Your product is trying to solve a business problem. Your SRED claim is trying to find out which aspects of your work are eligible for tax credits.

Learning how to craft a technological advancement statement correctly will demonstrate to your reader – the auditor – that you understand the SR&ED program’s criteria and that you are only claiming what is eligible. If you try to keep these 4 tips in mind as you formulate your technological advancement statement, you’ll strengthen your claim by focusing on the eligible components of your project.