Scientix Inc.
Working with you to maximize your SR&ED incentive

In 2012 CRA began a process of updating their SR&ED publications, ostensibly to make them easier to understand. To give them credit where it is due, they have made significant progress.

The prior to December 19, 2012 the main document discussing and setting guidelines as to what constitutes SR&ED was Information Circular (IC) 86-4r3 in May 1994; this was a 15-page document. This was replaced in December 2012 by Eligibility of Work for SR&ED Investment Tax Credits Policy, a 9 page document, which took effect on publication and is much easier to read.

The three criteria for SR&ED eligibility set out in IC86-4r3, namely Technological Advancement (TA), Technological Uncertainty (TU) and Technological Content (TC) remain.

However, instead of asking the taxpayer three questions, focussing on the each of the three criteria separately, CRA will now approach the eligibility decision based on five questions. These are:

1. Was there a scientific or a technological uncertainty—an uncertainty that could not be removed by standard practice? (TU)
2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty? (TU, TC)
3. Was the adopted procedure consistent with the total discipline of the scientific method, including formulating, testing, and modifying the hypotheses? (TC)
4. Did the process result in a scientific or a technological advancement? (TA)
5. Was a record of the hypotheses tested and the results kept as the work progressed? (TU,TC)

The intersection of the original 3 criteria and the 5 questions used commencing in January 2012 are shown in the above list.

Where do the five questions come from? In 1998 the Tax Court of Canada heard an appeal by Northwest Hydraulics against a CRA decision to disallow their SR&ED claim for five projects. The tax court, in a 30 page decision, found that four of the Taxpayer’s projects were eligible for SR&ED. In this decision Mr. Justice Bowman enunciated five tests for the existence of “systematic investigation” as provided for in the Income Tax Act. These tests form the basis for CRA’s five questions and are taken almost verbatim from this case.

For those interested in reading the complete decision it may be found by following this link: Northwest Hydraulics

The Northwest Hydraulics decision has been cited in most of the Tax Court of Canada decisions on SR&ED and often referred to by CRA to justify disallowing work as not eligible for SR&ED.

CRA has announced that there will be changes to the T-661 form to be published in October 2013 which will reflect the changes to the eligibility criteria. Effective January 1, 2014 this new form will be the only version of the T-661 accepted.

In next week’s blog we will address what companies need to be doing to ensure compliance with these new standards.

If you wish further information please feel free to contact

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SR&ED Basics

Scientix Inc.

Working with you to maximize your SR&ED incentive

What Is SR&ED And How Is It Defined?

SR&ED is an acronym for Scientific Research and Experimental Development, a federal incentive program for companies performing SR&ED. Many provinces have similar programs. In the past several years the Federal Government has issued $3+ Billion, annually, in SR&ED credits.

Over the past few years the frequency and rigor of SR&ED Technical Reviews has increased noticeably, as has the frustration of SR&ED claimants. This trend will continue. In addition the incentive available has been reduced.

This has resulted in some would-be claimants withdrawing from the program. Worse, would-be claimants who might benefit from the program are discouraged from making a claim.

This could be a costly mistake. This is particularly true for Canadian Controlled Private Corporations (CCPC’s in accounting language). A CCPC is defined as a Canadian-controlled private corporation, whose taxable income is $500,000 or less, including the income of any associated companies. These companies can qualify for tax credits of up to 70.6 cents per dollar spent on SR&ED, with a minimum credit of 36.4 cents per dollar spent. (Rates are based on companies performing SR&ED in Ontario).

How often have you been offered rebates of this magnitude for doing something that most businesses should be doing anyway, if they want to stay ahead of the technology curve?

So is SR&ED the same as R&D. Most definitely not.

SR&ED is defined in the Income Tax Act as:
scientific research and experimental development means “systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is
(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,
(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or
(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,”
What differentiates SR&ED from R&D are the following:

1. Technological advancement (TA)
2. Technological uncertainty (TU)
3. Technological content (TC)

In order to qualify as SR&ED, the project must meet what we term the “3-legged stool test”. Just as a 3-leeged stool cannot stand without all three legs, a SR&ED claim must comply with all of the three tests cited above.

What is most interesting is other than TA, the expressions “technological uncertainty” and “technological content” are nowhere mentioned in the Act or the Regulations to the Act.

TA occurs, according to CRA, from the resolution of a TU.

A TU according to the CRA’s Glossary of Terms is defined as follows:: “Scientific or technological uncertainty means whether a given result or objective can be achieved or how to achieve it, is not known or determined on the basis of generally available scientific or technological knowledge or experience”.

TC refers to several the presence of several elements:
• The work is carried out by people who are technically qualified for that work. It is judged by either academic credentials, certifications (e.g. licensed mechanic) or job experience.
• Use of the scientific method.
• Documentation. The CRA is focussing more and more on the issue of documentation. Even if one has both TA and TU covered, if one can’t document them, then the SR&ED claim will fail.

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Change to SR&ED T661 Form Coming This Fall

CRA has added a new form to replace the existing T661 form. Use of this new form will become mandatory on January 1, 2014 for all years. The posting follows below:

SR&ED T661 Claim Form – 2013 Revision

In October 2013 the Canada Revenue Agency (CRA) will be releasing a revised Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, to accommodate the legislative changes coming into effect on January 1, 2014, and to make sure the form is consistent with the consolidated SR&ED policy documents released in December 2012.

This version of the form will also consolidate former Sections B and C in Part 2 so that all claimants answer the same three questions in Section B. The order of the questions in Section B will also be changed for consistency with the Eligibility of Work for SR&ED Investment Tax Credits Policy document released in December 2012.

This revised version of Form T661 (13) (revision code 1301) will be effective as of its publication date. We encourage you to start using the new form as soon as it is available.

You can submit the T661(12) version of the form until December 31, 2013. Starting January 1, 2014, we will accept only the T661(13) version of the form for all tax years.

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SR&ED and the March 21, 2013 Budget

There was little of consequence in the March 2013 Budget that relates to SR&ED.

What was of interest, however, was a new requirement for applicants to provide information about their consultants (Business Number) and the basis of the fees paid to them. This requirement will take effect for SR&ED claims filed on or after January 1, 2014.

Failure to provide this information may result in a fine of $1,000.

In 2012 the CRA asked for feedback from the SR&ED community of the issue of the impact of contingency fees on claimants and potential claimants. The responses showed no great concerns about this issues. Responses from the consultant community asked CRA to disclose the information that formed the basis of their concerns about contingency fees.

This may be a case of “Be careful what you ask for. You might get it.”

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SR&ED T661 claim form – 2012 Revision

In October 2012 the Canada Revenue Agency (CRA) will be releasing a revised Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim, to accommodate the legislative changes proposed in the March 2012 federal budget that will be coming into effect starting January 1, 2013.
This revised version of Form T661(12) (revision code 1201) will be effective as of its publication date. We encourage you to start using the new form as soon as it is available.
You can submit the T661(11) version of the form until December 31, 2012. Starting January 1, 2013, CRA will accept only the T661(12) version of the form for all tax years.

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Employees or Consultants for SRED work?

Many companies choose to use consultants to conduct R&D. Among the reasons for doing so are the perception that they can avoid the extra costs of paying for the employer’s portion of CPP and UI. They also feel that they can also avoid termination costs when the need for the consultant ends.

The numbers do not support this argument.

A salaried employee earning $50,000 per year costs an employer $53,147, including CPP and EI premiums. A consultant earning the same rate costs $50,000, a savings of 5.92%. This seems to support the perception.

However, the employee engaged in SR&ED activity generates $82,500 in Eligible Expenditures; a consultant only $50,000. For a CCPC in Ontario the employee will generate total tax credits of $37,579 (75 cents for every dollar of salary cost). Using a consultant generates only 45.5 cents of tax credits per dollar spent. This is due to the 65% Prescribed Proxy Amount (PPA) that can be added to the claim for  wages and salaries.

The changes in the SR&ED program contained in the 2012 Budget create an even larger payback on the use of employees for SR&ED, even though the PPA is reduced to 55%. This is because only 80% of contract expenditures can qualify. The same $50,000 consulting fee that today creates a $50,000 eligible expenditure will, commencing January 1, 2013, be worth only $40,000.

The end result of these changes is that a $50,000 expenditure on salaries will generate $35,301 in credits; the same amount spent on consultants will only generate $18,220 in tax credits. The ratio in favour of employees over consultants increases from 1.65 to 1 to 1.94 to 1.

What has been absent so far in this discussion has been the termination cost associated with employees. This can be avoided by using employment contracts. Also, it should be remembered that using consultants opens the risk that CRA may consider them to be employees, which can result in CPP and EI premiums to the employers, along with penalties and interest for not withholding and remitting.

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The Federal Budget introduced today contains a number of the recommendations in the Jenkins Report.  The table on the next page summarizes the main changes.

The good news is that the program has fundamentally remained the same, although it is somewhat less generous.  It still remains a strong incentive for companies to take risks in advancing the boundaries of technical knowledge in their field of endeavour.

The only significant disappointment is the reduction in the amount of an arm’s length contract that can be included in eligible expenditures.

The Government has also indicated that it will add technical advisors and take steps to improve training so that claimants can expect consistent treatment, no matter who is their Technical Reviewer.


Capital Expenditures Removed from expenditure base in 2014 We have been counselling our clients against claiming Capital unless it was a major expenditure.  It results in no effective long term cash effect.
Labour, material contracts overheads No change  Jenkins recommendation re: “labour-only” basis not accepted.
Prescribed Proxy Amount (65% of labour) Reduces gradually to 55% and completed January 1, 2013. This actually makes sense and we have often wondered why it was set at 65% in the first place.  At 55% it is still a very good incentive as it assumes that the overhead ratio is now 55%.  Most companies could not survive with a 55% overhead rate..
Arms-length contracts Reduced to 80% of expenditures effective January 1, 2013 This will remove the so-called “profit element” from eligible expenditures.  If you use contract employees, it makes the use of employees paid through the payroll much more attractive.
General SR&ED credit rate Reduced from 20% to 15% effective January 1, 2014. Matches reduction in corporate tax rate. No a change in the rate for CCPC’s (35%) on expenditures less than $3 million..
Use of Notice of Objection Extends the use of the NOO process to include a second review of scientific eligibility determination. This is an excellent change.  Presently one needs to go to Tax Court to get a second look at the scientific eligibility of a claim.
Contingency Fees The Government will conduct a study over the next year to determine why claimants prefer to hire consultants on a contingency fee basis. None of our clients pay contingency fees, even though we offer the option.
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