Tax Tip[] SR&ED

Scientific Research & Experimental Development

“Early identification and good documentation are critical.”

The Scientific Research and Experimental Development (SR&ED) tax credit program has existed for close to 25 years, yet it is still very much under-used by many corporations in Canada. One reason for this is the misperception by the general public about what this program is intended to encourage.

It is often thought that the SR&ED program is really only an SR program that applies to breakthroughs in science. Broadly speaking, basic and applied research without any commercial goal may qualify under the SR&ED program.

Don’t forget about the ED part of the definition. Experimental development is the undertaking to resolve technological obstacles to overcome a scientific risk where there is a real likelihood of failure without any economic gain. ED can arise in the context of development or improvement of new or existing products and processes and it often occurs on the shop floor. Identifying ED “after the fact” reduces the chances of a successful claim for many reasons. Early identification and good documentation are critical.

The benefits of the SR&ED tax credit can be significant. For a Canadian-controlled private corporation (CCPC), a 35% federal refundable tax credit can be received on the first $3 million of eligible SR&ED expenditures. Depending on the provincial SR&ED tax incentives, the SR&ED tax benefits can help CCPCs recover up to 75% of eligible expenditures.

For a taxpayer that is not a CCPC (including an individual), the federal benefit is a 20% non-refundable tax credit and there may be provincial incentives that may or may not be refundable.

The SR&ED rules are complex, and obtaining these generous benefits requires an understanding of the tax and the scientific rules, as well as the practical requirements for documenting the work being done.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

High Investment Income Reduces SR&ED Expenditure Pool

“Investment income can reduce a company’s ability to claim refundable credits.”

There is a 35% refundable tax credit on eligible scientific research and experimental development (SRED) activities for Canadian-controlled private corporations (CCPC’s). The 35% refundable credit is only available ona $3 million expenditure pool as was recently introduced in the February 26, 2008 federal budget. Subsection 127(10.2) of the Act reduces this $3 million SRED expenditure pool. If the SRED expenditure pool is reduced completely, then the CCPC is entitled to a 20% non-refundable tax credit for federal income tax purposes.

If the current year’s taxable income of an associated group exceeds $400,000, subsection 127(10.2) of the Act reduces the SRED pool in the following year for the associated group. For every $1 increase in the associated group’s taxable income in the current year, there is a $10 decrease in the associated group’s SRED expenditure pool in the following year. The SRED expenditure pool is eliminated if the taxable income of the prior year is in excess of $700,000 (on an associated group basis). This change was included in the February 26, 2008federal budget. The policy is to limit the enhanced 35% tax credit to “small” CCPC’s, measured by their taxable income.

Investment income is earned by the associated group could reduce the SREDexpenditure pool in the following year since it is included in the associated group’s taxable income. The threshold is based on taxable income, not active business income. The policy reason for this rule is unclear: What does investment income have to do with carrying on eligible SRED activities in an active business? The rule would make more sense from a policy perspective if only active business income of the associated group reduced the SRED pool in the following year.

Unfortunately this is not how subsection 127(10.2) reads. A planning point to circumvent this punitive rule would be to exclude the investment company from the associated group. This simple planning technique may save the associated group’s enhanced $3 million SRED pool from being inadvertently eroded.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.

SR&ED Claim for Stock Option Benefit

“Stock option benefit can be used for ITC calculation.”

The CRA has recently issued a bulletin accepting the position in Alcatel (2005 TCC 149).The CRA accepts that, where stock options are exercised by an employee, the resulting benefit will be allowed as”salary or wages” and the corporation will be entitled to an investment tax credit in respect of the value of the resulting benefit. As always, however, there are a number of conditions in order for this to occur:

  1. The stock options must be granted to the employee in a fiscal year during which the employee was involved in the SR&ED activities of the claimant;
  2. The options must be received by reason of the employee’s employment, not because the individual is a shareholder;
  3. All, or a portion of, the employee’s salary was an allowable SR&ED expenditure in the year that the options were granted;
  4. The employee has exercised or disposed of the option; and
  5. The claimant files within the 18-month reporting deadline all of the prescribed forms and prescribed information for the year during which the stock option benefits were earned.

The CRA bulletin explains that the stock option benefit is an eligible expenditure for investment tax credit purposes in the same proportion that the employee’s salary was allowed as an SR&ED expenditure in the year that the options were issued. For example, if the employee’s salary in the year that the stock options were issued was 80% eligible as an SR&ED expenditure, then 80% of the stock option benefit would qualify as an SR&ED expenditure. The value of the stock option benefit will not be an allowable SR&ED expenditure for purposes of subsection 37(1) (SR&ED deduction). The stock option benefits are only to be considered in calculating the investment tax credit.

One of the difficult issues with this bulletin is that the stock option benefit calculation is based on matters relating to the year in which the options were issued. This could be a difficult tracking exercise if the options were exercised five years after they were granted. The corporation would have to determine how much of the employee’s salary was allowed as an SR&ED expenditure five years ago in order to determine how much of the stock option benefit is allowable for the investment tax credit calculation.


TAX TIP OF THE WEEK is provided as a free service to clients and friends of the Tax Specialist Group member firms. The Tax Specialist Group is a national affiliation of firms who specialize in providing tax consulting services to other professionals, businesses and high net worth individuals on Canadian and international tax matters and tax disputes.

The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.