Technical brief: Tax credits for science, research and development

Scientific research and experimental development (SR&ED) often evokes images of laboratory technicians and test tubes, but even basic development work — done by many business owners and taxpayers in Canada — may qualify for SR&ED tax incentives.

Even if research work is done outside of Canada, recent tax policy changes to the SR&ED investment tax credit (ITC) makes it possible for Canadian-resident employees carrying on SR&ED work outside of Canada to qualify for the incentives.

As your clients look to manage their cash flow and maximize their tax savings during this economic downturn, are they leveraging the opportunities available to them?

What is SR&ED?

To qualify for research-related tax incentives, your clients must perform work that is either basic research, that is, work undertaken to advance scientific knowledge without a specific practical application in mind; applied research, work undertaken to advance scientific knowledge, but with a specific practical application in mind; or experimental development where the results of basic or applied research are used to create new, or improve existing, materials, devices, products or processes.

Your clients may already be conducting SR&ED work, particularly if their company uses systematic processes to:

• develop or modify technological capabilities, including computer software; • manufacture existing products for less cost; or • develop, enhance or modify a new or existing product or process.

Activities that directly support basic research, applied research or experimental development are also eligible for SR&ED tax incentives. These activities can include engineering or design, data collection, testing, operations research, psychological research, mathematical analysis or computer programming.

Which costs qualify?

Eligible costs can include wages, salaries and related benefits for personnel directly involved in research and development activities. Material and supplies, certain contractor payments, directly related incremental overhead costs (other than rent) and certain capital expenditures might also qualify, depending on the extent to which the assets are used in R&D activities. The same is true for expenditures for the acquisition of new tangible assets used primarily for R&D, certain prototypes and pilot plants.

What’s new?

Under the new policy, certain salary and wages of Canadian-resident employees carrying on SR&ED work outside of Canada will now qualify for these incentives if

• the salary and wages are earned by Canadian-resident employees carrying on SR&ED work outside Canada; • the work outside of Canada is directly undertaken by the taxpayer; • the SR&ED is related to the taxpayer’s business; and • the work solely supports SR&ED carried on by the taxpayer in Canada.

Payments to sub-contractors or persons who are not employees of the taxpayer will not qualify because the work is not “directly undertaken” by the taxpayer.

Of note: In November 2008, the government released a revised version of the T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim form, which has numerous changes including accommodation for the new salary incentives.

What are the benefits?

Canada’s SR&ED tax incentives are among the most generous in the world. These lucrative tax incentives promote the development of new or technologically upgraded products and processes in Canada. The change in tax policy can also create additional tax savings, and should benefit many industries.

The direct benefits can be numerous. Taxpayers engaged in eligible SR&ED activities now, or any time during the last 18 months, may:

• generate valuable federal (and provincial) SR&ED credits of either 20% or 35%, depending on the type of corporation being used; • apply federal tax credits directly against federal income tax liabilities; • receive tax credit cash refunds if the company is a Canadian-controlled private corporation; and • deduct all SR&ED expenditures against taxable income.

Generally, there is no dollar limit on the SR&ED tax credits.

As your clients look to manage their cash flow and maximize their tax savings during this economic downturn, it should also be noted that most provinces also offer their own SR&ED incentives, which work in conjunction with the federal tax program. If your clients are deciding where to perform research-related operations, they should also consider all provincial incentives.

In a global marketplace that demands innovation, Canada’s SR&ED tax incentives reflect government recognition that SR&ED is essential not only to the success of your clients and individual companies, but also to that of Canada as a whole. They also provide a valuable opportunity for your clients to increase their tax savings at a time when managing cash flow is critical.

Vik Sachdev is a partner in the Tax Services practice of PricewaterhouseCoopers LLP working in the Toronto office. Vik is the national leader of the firm’s Scientific Research and Experimental Development (SR&ED) tax practice. vik.sachdev@ca.pwc.com

(03/16/09)