Guide to claiming R&D tax credits effectively.

Scientific Research and Experimental Development (SR&ED) is a generous government incentive program to aid Canadian business that promote in house research and development activities. Eligible businesses can benefit from refundable and/or non-refundable tax credits. Depending on your overall corporations tax scenario, you could receive cash and/or tax credits, which can be used to either, offset your tax payables, bank them in your business or reinvest back as deemed fit.

Today, many Canadian businesses have been exposed to such credits. They have either been successful or been disappointed on the outcome. Has the law ever changed? The basics of what a tax practitioner will tell you about SR&ED are covered under section 248(1) of the ITA and remains unchanged.

Setting aside the technicalities, a key element of the SR&ED tax credit is in knowing and being able to communicate how you have advanced your technology as part of your business operation? To a busy business owner, how does this translate to actual tax dollars as receivables? There are many ways to respond and I choose to answer this by asking the basic question of understanding technological uncertainty and also assist with developing your SR&ED thought process. SR&ED reporting has two parts, science and cost reporting. Our discussion is only related to the science reporting side and there is a separate costing element that is not discussed here.

An example framework:

Let us consider an example scenario of a delivery company that is concerned about having accurate information on its goods location and time of arrival to a predetermined location. Our company provides local road delivery and is assured of the accuracy on relevant parameters (such as accuracy of GPS information, average speed of the truck that delivers the goods, local driving conditions etc), it is a reasonable task to know your goods location, and time of arrival. This is fairly deterministic and there are likely no uncertainties in the outcome.

However, let us assume a simple but realistic twist and include the path to be multi-faced (road, water and a trip by flight.) Quickly we realise that there are several parameters that are intrinsically dependent and correspondingly, the task of knowing the location and time can become uncertain. The uncertainty is now dependent on your required levels of data accuracy or desired system tolerances. Clearly, if you cared less for timeliness and how you report the information, there is likely no uncertainty to address! You have either delivered the goods one way or another or it is lost in transit with no recovery! I am sure your business is operational and its wanting to be competitive in the market has worried a lot about such issues. 

Defining your challenge: What the example is leading you in to be a fairly routine issue which delivery and transport companies encounter – data accuracy and reliability within an intermodal transportation network that has diverse geo-locations. It can surprise one that inclusion of such a minimal complexity can already turn a predictable system to show elements of uncertainty. As companies are working to address these uncertainties to make a profit some of the efforts required to improve data and information accuracy can become eligible for a SR&ED claim process. What this means to the business is work that meets the SR&ED criteria, can have its expenses (such as labour, subcontractor costs, etc) be considered for a refund via the R&D tax credit platform.

Linking technicality to an uncertainty: Let us briefly digress from our example to highlight some key elements for the SR&ED reporting process. Very often in our experience, a claimant has undergone similar uncertainties, however, there is often a (mental and also documentation) roadblock when identifying the uncertainties to an underlying technical concept. What we see is that the claimant is often deeply involved in addressing the issues and unable to step aside to identify them as appropriate for SR&ED tax credits. As a first step, your SR&ED consultant wants to know these:

• Can you describe the subsystem in technical terms that is experiencing the uncertainty and identify the technology roadblocks? In many cases, the subsystem could even be a source of such an uncertainty. Why do we need this? A simple answer is the requirement to demonstrate how addressing the uncertainty correlates to a systematic change to the technical conditions upon which a subsystem operates;
• The various actions taken to resolve the issue requires to be documented (there are several methods to address this) and can you demonstrate a systematic work process undertaken to resolve the issues? This is an important element that CRA looks for in its assessment of your tax credit filing.

As a next step, have you undertaken systematic sequence of steps and resolved the issue. At the end of this process,

• Can you identify how your work translated to relevant advancement in technology? One approach would be to document the technical changes in your system before and after the issue was resolved and if it is demonstrable to be an advancement of your technology. The key is to note that you could not have achieved this advancement by your day to day trouble shooting procedures;
• Assume the attempt was a failure. Yes, you failed and it could be eligible! In such a case, what were your lessons learnt? Note that lesson learnt is part of your advancement in any case, and a failure simply highlights this as in that case what not to do the next time! This is very much like a growing up process – childhood to being an adult!

Building my SR&ED Thought Process:

We return to our example and build a SR&ED thought process through a sequence of steps.

1. Sources of uncertainties: In our specific example, there are inherent complexities that is being built by (i) intermodal nature of travel; (ii) external constrains (ex. weather and transit conditions); (iii) data communication (knowledge of present location of a carrier), geo-location, time, local language, etc all of which can add layer of challenge to your data and information.

2. Identifying your key reporting elements: Our first question is what are the constraints that we want to focus? The main element is the necessity to identify what sources when addressed contribute to the development process. This can be a difficult process and interestingly also sets you in to what would be a due diligence phase. This is also your opportunity to show how standard routine process failed to resolve your issues.

In our example, one could safely observe that the intermodal nature by itself is not expected to contribute to advancement. Here is an argument why? It is an external framework upon which your business operates and is fixed external constraint. It is simply not under your control and unlikely to contribute in your advancement. What about weather and transit conditions – while it is not under your control, it sets a variance in your processing. It is a parameter of relevance only if it is attached to your technical uncertainty.

For example, are you addressing data accuracy or real-time information on your item location? Is your development aiming to incorporate such external variances? But how about geo-location or time? They are an inherent part of data that your system uses for processing useful information. The lesson is in identifying and gathering the elements that you need as part of your SR&ED reporting process. You have limited reporting space a

nd what you state must have direct relevance to your issues and further to your technological objectives. But what are they in this example case?

3. Your objectives: How often do we hear about developing a processing system that can aid in obtaining accurate data and in some cases, real-time data that is accurate? All of the elements that we have discussed so far become relevant to achieving this objective. Now, if I had a single package to follow, this may be a manageable. Imagine, running a tracking system for a large set of packages over a network. Your scale of operations can explode and you probably need something that can automate the process. Soon you have a well-defined objective! The constraints of relevance are all identifiable and quantifiable elements that relate to your data processing, communication and information that your system delivers as output. Turning backwards, where did my laws helping with a deterministic solution fail? The answer lies in not the failure rather do we have an advancement, which in this case is developing a fully automated data management system that can process information efficiently and within required levels of accuracy? With this developed thought, your technical team has been able to slowly but surely gather the relevant elements that correspond to this objective. But how many of those have an actual technical bearing to an uncertainty (remember, your outcome is not assured by addressing these element through routine methods.)

4. Address my uncertainties: In our example, uncertainties can be identified in to several distinct classes. Here is a sample tabular form (not exhaustive) that lists some uncertainties and how this translates to technical elements.

We now see how a simple pedestrian description of package tracking can be translated to a scientific issue with real challenges and uncertainties that have a related technical component to address.

Documenting your advancements: Do you have evidence that show how you identified the interplay of constraints and related them to technical issues? Can we show how your work progressed to address these issues? Is it temporal and concurrent? Do you have records of different intermediate steps? Can you quantify the change to your final solution to each of the identified classes from its initial stage to when you were successful? Can you demonstrate how routine daily operation methods could not have resulted in these changes? Let us be assured, this is development within your environment and that you have exhausted known solutions that are readily available to you.

Summary: Your key elements in developing a SR&ED thought process are:

• Clear definition of a problem – this often starts with a murky feeling something is not right and sustains even after failures from several standard operational approaches to resolve the issues;
• Identifying and differentiating the constraints which are present in your system and being able to quantify them – report and focus on those which have relevance to your advancement;
• Asking how you propose to address the challenges and how they relate to a technical aspect; leave out activities such as marketing, human resources or routine development tasks, etc;
• You have temporal records for actions carried through to address the issues identified. This is crucial since the CRA can deny an eligible claim if there is no supportive documentation.

Tax benefits: Regular eligible business activities such as labour, subcontracting expenses, materials, leases (if of certain nature) can become qualifying expenses can be related to eligible SR&ED activities.

How we can help For a busy business, the task of identifying, documenting and quantifying SR&ED to eligible tax dollars can be time and resource consuming. With our expertise, we will assist in a continuous process and identify the SR&ED elements, scope, draft and file your SR&ED credits as part of your annual tax returns. We want to take the load and have you focus that time on your regular business operation.

ABOUT THE AUTHOR

ALLAN MADAN

CPA, CA

Allan Madan is a CPA, CA and the founder of Madan Chartered Accountant Professional Corporation. Allan provides valuable tax planning, accounting and income tax preparation services in the Greater Toronto Area.

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