Research and development (R&D) can be a costly endeavor, and the Scientific Research and Experimental Development (SR&ED) program provides many organizations with an invaluable opportunity to ease the burden. In 1983, the federal government established the tax incentive program to encourage organizations to bring research and development projects in-house by offering tax incentives to reduce financial pressures associated with undertaking an uncertain and risky endeavor. Many countries across the world offer variations of the SR&ED program to stimulate research and development innovation in their economies.
The Scientific Research and Experimental Development (SR&ED) is now the largest single source of Canadian federal government support that incentivizes business-led research and development projects. The program provides more than $3 billion in tax incentives to over 20,000 claimants annually.
This is an exciting opportunity, and some of the most common questions asked to tax professionals are, “When should a business apply for SR&ED?” and “What important criteria should be met by new applicants to the SR&ED program?” In this article, we’ll address these questions and provide some examples.
If you want to apply for SR&ED or learn more about the basics of the SR&ED program, read our “What is SR&ED?” article for a more general overview of the initiative and how it began. Although SR&ED is not exclusively a Canadian program, this article will focus only on eligibility criteria for the Canadian version.
When Should a Business Consider Applying for SR&ED?
Any company that is developing new or improving upon new products, processes, materials, or making incremental improvements to them, may be eligible. It’s worth noting that the income tax act goes out of its way to say “incremental improvements” are eligible. In other words, businesses don’t always have to create a whole new product or process. Continuous improvements to current products are equally valid, and developing new knowledge, capabilities, and techniques along the way do count.
The research and development project, however, must be solving a technological issue; it cannot be a social sciences or business problem. This could include virtually any area of science and engineering technology, including software programming.
The key to eligibility is that some new understanding of the technology, including capabilities, techniques, and approaches are being developed that address some core technological issue. While these are valid in terms of Intellectual Property (IP) development and contributions to a company’s knowledge base, they don’t have to be patented or even patentable.
Moreover, it is important to note that eligibility criteria may vary by provincial variants. To see a comprehensive review of each variant, visit the Scientific Research and Experimental Development Tax Credit program page.
A SR&ED Example: Adopting Innovative Technology
Let’s look at an example of a technology adoption project in the field of carbon capture technology to see what qualifies for SR&ED. This will help us distinguish projects that may be innovative and R&D intensive, from those aspects of the project that are actually SR&ED eligible.
Let’s say that a company has an objective to reduce emissions for its carbon footprint. They might choose to do so by buying and adopting new CO2 sequestration processing technologies. While this may be an innovative technology, this will not automatically qualify as SR&ED. This is because SR&ED is not about the use or adoption of a technology per se but rather the process and pain incurred in the development of that technology. The commissioning phase of the project may require significant development work by the company’s engineers to implement. While this is complex and significant work, this may or may not be SR&ED yet. If the engineering approach and methods employed are well known or available in the public domain, it is not SR&ED.
“SR&ED is not about what one does “with” the technology but rather what you do “TO” the technology that creates the SR&ED opportunity.”
– David Douglas, Principal, Scientific Research and Experimental Development, Ryan Canada
Now, let’s say the introduction of the new CO2 sequestration system required experimental modifications to the equipment to solve a novel problem, then the project may qualify as SR&ED. Maybe the business doesn’t know how such technology will interact with their equipment and processes. This may force them into an experimental mode to understand more about the interaction variables and make necessary modifications and adjustments to the design to achieve their objectives.
Now the project falls in-line with the three main SR&ED criteria as follows:
- Technological uncertainty;
- A systematic approach (i.e., Experimentation); and
- New technological advancement (New Knowledge/Learning).
In summary, this example demonstrates the following:
- Simply adopting new innovative technology does not qualify as SR&ED; however,
- Developing new processes or undergoing experimental modifications to the new technology may qualify as SR&ED.
What Are the Most Important Aspects of SR&ED that a New Applicant Should Know About?
As mentioned previously, projects must be technologically based to qualify for the program. To be specific, the term that should aptly describe a SR&ED project is “technological uncertainty” following a foundational court case, Northwest Hydraulics v. The Queen, in 1997. The Northwest Hydraulics case established the need to identify a specific reason why a business cannot achieve a technological objective such as a lack of knowledge of key variables and interactions, techniques, materials, etcetera, which prevents the entity from achieving their goal without experimentation.
The technological uncertainty associated with an obstacle and the advancement towards its solution are linked. If there is a gap in the public domains’ knowledgebase, which doesn’t give enough insight to resolve an issue, a business is then entitled to apply for SR&ED tax incentives for creating new knowledge through research and development, even if the result of the experimentation is knowledge through failure.
“I have not failed. I’ve just found 10,000 ways that won’t work.”
-Thomas A. Edison
The Northwest Hydraulics case also concluded that businesses should approach this decision framework by starting with a hypothesis designed to reduce or eliminate the aforementioned uncertainty. A hypothesis begins with an unknown state of affairs. In our carbon sequestration example, this factor would be that no one knows how to implement a new carbon capture technology into the business’s unique waste treatment facility without interrupting crucial processes and, therefore, investigation is required via any available method; logical deduction of consequences, direct experimentation, and beyond.
Once a hypothesis is established, a business must ensure that they proceed according to disciplined scientific methods of formulating, testing, and modifying their hypothesis to accommodate SR&ED criteria and come to a logical conclusion (i.e., testing various filters to ensure the new carbon capture technology does not conflict with treatment processes). After conducting and completing this systematic research and experimentation, a company must record their findings to advance current understandings. While this sounds like white lab coat talk, it is simply a demonstrable systematic approach to the investigation. Engineers and technical staff working in a real time environment are often setting the hypothesis intuitively rather than using a more formal approach. Setting out in advance what you expect to happen is really a hypothesis.
Should each step be conducted accordingly, a business may claim their SR&ED tax incentive as reward for their diligence and problem solving.
In summary, a business’s technical objective to qualify for SR&ED is to move through each of these stages:
- Identify a technical uncertainty;
- Generate a hypothesis to test;
- Test and modify the hypothesis through a rigorous systematic approach;
- Establish whether or not the testing generated a solution or new information; and
- Document and publish said findings.
Exploring Government Funding Opportunities
Now that you understand the high-level criteria for SR&ED qualification, your business should get in touch with a SR&ED expert to apply for SR&ED. However, SR&ED is one of many other programs available to Canadian organizations. For example, a popular grant available is the Industrial Research Assistance Program (IRAP), a Canadian government funding program which accelerates research and development projects for Canadian innovators. However, many businesses find themselves unsure whether IRAP or SR&ED would be a better fit for their initiatives. To help with distinguish the two, check out our IRAP vs. SR&ED Free Slide Deck.
Should your business be engaged in research and development activities within Canada, you could qualify for tax credits. These can cover as much as 69% of labour and overhead expenses, 36% of contractor fees, and 45% of material costs, all thanks to the Scientific Research and Experimental Development (SR&ED) program. To help you understand how you can reduce your R&D project expenses, we have compiled a complimentary SR&ED 101 guide in PDF format for you to download.