The Canada Revenue Agency (CRA) may instigate an audit related to a particular SR&ED claim for any number of reasons, and when they do, they will request supporting evidence to ensure a claim is legitimate. One of the primary focuses of an audit is salary and wage expenditures in relation to projects that prove the amounts being claimed are indeed for eligible SR&ED activities. Technical eligibility isn’t the sole determining factor here, and there is an immediate risk of the claim being denied if a claimant’s financial records are deemed inadequate by the CRA.
The CRA often makes two document maintenance recommendations to claimants during an audit:
- Ensure documentation demonstrates the process of a systematic investigation including formulation of a hypothesis and the associated activities of testing in an identified field of science or technology;
- The documentation demonstrates when and who was involved in the activities to link the salary and material expenses to eligible SR&ED activities.
It is quite common for claimants to maintain time sheets that identify the names of employees who were directly engaged in the SR&ED project with attributes such as date, work order number, vacation time, estimated hours worked, overtime hours, and total hours. In practice, it seems CRA auditors look for a far more granular, activity-based time tracking method that is not necessarily normal for claimants conducting experimental development outside of a laboratory environment. Failure to specifically provide activity-based time tracking when requested can lead to a determination by the CRA that a claimant’s records are not adequate. This assessment approach, however, is duly shown to be inconsistent with both CRA policy and Tax Court of Canada (TCC) jurisprudence on the matter of record keeping, including supporting salaries and wages expenditures.
A recent TCC decision was made in favour of the Quebec claimant, where the judge held that “the existence of contemporary literature or contemporary documents with special content is not a condition for the recognition of scientific research or experimental development [emphasis added].”
The CRA’s published policy considers numerous kinds of “cost allocation methods,” including but not limited to “estimates.” The SR&ED Salary and Wages Policy (Section 13.1) defines a cost allocation method as “a systematic approach to determining which expenditures, or portion of expenditures, relate to SR&ED work. A claimant must be able to show that the cost allocation method used is based on a systematic approach, and provide a reasonable level of accuracy in calculating the SR&ED expenditures.”
The same section also states that the size of an organization may also be a determining factor in how sophisticated the cost allocation should be – keeping log books or detailed diaries may not be a claimant’s normal practice. CRA auditors often assert that, if a company has claimed SR&ED before, they may be expected to have a much more sophisticated system for tracking SR&ED.
According to CRA policy, there is no absolute requirement for a claimant to maintain a more sophisticated system. Informal, naturally generated information to support allocation of labor costs to SR&ED projects, coupled with other supporting documentation, should be sufficient. Time sheets that differentiate between SR&ED activities and non-SR&ED activities (whether by project or individual tasks) are also helpful supporting evidence. It is sometimes the case that more than one form of evidence is required to support claimed expenditures, depending on the nature of the company and the claim.
Whether you are a first-time claimant or have claimed SR&ED in the past, BeneFACT provides comprehensive SR&ED services, from claim preparation and filing, to supporting Claim Justifications. We are Canada’s largest independent SR&ED firm with a full-time staff of over 60 employees. If you have any question(s), please do not hesitate to give us a call toll free at 1-855-TAX-BACK (829-2225).