SR&ED and Due Diligence: Are you informed?

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The term due diligence is often used by the Canadian Revenue Agency’s (CRA) Research and Technology Advisors (RTA) when auditing a Scientific Research and Experimental Development (SR&ED) claim. Yet, a clear definition as it relates to SR&ED, especially in the areas of technical and analytical work does not exist in the Income Tax Act (ITA). Equally important, the CRA does not consider due diligence to be a part of SR&ED work, which creates a catch 22 situation because there can be no SR&ED without due diligence.

According to the CRA, due diligence as it pertains to SR&ED is based on a scientific or technological uncertainty that includes all of the preliminary work conducted up until a scientific limitation or technological uncertainty/obstacle within the technology base or level used, is identified. A technological or scientific uncertainty prevents an organization from reaching its objective using standard practices. This is where a major shift takes place; the investigation and experimental work that takes place is now aimed at overcoming the existing scientific or technological limitation. This situation propels the project into SR&ED work where uncertainties are worked through and scientific or technological advancements unfold to contribute new information to the current knowledge base and/or advance technology. To this end, it is imperative to describe and document all work leading up to the identification of the scientific or technological uncertainty because during an audit, it helps to prove that due diligence was carried out and ensure completed scientific and experimental work is not incorrectly characterized by an RTA as non-SR&ED during an audit. The RTA is looking for proof that a claimant a) tried to achieve a scientific or technological objective using the available technology or science before encountering an uncertainty and b) could not overcome the uncertainty using standard scientific or technological practices and knowledge. Finally, the RTA looks at the technology base or level of the company.

The claimants must understand that during the due-diligence phase of the work, they might conceive a novel and innovative way to conduct their due-diligence to arrive at a technological uncertainty.  Although this novel and innovative way to conduct the due-diligence can be considered as SR&ED work, the RTA may attempt to disregard it as such, claiming that there can be no SR&ED work during the due-diligence phase, thus, carving out a huge portion of the work that could qualify as SR&ED work. In this manner, the RTA may reject experimental or analytical work that goes beyond a routine approach in the due diligence phase by not qualifying it as SR&ED work.

The next section defines some key ITA terms that can help claimants increase their understanding of due diligence.

Technology base or level refers to the existing level of technology and takes into account the knowledge of the technological resources within the company and sources available publicly.

The technological resources within a company include:

  • technical knowledge, education, training, and personnel experience
  • technical capabilities characterized by current products, techniques, practices, and methodologies such as trade secrets and intellectual property

Publicly available sources generally include scientific papers, publications, journals, textbooks, and internet-based sources. It also includes expertise accessible to the company such as the recruitment of employees or contractors. The company is expected to have information that is common knowledge at the time the work is performed. Common knowledge refers to the knowledge professionals possess in the specific areas of science or technology that are in question.

Note, the technology base or level will vary from company to company because the internal resources vary from company to company, even though the knowledge available publicly remains the same.

Scientific or technological uncertainty and technological obstacle represents a situation when no one knows or can determine on the basis of generally available scientific or technological knowledge or experience whether a given result or objective can be achieved or how to achieve it. Note that scientific uncertainty relates to science whereas a technological uncertainty and technological obstacle relate to technology.

For more information, refer to section 2.1.1 of the Eligibility of Work for SR&ED Investment Tax Credits Policy.

Scientific Advancement or Knowledge or Technological Advancement is the generation of information or the discovery of knowledge that advances the understanding of scientific relations or technology. Note that scientific advancement and advancement of scientific knowledge relate to science whereas technological advancement relates to technology.

For more information, refer to section 2.1.4 of the Eligibility of Work for SR&ED Investment Tax Credits Policy.

In practice, as it applies to a claimant, due diligence encompasses all work conducted to reach a scientific or technological objective, using available technology, either in-house or external up to the point where a scientific or technological uncertainty has been identified. Technological uncertainties may arise from shortcomings or limitations of the current state of technology or budget limitations that prevent a new or improved capability from being developed. In other words, the current state of technology or finances may be insufficient to resolve a problem. Alternatively, if the scientific or technological objective or solution can be resolved with the available knowledge base, then there is no SR&ED work as SR&ED work can only start when an uncertainty is identified. Recognition of a technological uncertainty is a major step in systematic investigation and it implies the identification of the need for advancement and proof that due diligence was carried out. As such, claimants must remember to track and document all their work.

Is it Getting Tougher for Firms to Claim SR&ED Funding?

SR&ED Funding

The Scientific Research & Experimental Development (SR&ED) program is the largest tax incentive federal program, administered by the Canada Revenue Agency (CRA). It encourages Canadian business of all sizes and in virtually all sectors to conduct Research and Development (R&D) in Canada. Each year, the SR&ED program provides over $3.6 billion in Investment Tax Credits (ITCs) to over 23,000 claimants across Canada. Of these, approximately 75% are small businesses. So despite these well-established facts, why is it getting tougher for firms to claim SR&ED funding?

In the past, especially before the Jenkins report was published in 2012, it was easier to apply for SR&ED funding. The eligibility rules were not as stringent and the definition of Technological Advancement was loosely used. As a result, there were many consultants taking advantage to assist their clients with this program. The CRA, based on the loosely defined eligibility criteria, was generous in assessing the tens of thousands of claims that would come to their desks each year. As a result, more and more firms began to take advantage of this program and even those that were on the border line of SR&ED eligibility. With the recent changes to the program, additional hiring of CRA employees to oversee the SR&ED program, and the tightening of the eligibility criteria, it has become harder for firms to claim for SR&ED funding. Whereas many firms in the past had their SR&ED claims accepted as filed, these same firms are under major scrutiny. And this is the result of redefining the eligibility criteria by the CRA to overhaul this existing program and to remove those claimants that are outside the jurisdiction of the SR&ED program.

The increase in reviews will continue to dominate the Canadian SR&ED landscape. Nonetheless, at BeneFACT we are experiencing successful reviews and the reasons for this are:

  • We are ISO 9001:2008 registered, which means we are process driven and have systems in place to counteract the threat of any reviews.
  • We work with our clients long before the presence of a review to assist them with gathering of important documentation, lab reports, prototypes, photographs, etc to ensure that all SR&ED projects are well supported.
  • We have a dedicated reviews team, who are experts in the field. We provide a mock review with the client, before the actual review, to ensure that our client is fully prepared to handle all questions posed by the CRA.
  • We meet with CRA SR&ED directors from different markets to go over policies and procedures.

If you feel overwhelmed with your current claim or need a second opinion to assess your claim, please contact one of BeneFACT’s highly trained SR&ED experts to assist you. Speak with a BeneFACT SR&ED expert today to learn more about the SR&ED program to see if your company’s activities qualify for this lucrative tax credit.  Get the information you need to start maximizing your claim today! Toll Free: 1-855-TAX-BACK (829-2225)

The Early Bird Gets the SR&ED

Early Bird get the SR&ED

Starting the SR&ED claim preparation process early has many benefits. The most obvious is that earlier preparation leads to earlier submission and getting the tax refund sooner but there are other benefits as well. Even so, every year countless SR&ED claimants leave their claim preparation until the last minute.

The Consequences of Being Late                                                                                     CRA has published service standards that they try to meet based on the category that the claimant company falls under and when the SR&ED claim is submitted. CRA has committed to meeting these service standards at least 90% of the time. Ideally, the SR&ED claim should be filed with the initial tax return submission by the filing due date for the tax return (6 months after the fiscal year end) for the fastest processing. For Canadian Controlled Private Corporations (CCPC) with refundable claims (see our blog post here) a lower service standard applies when the SR&ED claim is filed as an amendment to the tax return. The difference in processing time is significant.

CRA’s SR&ED Service Standards:

• Refundable claims submitted with original tax return submission – 120 calendar days from receipt of a complete claim
• Refundable claims submitted as an amendment to the tax return (“claimant-requested adjustments”) – 240 calendar days from receipt of a complete claim
• Non-refundable claims whether timely filed or amendments – 365 calendar days from receipt of a complete claim

As a worst case scenario, there is also a deadline for filing a complete SR&ED claim after which no claim will be accepted by CRA. This is 12 months after the normal tax return due date, or 18 months after the fiscal year end.

The Benefits of Starting Early                                                                               Obviously starting early creates a higher probability of submitting a claim with the initial tax return for the year. This leads to a faster service standard with CRA for refundable claims. On top of this, there are a number of other benefits:

• If an incomplete claim is inadvertently submitted, CRA will inform the claimant regarding the missing information. This generally happens within 30 to 60 days following receipt of the claim by CRA. Filing well ahead of the 18 month deadline gives a claimant an opportunity to act on this information before it’s too late. This is especially beneficial to claimants that prepare their own submissions.
• The earlier the better! At BeneFACT, we frequently submit complete claim packages to our clients within two to three months after their fiscal year end. This allows them to include the impact of the SR&ED in their final tax balance payment and potentially reduce next year’s tax instalment payments.
• Claims prepared closer to the time when the work happened are usually stronger and better supported. Documentation is easier to identify and find, and the technical personnel generally have an easier time articulating the technological aspects of their projects. Stronger and better supported SR&ED claims lead to easier reviews with CRA and more SR&ED tax credits in claimants’ hands sooner.

Although the benefits of preparing your SR&ED claim early are significant, the impact of being late could be catastrophic. The moral of the story? Be an early bird!

BeneFACT Consulting Group has a team of financial and technical experts dedicated exclusively to helping Canadian companies maximize their R&D refunds. Speak with a BeneFACT SR&ED expert today to learn more about the SR&ED program to see if your company’s activities qualify for this lucrative tax credit.  Get the information you need to start maximizing your claim today! Toll Free: 1-855-TAX-BACK (829-2225)