SR&ED – is it worth it?

SR&ED (Scientific Research and Experimental Development) is the name of the largest, most generous and most important tax incentive program in Canada.  The program has been around since the 80s, overhauled in the 90s, and firmly embedded in the income tax act and indeed the very fabric of the Canadian economy.  Without it, Canada would see a swift exit of many international companies that set up shop here due to this very program that guarantees sizable tax credits in exchange for operating here and employing our citizens.

But certainly, there are many CEOs, CFOs and business owners that have become frustrated with the program due to a shift in focus from “incentive” to “compliance”. R&D Managers that have been subject to an SR&ED audit or review in the past 5 years may have found themselves confused or baffled by the SR&ED reviewers, which are employees of the CRA (Canada Revenue Agency).

The program is about innovation? Right?  Actually, ask any SR&ED reviewer, and he or she will correct you on that very point. It is NOT about innovation.  The program is about technological advancement, which is the embodiment of new technological knowledge through advancements in techniques, products, devices, materials, or applied science & research.  Success or innovation, apparently is irrelevant.

But new devices and techniques, isn’t that innovation?  Actually, it’s not.  Many innovative ideas would never qualify for an SR&ED tax credit, due to the lack of a technological obstacle. An SR&ED expert can tell the difference, but the average R&D Manager still has difficulty grasping the difference, which appears to be subtle and perhaps slippery.

Isn’t the program supposed to represent an economic incentive?  Well, yes, that’s true. But like any program, there’s always a potential for fraud.  The CRA does operate on an honour system, but in the past, that leniency has been exploited by unscrupulous business owners and worse yet, unpatriotic tax consultants that have abused the programs tenets for their own benefit.

So, the program is more strict now. CRA reviewers are more cautious before approving credits or refunds. The resulting behaviour – CRA asks for more documentation, and particular kinds of documentation that may appear obscure and esoteric to the average R&D Manager or business owner.  He or she is trying to solve technological problems, but could very well be ignorant of the preferred methods of CRA.

What does CRA prefer? What do they actually want to see?  Good question.  They want to see well-organized rigorous documentation that clearly demonstrates eligibility. That said, some reviewers cannot be satisfied no matter what you give them, and that’s a separate problem.  But the well-trained reviewer wants to see that the company is following some type of method that resembles the scientific method, like we all learned in high school.  Here’s where the great disconnect rears its ugly head.  Business owners do not care about the scientific method! And CRA cannot fathom a world without it.

Back to the original question then – is the SR&ED program worth it? Practical business owners must weigh the pros and cons.

The negative: a requirement to keep documentation that is not really required in order to obtain its objectives (ie. solutions to technological problems, satisfying customers, gaining market share, paying the bills).

The positive: a tax credit or refund that is substantial enough to change the way the a business operates, allowing for the acquisition of new equipment, attracting new talent and rewarding the existing staff, attending international trade shows, better marketing budgets, or even, salvation from insolvency.

Business owners are often practical people. Believe it or not, they would prefer to take a smaller tax credit than maintain proper books and records.  R&D Managers have been moving towards smaller credits as a tactic to avoid audits.  But, ultimately, they get audited anyway, and then they are left with seemingly unreasonable volumes of homework in order to obtain an apparently inconsequential tax credit due to their own conservative practices. Perhaps, not worth the effort, he or she might grumble.

How about an alternative? How about, keep proper documentation and claim all of your eligible expenses, and if selected for audit, you could actually be ready and able to defend?  Eureka! What a novel idea?

The savvy business person then reflects, Yes! I will document properly, because the refund outweighs the loss.  And, my competitors may be enriched by this program, which creates a strong incentive to participate as well. But now what?

One might think, well, CRA will provide me with the method, the system, the templates, the spreadsheets. Wouldn’t that be lovely?  But sorry, CRA doesn’t actually do that. This might seem unfair to the firm that is striving towards compliance.

An SR&ED Expert should be able to provide you with a bullet proof documentation methodology that is easy to use, easy to understand, and easy for your firm to adopt. If not, you could be working with the wrong firm. The next time CRA comes knocking, you will regret it if you are not well organized.

Ask yourself this question? If selected for a full technical audit, are you positive that you know what to prepare and present? And if selected for a full technical audit, how long would it take you to get ready?

This article was written by Julie Bond, President of Bond Consulting Group. For more SR&ED articles, visit our Blog. To learn more about SR&ED, visit our Video Learning Centre.