Tax Breaks For Doing Research

In Canada, corporate innovation is rewarded with more than $4 billion in incentives from the federal government’s scientific research and experimental development program (SR&ED). Many consulting engineering companies are performing innovative work that may qualify for the credit, but they don’t know about the program, or they are filing for the incentive but are not maximizing their claims.

Taxpaying entities can receive SR&ED incentives for such activities as:

• developing new kinds of products

• developing new computer software

• developing new or improved processes

• changing how products are manufactured

To qualify for the SR&ED program, work must be done to advance scientific knowledge and technology, and to resolve scientific or technological uncertainty, while incorporating a systematic experimental investigation by qualified personnel. It is important to note that the SR&ED work does not have to be “successful” to qualify for the SR&ED tax credits. A project can be a failure from both a commercial and scientific point of view but may still qualify for SR&ED if the above criteria are met.

However, engineering firms face unique challenges from the Canada Revenue Agency when their SR&ED work is performed on behalf of their clients. The agency wants to avoid “double dipping” of SR&ED tax incentives where both the engineering firm and their clients claim the incentives on the same activities, so it may deny a claim if the work is not properly planned and documented. To claim the tax credits, engineering firms must take several pre-emptive steps to properly document the work as it is performed.

The SR&ED program is intended to provide benefits in respect of labour, materials, contracts, capital, overheads and some other costs. Many engineering projects involve some costs that are eligible for SR&ED credits, and some that are ineligible. Therefore, it is important to isolate the eligible costs.

Who gets to claim — client or engineer?

Sometimes, it is difficult to determine whether it is the client (“the payer”) or its consulting engineer (“performer”) who is entitled to the SR&ED tax incentives. This problem usually arises where a contract is not specific about whether an amount paid to the performer is for them to conduct SR&ED on behalf of the payer, or whether it is for the payer to purchase a solution from the performer.

Following is a list of criteria that Canada Revenue Agency looks at to determine who should be entitled to the SR&ED tax incentives. No one criterion below should be looked at in isolation.

• Does the contract indicate that the engineering company was required to perform specific SR&ED work? Are there certain specifications that the engineer had to comply with in performing the contractor’s tasks? If the answer is yes, it indicates to Canada Revenue Agency that the engineer company had to perform SR&ED on behalf of the client and therefore the tax incentive belongs to the client.

• Who is assuming the risk of development? Is there a price ceiling on the contract above which the client will not pay? Or will the client not make a payment to the engineering company until certain milestones are reached? If the answer is yes, it gives an indication that it is the engineering company taking the risk of development and, therefore, SR&ED incentives should reside with them.

• Who has the right to the intellectual property? If the rights to the intellectual property of the SR&ED work reside with the engineering company, this may be an indication that the engineer was not required to perform SR&ED on behalf of the client and therefore the engineer should be entitled to the SR&ED incentives.

To maximize the SR&ED tax incentives, it is therefore important to structure contracts carefully and ensure that the above criteria are taken into consideration well in advance of making a claim.

Although engineering firms should retain professional assistance to ensure that an SR&ED strategy is aligned with the firm’s overall tax planning, making a claim itself is not normally a lengthy process. Following the government assessment, Canada Revenue Agency tries to return claims in as little as 120 days for refundable claims and 240 to 360 days for non-refundable claims. This means that a credible SR&ED claim can be made with some degree of certainty, which is especially useful if a company is in a cash-short position.

Anil Chawla is a partner and Pesh Patel is an associate partner with Deloitte in Toronto. They provide tax advice for engineering and science firms. Tel. 416-643-8006/416-643-8386.