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Calculating SRED Investment Tax Credits
Eligible SRED Expenses
Once you have determined that a project satisfies the necessary criteria for SR&ED eligibility, many of the expenses associated with this project can be claimed. Companies often fail to identify support activities that are necessary to conduct or validate the direct SRED activities and thereby minimize their claim.
Directly Engaged Personnel
Staff who are directly involved in experimentation or analysis of the experimentation results in the performance of research or experimental development are considered to be directly engaged in SRED. This work includes preparation of materials and equipment calibration, data collection, experimentation and analysis of results.
Employees who perform technical work in direct support of the Directly Engaged Personnel, in relation to the claimed SRED project(s) are also considered to be engaged in SR & ED. For example, the salaries of someone who is responsible for testing the results of an SRED project would be considered a valid SRED expense during the period in which this testing occurs, up until the point at which all technological uncertainty has been resolved. Similarly, a portion of a direct supervisor of someone involved in experimental development or research can normally be allocated toward the SRED project provided the supervisor is involved in assisting or directing the researcher(s).
There are two methods for calculating overhead and other expenses related to an SRED project:
1. Traditional Method
The "Traditional Method" for calculating overhead expenses requires the claimant to identify actual expenses claimed. A justifiable methodology must be established in order to allocate costs to particular SR & ED projects. This method can be complex and time-consuming and is subject to scrutiny by CRA, especially for businesses that are engaged in commercial activities.
Allowable overhead costs are those that are directly attributable to the prosecution of SR&ED in Canada. This may include an allocation of salaries for clerical or non-technological staff as well as employer payroll expenses and benefits. Other overhead costs that may qualify include a portion of utilities, internet service, long-distance calls, supplies, travel and training expenses.
2. Proxy Method
The "proxy method" is a much easier way to compute overhead costs since it is simply calculated as 65% of the salaries associated with employees directly engaged in SR&am[;ED activities in Canada. This requires less tracking and estimation and, in most cases, results in a larger SRED claim than when using the traditional method.
It is important to note that, when using the Proxy Method, certain support staff are considered to be "covered" by the proxy amount. For example, a portion of the wages incurred for an employee who performs administrative support work may be eligible to be claimed using the traditional method whereas they may not be eligible when using the proxy method since their costs are assumed to be incorporated into the proxy calculation.
Which Method Should be Used?
Naturally, you should try to choose the method with the greatest financial benefit. In cases where the financial benefit is relatively close, the proxy method should always be chosen since it is much easier to administer and justify. Ironically, the Traditional Method, is by far the lesser used method.
The main situation in which the traditional method is most compelling is for projects that involve a lot of contract staff. Since the proxy amount is calculated as a percentage of "salaries" of those directly engaged in SRED activities, if the sum of your directly engaged employee salaries is low, so too will be your proxy allocation. This is also something to be considered when deciding whether to staff a project using contractors as opposed to regular employees.
The cost of contractors and subcontractors engaged in SR&ED activities can be included in your claim. Payments to qualified third-party organizations including universities, research centres and approved associations that undertake SR&ED activities, are also permitted. When engaging contractors and third-party organizations it is important to formalize ownership of intellectual property. In general, only one firm can make a claim for a specific project. Even though your company may be paying a contracting firm to perform experimental development, if the contractor retains the rights to the resultant IP, they may be the ones entitled to make an SRED claim for the project.
The cost of materials that are fully consumed or destroyed in the pursuit of R&D can be included in your eligible SRED expenses. Supplies to build prototypes, test units and even commercial samples are all material costs recoverable under SR&ED. The costs of materials transformed into another product or component for the purpose of SR&ED may also be claimed.
Occasionally, material may be partially consumed in the pursuit of SRED. For example, a component may be altered in such a way that it can no longer be sold for full-value but it does retain some value. In this case, you may claim the difference between the full value and the residual value of the consumed materials.
Equipment Lease Costs
The cost of leasing equipment can be claimed if at least 90% of the equipment usage can be attributed to SR&ED activities. Examples of allowable lease costs include lab equipment, computer hardware and design and tools.
Depreciable equipment that is used at least 90% of the time for the pursuit of SR&ED can be included in the ITC calculation. Equipment that is used at least 50% for SR&ED related activities can be partially claimed.