- Scientific Research and Experimental Development Program
- April 2, 2012
- Law Firm: Miller Thomson LLP - Toronto Office
The Scientific Research and Experimental Development (“SR&ED”) program is a tax incentive program that is meant to encourage the private sector to engage in research and development (“R&D”) in Canada. Allowable SR&ED expenditures are 100% deductible from income, and generate an investment tax credit of 20%, or 35% for certain small to medium Canadian-controlled private corporations (“CCPCs”).
The Budget proposes to make several fairly significant changes to the SR&ED program. The income tax changes mostly involve cuts to the program. In conjunction with the changes to the SR&ED tax deductions and credits, the Government will fund and support R&D initiatives to promote innovation. This includes: (i) doubling the contribution to the Industrial Research Assistance Program; and (ii) redirecting the research of the National Research Council to industry-relevant applied research.
SR&ED Investment Tax Credit Rate Reduction
Qualified SR&ED expenditures incurred in Canada and certain transferred amounts are included in a taxpayer’s SR&ED qualified expenditure pool (“SR&ED Pool”). The balance in the SR&ED Pool at the end of the year is multiplied by 20%, or 35% for qualified CCPC expenditures, to determine the SR&ED investment tax credit. The enhanced 35% rate applies on up to $3 million of qualified SR&ED expenditures incurred by a CCPC in a year. The general 20% rate applies to a CCPC’s SR&ED expenditures that are not eligible for the 35% rate.
The Budget proposes:
to reduce the general rate from 20% to 15% for tax years that end after 2013, with the reduction in the general rate pro-rated for tax years that include January 1, 2014; and
no changes to the enhanced 35% rate or the $3 million maximum.
Capital Expenditures Exclusion
Under the existing SR&ED program, current and capital expenditures on qualified R&D are fully deductible. This is in addition to the tax credits noted above. The Budget proposes to exclude capital expenditures from eligibility for SR&ED deductions and investment tax credits. This measure will also apply to payments made in order to use property that would be capital property if it was bought by the taxpayer. This measure will apply to both property acquired after 2013 and the right to use property after 2013.
SR&ED Overhead Expenditures Proxy Reduction
Currently, itemized overhead expenditures that are directly attributable to the conduct of R&D are eligible for the SR&ED tax incentives. Taxpayers can elect to use a proxy method instead of calculating overhead expenditures. The proxy method allows the taxpayer to claim as eligible SR&ED expenditures 65% of the total of the eligible portion of salaries and wages of the taxpayer’s employees directly engaged in the conduct of R&D in Canada.
The Budget proposes to reduce the proxy rate from 65% to 60% for 2013, and 55% for years after 2013. The proxy rate that will apply for taxation years that include days in 2012, 2013, and 2014 will be pro-rated based on the number of days in the taxation year that are in each of those years.
Contract Payments - 80% Proxy and Exclusion of Capital Expenditures
Currently, when a taxpayer hires an arm’s length party to perform R&D, the taxpayer is entitled to claim qualified SR&ED expenditures equal to the entire amount of the contract payment, less the amount of qualified SR&ED expenditures claimed by the arm’s length party in respect of the contract.
The Budget proposes to:
limit the qualified SR&ED expenditures to 80% of the amount the taxpayer paid on the arm’s length R&D contract, applicable to expenditures incurred in or after 2014; and
exclude any amount paid in respect of a capital expenditure incurred by an arm’s length provider in fulfillment of the R&D contract, starting in 2014.
In addition, the amount that the arm’s length R&D provider is required to net against its qualifying SR&ED expenditures because of the contract payment will be reduced by the amount received by the provider that is in respect of its capital expenditures.
The Government announced that it will invest $6 million to implement changes to the SR&ED program, including:
enhancements to the online self-assessment eligibility tool and more effective use of tax alerts in this area; and
improvements to the notice of objection procedure to allow a second review of the scientific eligibility determination.
The Government also announced that it will conduct a study on contingency-fee based consultants used by businesses to determine eligibility and the amount of SR&ED claims. Future action may be taken on such arrangements.