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How to Avoid a SR&ED Claim Review

It may not always be possible to avoid a SR&ED claim review, but there are steps you can take to avoid a sred review 2014minimize the chances of one. By understanding why claims are reviewed and what terminology are red flags that can trigger a review, you will be doing your part to make a review unnecessary from the CRA’s perspective.

It’s important to keep in mind that a review of your SR&ED claim does not trigger a full tax audit.  A SR&ED review is an isolated review of the claim only.  Although SR&ED claim reviews are becoming increasingly common, as long as you understand the process and document your claim properly, there is no reason to fear a review.

Why are SR&ED reviews done?

There are some reasons for a SR&ED review that are not in your control.  These are good to be aware of.  If there are particular review triggers you believe exist in your claim, you can take extra care in preparing records and documentation so you will be ready to defend your case should a review happen.

Filing history – it’s likely that your claim will be reviewed at least once every 5 years.

Amount of ITC – larger claims are more likely to be reviewed, especially if the claim is large relative to company’s total resources.

There are several factors that can trigger a review that are in your control.

Your compliance history – if you are reviewed and found to be non-compliant in your claim, your chances of a future review will increase.  It’s wise, therefore, to have your claim reviewed by an expert if you have any doubts about its accuracy.  Most SR&ED consulting firms provide various levels of service, from full claim preparation to supporting and reviewing.

Work described in the project descriptions – in order to be eligible for SR&ED funding, your project has to meet the definition of the CRA’s policy.  At a basic level this means:

  • Projects must clearly show an attempt to overcome a scientific or technological uncertainty;
  • SR&ED work must follow the scientific method, or a systematic investigation, including, formulating a hypothesis, testing and analysis and modifying the hypotheses as necessary;
  • The process must be documented properly.

Certain terms in the project description can trigger an audit as they indicate that the policy definition is not being met.  This includes:

  • Trial and Error – involves execution of number of tests in any order and not making it a part of a systematic plan
  • Words like fine tuning, debugging, trouble-shooting are not regarded as SR&ED as there is no need to resolve uncertainties of underlying technology.
  • Standard practice is based on the application of routine approaches and procedures which can be accessed by skilled professionals in their respective fields.
  • In most cases migration is also regarded as standard practice.

Projects that seem unusual for the claimant’s business line – you can mitigate this by explaining how the project connects to your business clearly

Indications of lack of separation of SR&ED and commercial activities – SR&ED is focused on advancing technology.  Although advancing technology can and should help a company develop commercial activities, it is not the objective of SR&ED funding.  Keep SR&ED claims focused on the technology development and leave out the commercial element.

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Defining SR&ED Salary and Wages

According to SR&ED policy, eligible salary and wages for the purposes of SR&ED are defined by sr&ed salary and wages policy 2014the CRA much as it is defined in the Income Tax Act – namely that salary or wages must be taxable benefits.

Payments that would be taxable to the employee can include vacation pay, statutory holiday pay, sick leave pay, pay in lieu of termination notice, bonuses, tips and gratuities, honorariums, director’s fees, management fees and commissions.

Incurred expenditures

For the purposes of a SR&ED claim, a second requirement that must be met to be approved as “salary or wages” is that the expenditure must be incurred.  In other words, payment of salary and wages must be paid within 180 days of the tax year the employee completed the SR&ED work.  Stock option benefits, for example, are not considered incurred and therefore would not be included.

Work must be directly related to SR&ED or in direct support

Obviously, amounts included in SR&ED salary or wages must be for work done on a SR&ED project.  However, SR&ED work can extend to salary or wages for employees directly supervising or supporting SR&ED and can include the portion of the supervisor’s work allotted to SR&ED activities.

Administrative salary or wages for employees “directly attributable” may also be included as SR&ED overhead and other expenditures.  Directly attributable costs include salary or wages of clerical and administrative staff providing a service to SR&ED employees.

In these cases, the duties of the administrative staff assist indirectly in the SR&ED work. For example a portion of the work of a payroll clerk could be considered directly attributable if the employee processed payroll for SR&ED staff.

Other eligible SR&ED “salary and wages” expenditures

There are a few scenarios that one might not presume to be included in SR&ED salary and wages.  For example, work that is done outside of Canada may in fact be relevant.  However, SR&ED work that is done outside Canada cannot exceed 10% of the total amount of salary or wages for the SR&ED work completed inside Canada.

Bonuses can qualify under “salary and wages”.  A “Bonus” is a gifted amount, or gratuity, to which the employer was under no obligation to make.

Remuneration based on profits may also be counted as “salary and wages” in SR&ED policy. “Remuneration based on profit” refers to remuneration that is conditional on the profit of the business.

Inducements and non-competition payments, such as signing bonuses, can be considered remuneration during employment.

Amounts excluded from SR&ED Salary or Wages

In general, situations which remove an employee from direct engagement in SR&ED activities are not allowable under salary and wages.  Extended vacation or sick leave are examples of this, as the employee would not be performing any SR&ED related duties during the leave period.

Stock option benefits are not considered under “salary and wages” for SR&ED since no expenditure will be considered to have been made by a taxpayer on shares issued on the exercise of options.

Note: always check the complete CRA rules or refer to an expert there are specified employees that may not fit these guidelines.

Enhanced Capital Recovery offers professional SR&ED consulting services in Vancouver, Edmonton and Toronto and are here to support you fully in your SR&ED claims.

Put our expertise on your side by contacting us for a free consultation today.