The most notable government-backed financial support for research and development, the Scientific Research and Experimental Development (SR&ED) tax incentive program, delivers over $3 billion in refunds to thousands of claimants annually, many of which are small businesses.
To utilize this tax incentive properly, innovative organizations that receive the credits should know the SR&ED expenditure limit. Discover an in-depth overview of the expenditure limit, as well as information about SR&ED eligible expenses.
How Does the SR&ED Expenditure Limit Work?
Organizations that qualify for SR&ED tax incentives attain either a refundable or non-refundable investment tax credit (ITC), or a deduction against income, depending on their size and type.
Several businesses qualify for SR&ED tax incentives, including Canadian-controlled private corporations (CCPCs), trusts, and individuals.
Corporations that are not CCPCs can claim a non-refundable ITC at a 15% rate on qualified SR&ED expenditures, while trusts and proprietorships can claim a refundable ITC at the same rate. The rules for CCPCs are more liberal. CCPCs earn an ITC at a 35% enhanced rate on the SR&ED eligible expenses they incurred during the year to a maximum of $3 million — otherwise known as the expenditure limit.
What Causes a Reduction in the Expenditure Limit
A gradual reduction of the SR&ED expenditure limit begins when the taxable capital for the previous year of a CCPC with no affiliated corporations arrives at $10 million. The expenditure limit continues to decrease as taxable capital increases above $10 million and reaches $0 once taxable capital reaches $50 million. A similar rule applies to CCPCs with associated businesses.
An additional reduction to the expenditure limit exists for tax years ending before March 19, 2019. Once taxable income reaches $500,000, the expenditure limit gradually phases out. When taxable income reaches $800,000, the expenditure limit will be reduced to $0. Taxable income for the prior year of the CCPC and affiliated organizations will also decrease the expenditure limit.
Figuring Out the Expenditure Limit
A formula in the Income Tax Act enables corporations to calculate their expenditure limit.
Separate formulas exist for businesses linked to one or more corporations and those associated with no other companies.
For tax years that end before March 19, 2019, the formula includes the CCPC’s taxable income for the prior tax year and, if applicable, the taxable incomes of previous years for connected corporations. Taxable income for the preceding tax year is factored in before any specified future tax consequences.
If the previous tax year is less than 51 weeks, the CCPC must increase taxable incomes using a ratio of 365 to the number of days represented in those tax years. If the current tax year is less than 51 weeks, the CCPC will distribute the expenditure limit for the tax year-end by dividing 365 by the number of days in the tax year.
Additional rules apply when calculating the expenditure limit if the CCPC has two or more tax year endings in the calendar year and is associated with another corporation whose tax year ends in the same calendar year for two or more of those years. In this case, the expenditure limit of the CCPC in each tax year ending in the calendar year is the same as the limit for the first tax year. The only exception is if the tax year is less than 51 weeks. Then, the limit is apportioned according to the number of days in the year.
Allocating the Expenditure Limit
The CCPC and any linked corporation must distribute the annual expenditure limit to determine the ITCs earned at the enhanced rate. The amount not reserved for the CCPC may go towards an associated company according to its expenditure limit. In a tax year that a corporation is affiliated with another business, the expenditure limit is not applicable unless all associated CCPCs file an agreement stating how they will allocate the expenditure limit in that year.
CCPCs may use a form provided by the Canada Revenue Agency (CRA). If they do not submit this form within 30 days of the initial request, the CRA will allocate the expenditure limit as it sees fit.
What Is SR&ED-Eligible Work?
Recognizing the expenditure limit is only part of understanding how to utilize SR&ED tax credits best. Businesses also need to know what constitutes SR&ED-eligible expenses.
According to the Income Tax Act, a quailed SR&ED expenditure is incurred during the tax year and revolves around scientific research and experimental development conducted in Canada. SR&ED activities belong to three general categories — basic research, applied research, and experimental development. Some support work also qualifies as SR&ED efforts, such as engineering, computer programming, and data collection. Specific examples of SR&ED-eligible work include:
- Testing and analysis
- Salaries and wages
- Overhead expenses (equipment, utilities, maintenance)
- Administrative support
- Technological planning
Finance SR&ED Tax Credits with Easly
If your innovative organization receives an SR&ED tax refund, you may be eligible to receive non-dilutive capital with Easly Advances. We work with businesses that obtain investment tax credit refunds — like SR&ED — from the Government. Our clients access this capital as on-demand and non-dilutive funding through the online Capital-as-a-Service platform.
Contact us today to learn more about SR&ED eligibility or schedule a 15-minute introductory meeting.