How Canadian firms can claim SR&ED tax credits for software development

Canadian companies developing a new software product or process — or improving an existing one — may be eligible for substantial SR&ED (scientific research and experimental development) tax credits if they meet certain criteria.

What are these? How do you know if your business is eligible? And what information and supporting documentation do you need to submit?

These and other questions were comprehensively addressed by Dave Sabina, director, MEUK Corp. during a presentation at the IT360 Conference and Expo in Toronto recently.

VIDEO: Dave Sabina on how to apply for SR&ED tax credits

Sabina started off by explaining what an SR&ED project is. 

Canada Revenue Agency (CRA), he said, defines it as a set of interrelated activities that:

  • Collectively attempt technological advancement, and
  • Overcome technological uncertainties, and are,
  • Pursued through systematic investigation by qualified individuals

He said a new CRA form issued requires claimants to specify their field of research for “technological advancement.” The IT related ones are: computer sciences; information technology and bioinformatics; and software.

Specifying the category helps CRA to determine who will review your claim, Sabina said. “They will try to assign a reviewer with the appropriate technical background. So picking this is very important.”

Starting June 30 this year, he said, Canadian businesses (including proprietorships) would have to submit claims in the new format.

Tech advancement

The first criterion – tech advancement – is a little nebulous, Sabina conceded.

To establish that you would first need to describe “standard practice” (current methods and processes) and how what you’re doing is goes beyond the realm of readily available information.

“They want to see steps you took to find out if there’s a solution or method out there, and its shortcomings.” MEUK has created a sample list of steps that can be taken to discover what’s out there. It includes:

  • Internet research – a Google search to find relevant articles, would be an example. Specify how many articles were identified and the shortcomings they benchmarked.
  • Patent searches – if you do this, he said, you should definitely let the CRA know about it
  • Looking at competitors’ methods – Your competitor may have a closed source product or process – and to figure it out you may require to do industrial R&D
  • Researching component suppliers – You may have a device that works really well, and believe that adding third-party components would make it work better
  • Queries to experts – looking to them to provide additional guidance on whether there’s a readily available solution

Overcoming technological uncertainties

This, according to Sabina, is really the crux of the entire SR&E process.

The government says tech uncertainty can occur in either of two ways: scientific uncertainty, where the person is unsure whether the goals can be achieved at all or system uncertainty.

The vast majority of claims aim at system uncertainty, he said.

“Here you are fairly confident the goals can be achieved, but are uncertain about which of several alternatives – paths, approaches, equipment configurations, system architectures, circuit techniques etc – will meet desired specs or cost targets or both.”

Basically, it involves experimenting with different methods to optimize a product or process, he said.

System uncertainty can also involve unpredictable upstream or downstream effects, he noted.

“If I’m developing a piece of machinery I may look at motor and drive selection, which may then create issues around spacing and electrical noise, which may cause me to change the frame, which may affect the power requirements, and this may cause different architecture alternatives.”

The first step he said, is to select three or four key “technology uncertainty variables” (such as interoperability, stability, footprint) of the 20 – 30 that a crack research team may identify.

Once these are selected, the rest is easy, Sabina said. “Then if someone does work that sheds light on one of the variables in question – that would be eligible for tax credit.”

Results of the research — and conclusions drawn from them – are crucial, he said.

“Conclusions are more important than results: what do I now know regarding the variables in question that I didn’t know at the start of the day. If you can illustrate that you probably have an eligible claim.”

Systematic investigation

Systematic investigation — the third pillar of the SR&ED process — can be accomplished in three ways, he said.

  • Peer analysis: I simulate alternatives on a computer. That’s the quickest method.
  • Process trials – This is used more in manufacturing environments.
  • Prototype creation – You usually you don’t have an acceptable prototype in the first try and may need 20 – 30 revisions before creating something acceptable.

It’s important to specify exactly how prototypes you created, Sabina said.

“If you say several, or many, or various you’re probably going to get a site visit from CRA reviewers.”

Also important is specifying results of looking at these prototypes, and how they tied to your original performance objectives. “You should also probably have some conclusions, as that would be expected.”

For supporting documentation, he said, the CRA would accept a variety of items. “They will even take source code, but they like high-level documents: design notes, meeting notes, evidence of problems, queries from experts.”

For instance, he said, an e-mail from Microsoft saying they don’t know why their Foundation Classes aren’t working in this case would be worth its weight in gold.

“If you have a problem and you ask the developer of the software – and they can’t answer it, that’s going beyond standard practice. The trick is to archive those e-mails or evidence.” The basic tax credit is 20 per cent for all corporations (and individuals can claim if they’re running a business as a proprietorship).

If you do it as a Canadian controlled private corporation and you meet certain income and size test criteria – basically, you have under $50 million of assets in Canada and your previous year’s taxable income was under $400,000 after you bonus out all the amounts, you will earn an enhanced credit of 35 per cent fully refundable. This means if you have no tax payable, you get a cash refund cheque from the government plus interest when they assess you.

That’s on the first $3 million of expenditure in a year – and this was increased with the last budget.

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