The anatomy of an optimized SR&ED claim
Alberta’s life sciences and medical technology sector is a crucial (and sometimes underestimated) part of the provincial economy. Most companies are aware of Provincial and Federal innovation funding and support systems. When used wisely, these programs (especially SR&ED) can accelerate the R&D timeline to get these important advances to market sooner. However, even if your company is currently claiming SR&ED, there are many ways to strategically optimize your claim to get a higher return.
This white paper will aim to answer the following questions:
- What types of activities normally qualify?
- What costs are normally claimed?
- What are the unique considerations for spinoffs from universities?
- How to optimize claims with inventor’s type of pay from their professional corporations?
- Do QA, QC, and regulatory approval work qualify for SR&ED?
- How do other sources of funding affect your SR&ED claim?
The SR&ED program’s technical eligibility criteria are a set of five questions; however, they focus on three primary aspects of your company’s technical work:
- Was there a scientific or technical unknown or uncertainty you had to resolve?
- Did you follow a systematic investigation to attempt to resolve the uncertainty?
- Did you keep documentation of the investigation?
Pharmaceutical companies rarely have trouble demonstrating their attempt to overcome a scientific or technological uncertainty; this is because the field has rigorous requirements for testing and development. As well, the documentation procedures are often well established and support the systematic intent of their investigation.
Documentation can make or break your claim
However, for some Med Tech companies, documentation doesn’t always follow the same strict procedures. Prototype developments often include iterative mechanical engineering improvements. With each new version, the company may not generate contemporaneous descriptions of what specific uncertainties exist and how they will be tested. While the actual work may follow a systematic investigation and seek to answer a scientific or technical unknown, lacking contemporaneous documentation can jeopardize your SR&ED refund.
Rate of return and qualifying costs
Many life science companies in Alberta are Canadian-Controlled Private Corporations (CCPCs) and are considered small businesses; as a result, they attract the “enhanced” rate of 41.5% back on allowable expenditures. The most attractive feature of this incentive is that it is returned to the company as refundable credits, i.e. cash-back. Claimants need not be taxable and can be pre-revenue.
The rate of 41.5% is applied to the pool of claimed SR&ED expenditures. Employee salaries are eligible SR&ED costs, allocated as a proportion of time spent on the project work as described above. Contractors and 3rd parties engaged in supporting the R&D efforts are claimable, as are materials used up, consumed, or transformed into a non-commercial prototype. Overhead costs can also be claimed, either as discrete items in support of the R&D project, or as a multiplier of 55% of SR&ED wages.
IP negotiation and university spin-offs
Often life science companies originate from academic research conducted at an accredited institution. While spinning out the venture from the university, principals will negotiate for the rights to the intellectual property. In order to claim any costs incurred through the company while at the university, your business must be able to preferentially exploit the IP generated. If IP is wholly retained by the academic institution, it invalidates your ability to claim for any costs incurred to generate that IP.
Allocating time between your professional corporation, university and your venture
If you’re paying yourself out a professional corporation, your salary would be proportionally allocated between your regular professional duties (e.g. physician, professor) and time spent on technology development or research. For example, if you spent 40 hours a week as a professor, and an additional 20 hours a week on your R&D, 1/3 of your wages would be attributed as a SR&ED expense.
However, many professionals elect to compensate themselves via a dividend that is typically done to avoid the issuance of remittances. While wages are a major category of SR&ED-eligible expenditures, dividends are not SR&ED-eligible. Of course, SR&ED is just one consideration for planning your personal finances and taxes, but paying a wage should be considered if you dedicate enough of your time to developing your technology or pursue R&D for your venture.
If you’re developing a prototype and using a third-party contractor, there are some important considerations you should take into account. Expenditures relating to 3rd parties (or contractors) are claimed at a rate of 80% of the contract value. In contrast, materials are claimed at 100% of their value. If you’ve arranged for your contractor to pay for the cost of materials upfront and then seek reimbursement from you, it’s possible that CRA will dispute claiming those materials at the rightful rate of 100% -- instead, CRA would argue the materials should be claimed at 80% of their value. Avoid this situation altogether by arranging for the corporation to incur the cost of materials rather than your 3rd party.
Contracts: out-of-country contract R&D
Generally speaking, if your company is paid to do R&D work on behalf of another organization, you cannot claim for the cost of your efforts (since you were compensated). Instead, the company paying you to do the work would claim the costs as a SR&ED 3rd party contract. However, an often-overlooked exception is when conducting R&D in Canada on behalf of an out-of-Canada organization. In this circumstance, there is a mechanism to get paid for that work, and claim your internal costs as SR&ED expenditures. For example, costs associated with working on a clinical trial in Canada for an American-based company can be claimed if they are not paying your company through a Canadian subsidiary.
How does CRA view QA/QC work?
Quality control or routine testing of materials, devices, products or processes are specifically disallowed as direct SR&ED activities. However, many companies struggle to overcome technical challenges with regard to the consistency of their product or process. As a result, QA/QC can be an important step in verifying the success of your core R&D project – and are indeed legitimate “supporting activities” for your SR&ED project. The nuance is in determining the right proportion of QA/QC for your project – how much QA/QC was necessary to validate the technology itself versus non-technical criteria such as appearance or consistency? An eligible SR&ED project could also relate to the development of a novel QA/QC technique or process.
Costs incurred to further your technology or understanding of science are the backbone of your SR&ED claim. Following the core development of the IP, we are often asked whether work done to file for patents or receive regulatory approval qualify as SR&ED. Patent-related costs are ineligible. Costs incurred to receive regulatory approval are often ineligible, but the answer may be more nuanced. If the constraints imposed by the requirements for regulatory approval require modifications or cause you to delve deeper into answering a technical question (about efficacy under certain conditions, for example), then the corresponding technical work could be claimed.
Implications of government funding on your claim
Life science, pharmaceutical and Med Tech companies almost universally take advantage of government support from multiple funding agencies. Generally, a company’s eligible SR&ED expenditures are reduced by the amount of government support they receive for those activities. At first blush, some companies might dismiss SR&ED as a viable pursuit because of their government support (“double dipping”). However, there are often numerous ways that you can strategically assess government grants and still have a sizeable pool of SR&ED-eligible expenditures to claim.
Through strategic optimization, other sources of government funding needn’t substantially reduce the size of your SR&ED claim
Firstly, wherever possible, claimants can attribute government support to offset non-SR&ED-eligible costs. For example, equipment is a capital item and therefore explicitly disallowed for SR&ED purposes. If a government grant went to the purchase of equipment, you would not be required to reduce your pool of SR&ED-eligible expenses.
Secondly, look for opportunities where certain staff are supported by multiple government grants (“stacking”). For example, researcher Dr. Jane Doe has her base salary fully covered by a provincial grant, and she’s working on a project for which her company also received a federal grant. Her work is not related to a SR&ED project which will be claimed. In this case, her salary and overhead “proxy” are covered multiple times by different funding sources. Given these facts, we would not claim any costs for Dr. Doe. But we would also not reduce the remaining SR&ED expenditures for other staff wages because the grants only pertained to Dr. Doe.
Where only one government grant offsets salaries...
In cases where claimants have most of their SR&ED wages covered by one source of government assistance, they should still claim the wages and related government assistance for a “proxy overhead” claim. SR&ED allows the 55% proxy multiplier to be applied to the gross SR&ED wage amounts (i.e. gross, rather than net contributions after government support). Therefore, even if a large portion of an employee’s wages are covered by a government grant, there is still a sizeable amount of SR&ED expenditures which can be claimed.
In conclusion, most life science companies in Alberta are conducting eligible SR&ED work and therefore have the opportunity to claim SR&ED. However, there is a wide divergence between simply submitting a claim, and submitting a claim structured to give you the maximum amount of SR&ED tax credits that you are entitled to. SR&ED can be a life-line for many earlier stage companies and provide a critical source of funds to offset costs, and as such the handling of your SR&ED claim is not to be taken lightly. If you’d like to speak with one of our experts about how to implement the strategies above, please reach out to set up a conversation.