Proposed SR&ED changes could bolster Canadian research

Around 80 per cent of Canada’s support for research and development is delivered in the form of tax incentives, which at the federal level is through the Scientific Research and Experimental Development (SR&ED) program.

The SR&ED tax incentive program offers significant benefits to businesses engaged in research and development, providing valuable financial support to foster innovation.

Sweeping changes to the SR&ED program to expand what entities qualify for it along with the types of eligible expenditures were first announced in last year’s fall economic statement and further articulated in August’s draft legislation proposals. These amendments still require legislative approval and could be modified before becoming law.

In the interim, businesses should start assessing their eligibility for the credits under the new rules to position themselves to take advantage of any newly available funding.

To help navigate these changes and maximize the benefits of the SR&ED program, businesses can engage tax professionals who specialize in these claims. As part of a holistic approach to tax planning, these advisors provide critical insights and consultation on claim documentation, application reviews and audit support, as well as exploring other government funding opportunities.

Existing SR&ED program

If an eligible taxpayer is engaged in SR&ED activities, they may be able to earn tax incentives that reduce the income tax payable.

Qualifying expenditures incurred for eligible work may be fully deductible in the year they are incurred and eligible for an investment tax credit.

Qualified SR&ED expenditures include salaries, materials, contracts, overhead and third-party payments. Expenditures made for capital or lease costs were disallowed in 2014.

The rate and refundability of the investment tax credit varies based on the type of entity the taxpayer falls under:

• Sole proprietorships, individuals, certain trusts and members of a partnership: These taxpayers can access a 15 per cent partially refundable tax credit. SR&ED credits are calculated at the partnership level and distributed to qualifying members.
• Canadian-Controlled Private Corporations (CCPCs): These entities can benefit from the enhanced 35 per cent fully refundable tax credit on up to $3 million of qualifying expenditures annually. This expenditure limit is phased out when taxable capital employed in Canada of the associated group exceeds $10 million to $50 million in the previous year. Expenditures exceeding this limit qualify for a 15 per cent tax credit, which may be partially refundable depending on prior-year income.
• Non-CCPC corporations: These businesses are eligible for the basic 15 per cent non-refundable tax credit on qualified SR&ED expenditures.

Proposed SR&ED program enhancements

These proposed enhancements would apply to taxation years that begin on or after Dec. 16, 2024 and represent the first phase by the federal government to further drive economic growth and investment in Canada.

These updates to the SR&ED program are meant to promote continuous development of intellectual property and growth of Canadian businesses—from start-up through initial public offering and beyond:

Increased federal expenditure limit for CCPCs

The federal government proposed increasing the annual expenditure limit from $3 million to $4.5 million for the enhanced 35 per cent investment tax credit. It also proposed expanding the taxable capital phase-out thresholds for determining expenditure limit from $10 million–$50 million to $15 million–$75 million.

These adjustments aim to extend access to SR&ED incentives to more small and medium-sized enterprises.

Enhanced rate for Eligible Canadian Public Corporation (ECPCs)

The latest draft legislation would extend the eligibility of the 35 per cent enhanced refundable SR&ED credit to ECPCs and their consolidated groups on up to $4.5 million of qualifying expenditures.

An ECPC would be a corporation that, throughout the taxation year, is resident in Canada, has a class of shares listed on a designated stock exchange—or, if not, has elected or been designated by the Minister of National Revenue to be a public corporation—and is not controlled by one or more non-resident persons.

Canadian-resident subsidiary corporations whose shares of capital stock are all or substantially all owned by one or more eligible Canadian public corporations would also be eligible.

This expenditure limit is subject to a phase-out threshold of $15 million to $75 million based on average gross revenue over the three preceding years. Once over $75 million, the corporation is subject to the regular 15 per cent non-refundable credit.

Phase-out option for CCPCs

Proposed legislative changes would allow CCPCs to elect to have their expenditure limit for the enhanced SR&ED credit determined based on the same average gross revenue phase-out structure proposed for ECPCs.

This could be beneficial for companies with high taxable capital or part of a large associated group, but with low gross revenues.

SR&ED capital expenditures

The August draft legislation would restore the pre-2014 eligibility rules for capital expenditures, enabling certain property acquired (or in the case of lease costs, the amount that first becomes payable) on or after Dec. 16, 2024 to qualify for SR&ED deductions and credits.

The value of the investment tax credit and the refundable portion will depend on the corporation type—CCPC or ECPC—and its expenditure limit.

At the time of acquisition, all or substantially all (90 per cent or more) of the property’s value or operating time must be intended to be used in SR&ED activities. If the property is used more than 50 per cent of the time but less than 90 per cent for SR&ED—for example, it’s also used commercially—then it may still qualify for tax credits as shared-use equipment at a reduced rate.