CRA Policy Review – Materials for SR&ED

February 22, 2022 Janette Conway

The numerous and detailed Scientific Research and Experimental Development (SR&ED) related policies can be overwhelming. In an effort to make the inner workings of the SR&ED program more understandable we have examined some of these policies and summarized them for our readers. This summary pertains to the Materials for SR&ED Policy.

This policy explains what materials can be claimed as eligible expenses under the SR&ED program. The cost of materials, along with other SR&ED eligible expenses, will determine the overall amount of investment tax credits received. It is important as a taxpayer that you have an understanding of what can be claimed as SR&ED materials on your tax forms, including what you may or may not include within them.

What are Considered Materials for SR&ED?

According to the Canada Revenue Agency’s (CRA) interpretation, the term “materials for SR&ED” refers to:

All the raw materials, substances, or other items, that compose the body of a thing at a given moment in the SR&ED process.¹

The cost of materials for SR&ED includes the cost of the raw materials, substances, or other physical items as well as any duties, transportation, other acquisition costs, and storage costs. The policy states:

Cost in the phrase “cost of materials” means the original cost to acquire an item plus all reasonable costs to bring that particular item to its condition and location to be consumed or transformed in the prosecution of SR&ED.²

In our previous article Can shipping costs qualify for SR&ED? we have gone into more detail on how these expenditures may apply to your SR&ED claim. For SR&ED, the cost of materials can be claimed when materials are consumed, or when materials are transformed in the prosecution of SR&ED.

Materials Consumed

To be consumed means something has been absorbed, used up, or broken down and destroyed into useless small pieces. Within the meaning of SR&ED, a material that has been consumed means:

the material was destroyed or rendered virtually valueless as a result of the SR&ED. If a material, that meets the interpretation of a material for SR&ED, is consumed so that 90% or more of its cost was consumed in the prosecution of SR&ED, then the entire cost of the material is allowable as a cost of material consumed in the prosecution of SR&ED.³

Examples of materials consumed in the prosecution of SR&ED include:

Components destroyed in testing that was commensurate with the needs and directly in support of the basic research, applied research, or experimental development work.

Input materials that formed part of the experimental production and were consumed or rendered virtually valueless in the prosecution of SR&ED.

The additional input materials, beyond what is normally necessary to produce a standard output, because of the SR&ED performed during commercial production. Materials that would have been consumed in performing commercial production work are not attributable to the SR&ED work.⁴

Certain items may be consumed during the SR&ED process and may be eligible as overhead and other expenditures under the traditional method but are not claimable as SR&ED material expenditures. These include:

broken or used lab supplies

cleaning supplies

general utilities such as water, electricity, oil, natural gas, etc.

CDs / DVDs

used lubricants such as engine oil⁵

Materials that are consumed while performing commercial production in which SR&ED work has also occurred may not be claimed as SR&ED materials. Please see our previous article SR&ED During a Production Run for more information on how materials may be claimed and the extent to which they may be eligible.

Materials Transformed

To be transformed means that something has been through a change in form, appearance, or character. Within the meaning of SR&ED, a material that has been transformed means the material has been:

Changed or incorporated into another material or product as a result of the SR&ED and still have some value either to the claimant or to another party (for example a sale greater than 10% of the original costs).⁶

Examples of materials transformed in the prosecution of SR&ED include:

Material incorporated into a custom product or a commercial asset if the material was transformed in or as a result of the prosecution of SR&ED.

Input materials that form part of the experimental production resulting from experimental development (ED+EP) that were not consumed or rendered virtually valueless as a result of the SR&ED. For example, yarn converted into fabric during a production run where the context of the run is ED+EP. For more information on ED+EP, please refer to the SR&ED During Production Runs Policy.

Component parts used in testing that is part of the SR&ED work, but the parts were not consumed or rendered virtually valueless.⁷

For more information on materials that are transformed during commercial production procedures, and may be eligible to claim on your SR&ED forms, please see our previous article SR&ED During a Production Run.

Materials for SR&ED: Traditional vs. Proxy Method

The cost of materials consumed or transformed in the prosecution of SR&ED in Canada are SR&ED expenditures under both the traditional and proxy methods. Under the proxy method “a current expenditure that is in respect of the cost of materials consumed or transformed in the prosecution of SR&ED in Canada is considered an SR&ED expenditure.“⁸ Under the traditional method “a current expenditure that is all or substantially all attributable to the prosecution of SR&ED in Canada or that is directly attributable to such prosecution is considered an SR&ED expenditure.“⁹ It is important to note that some materials which do not qualify as materials for SR&ED may be allowable as an overhead or other expenditure under the traditional method.

Materials vs. Overhead Expenditures

Even when carrying out SR&ED work, certain items are not eligible as SR&ED expenditures but may be claimed as overhead and other expenditures if the traditional method is used. Please see our previous article Proxy vs. Traditional SR&ED Claim: Which Method to Choose? for more information on the differences between the two methods. The following items are within this category and may be claimed as overhead and other expenditures:

cleaning products

discs used in computers

test tubes, pipettes, vials, bottles, beakers, flasks, dishes, and other similar glass or plastic ware

microscopes, incubators, Bunsen burners, measuring appliances

filter papers

acids, solvents, lubricants, soaps, and other similar items used in processing¹⁰

Unless these items are the subject of the SR&ED work, they are not considered SR&ED eligible because they would not compose the body of the thing on which the SR&ED is or has been performed. For the complete CRA policy see the SR&ED Overhead and Other Expenditures Policy.

Animals and growing things

There may be applicable SR&ED material expenditures in regards to animals and growing things. If they compose the body of a thing at a given moment in the SR&ED process the cost of the animals or growing things may be claimable as materials consumed or transformed. If animals are used in testing, as part of the SR&ED work, they would normally meet these requirements. Examples of materials used in regards to animals and growing things include; animal feed, plant fertilizer, pesticides, herbicides, and fungicides. It is important to note, however, that when animals or growing things are involved in SR&ED, a control group is commonly used for comparison or monitoring purposes. The expenditures associated with Animals and growing things that are part of the control group are not normally eligible for SR&ED, since usually no SR&ED activity is performed on them.

In the case of SR&ED occurring in conjunction with commercial production, a portion or all of the materials used for the animal or growing thing would be associated with commercial work. In this case, only the additional costs incurred for the materials which are attributable to the SR&ED work done would be allowable as SR&ED expenditures.¹¹

Energy and water

The cost of utilities directly related to the prosecution of SR&ED (water, fuel, electricity, oil, etc.) are not considered as materials for SR&ED and cannot be claimed as such. The costs related to these items are considered overhead and other expenditures within the traditional method and are accounted for in the prescribed proxy amount (PPA) when using the proxy method. However, there are circumstances where the energy used in the prosecution of SR&ED can be considered as part of the cost of materials within SR&ED.

In cases where the energy becomes part of the conversion/production process and is integral to the chemical reaction on which the process is based, or where the energy source is the subject of the SR&ED, the cost of the energy source can be claimed as materials consumed in the prosecution of SR&ED expenditures.¹²

For example:

Endothermic reactions, for example, those in the chemical, petrochemical, pharmaceutical, and biotechnology industries, most metallurgical refining processes, production of cement, glass, ceramics, and other industrial raw materials, as well as most forming operations in the plastics industry require significant energy input directly into the process. In physical terms, the intermediate and final products of these processes may retain this energy in their new form.¹³

Conclusion

The CRA Materials for SR&ED Policy explains the costs incurred concerning materials for SR&ED. It explains which material costs may or may not be included in a company’s eligible expenditures for the tax year and clarifies the CRA’s position concerning issues that are common to both the traditional method and the proxy method. For further details and to see the policy in its entirety see Materials for SR&ED Policy on the Government of Canada website. We will do our best to keep our readers up to date on any policy changes or amendments.