CRA Policy Review – SR&ED During Production Runs
The numerous and detailed SR&ED-related policies can be overwhelming, therefore, in an effort to make the inner workings of the SR&ED program understandable and straightforward we have examined some of these policies and summarized them for our readers.
The SR&ED During Production Runs Policy examines how to determine if the costs associated with experimental development carried out during the operation of a commercial facility are allowable expenditures for SR&ED tax incentives. This article gives a summary of the information contained within the policy. To listen to the policy see our previous post SR&ED During Production Runs Policy – Recording.
The Production Run
Experimental development can occur within a production or manufacturing environment when the operation is part of a systematic investigation or search by experiment or analysis. The ‘production run’ refers to the running of processes and/or equipment for periods to achieve specific objectives, and if the production run produces experimental development, which is SR&ED eligible, it then must be determined what portion of that run can be claimed.
The Context of the Production Run
To determine the extent of SR&ED eligibility and how the expenditures within a business’s production run will be treated, the context must first be determined. The rationale for the context of each production run must be supported by suitable evidence, please see our previous post SR&ED Supporting Documentation – Getting from Point A to Point B, for further information on effective contemporaneous documentation for your SR&ED claims.
The context of a production run that contains experimental development can be classified as either Experimental Development in conjunction or simultaneously with Experimental Production (ED+EP), or Experimental Development in conjunction or simultaneously with Commercial Production (ED+CP). The production run is classified as ED+EP when there is a technical risk attributable to the technological uncertainties to the process or product. The costs associated with CP are not allowable SR&ED expenditures therefore it is essential to divide and allocate the costs between SR&ED and non-SR&ED work within the production run.
Allowable SR&ED Expenditures
Once it has been established that SR&ED work did occur within the production work the allowable SR&ED expenditures can be calculated. The table Allowable SR&ED expenditures in the context of ED+EP and ED+CP displays what costs are considered for SR&ED eligibility and the extent of each cost. The expenditures considered in determining the extent of SR&ED performed include:
- Salaries or wages,
- Cost of materials consumed or materials transformed,
- Overhead and other expenditures (under the traditional method only), and
- ITC recapture. 1
Please see section 3.1. of the SR&ED During Production Runs Policy for more details on determining the allowable SR&ED expenditures.
An alternative approach to determine the allowable SR&ED expenditures is the incremental cost method. The method involves identifying the overall amount of incremental costs incurred as a result of SR&ED. The incremental costs are calculated by taking the overall cost incurred during the ED+CP production run and subtracting the standard production costs attributable to commercial production without experimental development. The difference is the cost attributed as SR&ED eligible and can be claimed as such. To use the incremental cost method it must be determined that isolating the SR&ED work within the production run is impossible by both the taxpayer and the Canada Revenue Agency (CRA), and the taxpayer must sign a waiver of the right to object or appeal under subsection 169(2.2) of the Act because this approach is not founded in law and is only available on an administrative basis.
The creation of commercial products cannot be claimed as SR&ED however, as the policy explains, it is possible for SR&ED to occur in within a commercial production setting. If you are unsure whether your production run may contain SR&ED eligible work and you do not want to miss out on possible SR&ED incentives feel free to reach out to us below.
To see the policy in its entirety see SR&ED During Production Runs Policy on the Government of Canada website.