Is Your SR&ED Refund Considered Taxable Income

We are often asked by our clients if their Scientific Research & Experimental Development (SR&ED) refund is considered taxable income. In this article, we will look at what your SR&ED refund is, the definition of an Investment Tax Credit (ITC), and how your SR&ED refund is taken into account at the end of the year.

What is the SR&ED refund?

The SR&ED refund is an Investment Tax Credit (ITC). ITC’s are defined as the amount that is available to a taxpayer at the end of the tax year and are ‘earned’ based on the below factors.

The total SR&ED ITC of the claimant at the end of the year includes:

  • ITC earned on SR&ED qualified expenditure pool;
  • ITC from a partnership;
  • ITC from a trust;
  • ITC carryforward and carryback;
  • additional ITC for certain Canadian-controlled private corporations (CCPC); and
  • ITC earned on repayments of assistance or a contract payment.

The total SR&ED ITC of the claimant at the end of the year excludes:

  • applied or refunded ITC;
  • acquisition of control restricts the carry forward or carry back of ITC;
  • exempt income; and
  • ITC not meeting the filing requirement.1

Applying ITCs

You can carry back SR&ED ITCs for three years (if not deducted in the year earned) or carried forward 20 years.2 ITCs can reduce the amount of taxes owed or be given as a cash refund depending on the needs of the taxpayer. No matter how one chooses to apply their ITCs it is vital to be sure to fill out the T2SCH31, T661, and Schedule 1 properly.

On the T661, the SRED expenditure pool is reduced by the previous year’s ITC’s received, thereby reducing the SRED pool claim and in effect including the ITC into taxable income the year after it is received. This is most easily seen when a company stops claiming SRED and has a negative SRED pool the following year because of this ITC reduction to the pool. The negative pool amount is a taxable income addition on Schedule 13.

Claiming SR&ED as Taxable Income

Schedule 1, Net Income (Loss) for Income Tax Purposes, is used to calculate the corporations’ net income/loss for income tax purposes. There are specific lines that do pertain to SR&ED expenditures and need to be filled in. As the net income (loss) reported on your financial statements will typically not be the same as the net income (loss) required for tax purposes, Schedule 1 is used to reconcile this difference.4

The lines directly related to SR&ED include:

Line 118 – SR&ED expenditures expensed in the accounts;

Line 231 – recapture of SR&ED expenditures (negative subsection 37(1) pool balance);

Lines 290-294 – other additions such as the provincial tax credit earned on the prescribed proxy amount (in the current or the prior year);

Line 411 – amount of SR&ED expenditures deducted in the year, as claimed on line 460 of form T661; and

Line 499 – sum of other deductions including ITC and government and other assistance recorded in the income statement of the claimant and / or other amounts not related to the SR&ED claim.5

Line 118 and Line 231 are added to the net income. Lines 290-294 are also added to the net income on Schedule 1. Lines 411 and 499 are deducted from the net income on Schedule 1.3

While your total SR&ED ITCs are not considered income earned, SR&ED expenditures expensed in the accounts and the recapture of SR&ED expenditures are added to the net income at the end of the tax year.

On the T2 form, SR&ED ITCs are input on Line 780 – Investment tax credit refund from Schedule 31. This line is used to reduce taxes payable.

Conclusion

A SR&ED investment tax credit refund is considered income earned the year after it is received. It is important to understand that the amount claimed must also be included in other parts of a taxpayer’s T2 and Schedule 1. If this information is not input correctly, it is likely to be flagged by the CRA. We recommend using an accountant well versed in SR&ED when filing your taxes and SR&ED ITCs to ensure that all information is recorded properly.

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Show 6 footnotes

  1. SR&ED Investment Tax Credit Policy. (2020, July 17). Canada Revenue Agency. https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/investment-tax-credit-policy.html#s3_3_2
  2. T2SCH31 Investment Tax Credit – Corporations. (2019, December 5). Canada Revenue Agency. https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t2sch31.html
  3. T2SCH1 Net Income (Loss) for Income Tax Purposes. (2019, December 5). Canada Revenue Agency. https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t2sch1.html
  4. Canada Revenue Agency. (2021, June 14). T2 Corporation – Income Tax Guide – Chapter 3: Page 3 of the T2 return. Government of Canada. https://www.canada.ca/en/revenue-agency/services/forms-publications/publications/t4012/t2-corporation-income-tax-guide-chapter-3-page-3-t2-return.html#P1273_106599
  5. Financial Claim Review Manual – Review procedures for financial reviewers. (2015, June 24). Government of Canada. https://www.canada.ca/en/revenue-agency/services/scientific-research-experimental-development-tax-incentive-program/financial-claim-review-manual-review-procedures-financial-reviewers.html
  6. T2SCH1 Net Income (Loss) for Income Tax Purposes. (2019, December 5). Canada Revenue Agency. https://www.canada.ca/en/revenue-agency/services/forms-publications/forms/t2sch1.html

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