Proxy or Traditional Method – Which should you choose?

If you have never filed an SR&ED claim before you may not be aware that there are two methods available to you for filing your claim: proxy and traditional. Traditional is the default method that will be selected for you if you do not choose the proxy method on Line 160 of the T661 form; however, this may not be the best option for your organization. It is important to review this decision carefully, as once the method has been selected, this will be the method used for all of your SR&ED projects for that tax year. You may change methods the following year, but once the claim process has been started you must complete that filing cycle with the method selected – even if it results in a lower refund.

What follows is a brief explanation of both the proxy and traditional methods. Each method has undergone several revisions in 2012, 2013, and 2014, so make sure you are referencing the most up to date information when filing your claim. While we cannot make the decision of which method to follow for you, after reading this post you should be sufficiently informed to make the appropriate decision for your organization.

Proxy Method

Most claimants with labour-intensive projects find the proxy method to be the easiest method of filling out an SR&ED claim.  The equation used for SR&ED calculations is based on a notional Prescribed Proxy Amount (PPA) calculated as a percentage of the salary base. The salary base is composed of the salary/wages of employees directly engaged in SR&ED. It also includes specified employees but this amount may be limited. Since 2014, the PPA is 55% of the salary base – this means that if you have $100,000 in eligible salary expenditures, the CRA will “top up” your expenses by $55,000 (thereby giving you a pool of eligible expenditures of $155,000 instead of $100,000).

The PPA is intended to cover overhead and other expenditures such as general purpose office equipment and furniture, office supplies, utilities, salaries or wages of staff providing service to SR&ED employees, travel, training, upkeep of premises, property tax and any other expenditure that would not otherwise have occurred had the SR&ED not taken place. It is important to ensure that your overhead costs exceed the proxy amount, otherwise, you will be subject to the PPA cap.

Materials consumed or transformed in the undertaking of SR&ED work in Canada are permitted and claimants can refer to the Materials for SR&ED Policy to confirm eligibility; however, these are not used when determining the proxy amount. Similarly, contract expenditures are also permitted but will not influence the proxy amount.

Traditional Method

As mentioned, this is the method that you will automatically follow if you do not pre-select the proxy method.  It should be noted that following the traditional method requires excellent record keeping because claimants will be asked to identify and justify all SR&ED related overhead and other expenditures. With the traditional method, SR&ED expenditures such as general purpose office equipment or furniture may be included – but it’s important to justify how these items relate to SR&ED.

Compared to the proxy method, salary or wages incurred for clerical and administrative personnel who provide a service to SR&ED employees could be claimed as overhead, but this is decided on a case by case basis. For any non-R&D costs, you should be prepared to prove that the expenses are directly related to SR&ED by showing that had the SR&ED not occurred these expenses would not have been incurred.

The traditional method also allows for a retiring allowance as an overhead if it can be shown that this expense was solely attributable to the undertaking of SR&ED in Canada. Other allowable expenses under the traditional method relate to SR&ED employee moving expenses and taxable benefits related to the hiring of SR&ED personnel, as well as the cost of training SR&ED employees.

Note: If you use this method, it’s important to add your overhead costs to the T661 form. Many companies check the “Traditional” box on their first claim, forget to add in overhead expenditures (as they must be calculated manually), and lost out on thousands of dollars. 

Example

In order to better illustrate the different calculations between the proxy vs. the traditional method, we have created a sample calculation below. We also suggest you try our online calculator as a predictive tool regarding your potential claim return.

Proxy vs. Traditional Calculation Method Example

ABC Corp is a CCPC with an ITC rate of 35% and the following SR&ED expenses over the past year:

  • Employee Salaries  $200,000
  • Overhead                  $75,000
  • Materials                  $20,000
Claimable ExpensesProxy MethodTraditional Method
SR&ED salaries$200,000$200,000
Materials$20,000$20,000
Overhead$ (N/A)$75,000
TOTAL pool of deductible SR&ED expenditures$220,000$295,000
PPA Amount (55%)$110,000$ nil
Total qualified SR&ED Expenditures$330,000$295,000
Total ITC earned (at 35% of qualified SR&ED expenditures) $115,500 $103,250

Comparison Table from the T4088

What are the benefits and challenges of each method? The CRA has outlined these in the T4088 – Guide to the T661. 

Table 2
Advantages and disadvantages of the proxy method and the traditional method
MethodAdvantagesDisadvantages
Proxy method
  • the PPA or any expenditures that the PPA represents cannot be included in the SR&ED expenditure pool of deductible SR&ED expenditures
  • the salary base must be calculated
  • overall cap on the PPA may need to be calculated (see example in Part 5, Section B)
  • the PPA may be less than the actual overhead and other expenditures incurred
Traditional method
  • overhead expenditures can be included in the pool of deductible SR&ED expenditures
  • may result in actual overhead and other expenditures incurred being greater than the PPA
  • do not need to calculate the salary base and determine the PPA in Part 5
  • do not need to calculate the overall cap
  • must demonstrate that the overhead and other expenditures are directly related and incremental to the SR&ED
  • can be complex in certain situations such as when SR&ED and non-SR&ED work are carried out in the same facility (for example, shop-floor SR&ED)
  • must specifically identify (track) and allocate which overhead and other expenditures are for the SR&ED work
  • must explain how you determined the amount and must provide support for the determination and expenditures claimed
  • the PPA may be greater than the actual overhead and other expenditures incurred 1

 

Changes

There have been a number of revisions to SR&ED claim allowances since 2012. For example, post-2012 only 80% of SR&ED contracts and third-party payments are eligible for ITCs. 2013 marked the end of the ability to use capital property (leases) for SR&ED incentives. Finally, the percentages the proxy method uses has also changed. Prior to, and including 2012 the percentage amount is 65%. This amount dropped to 60% for 2013 and further to 55% for 2014 and later. The proxy calculation is prorated based on the number of days in the tax year that straddle January 1, 2013 or January 1, 2014. 2

Conclusion: Choose the Best Method for your Company

Larger companies may find more benefit in the traditional method than smaller companies;  however, the method selected should be based upon which will garner the largest SR&ED Investment Tax Credits. You should also weigh the strengths and weaknesses of your organization. Clearly, the traditional method of claiming SR&ED credits requires extensive, accurate record keeping. If this is not your forte then the proxy method may serve your organization better. Another factor to consider is the length of time it takes to file the claim using either method against the amount of the return. If the difference in return is negligible but the effort is extensive then you may want to go the easier route. Try our calculator to predict your return amount based on each method as a first step in the selection process.

Why not try testing out the proxy and traditional method using our SR&ED calculator

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