Material Expenditures for SR&ED: Water, Chemical Reagents, and Other Inputs
The Scientific Research and Experimental Development (SR&ED) program offers valuable tax incentives for businesses engaged in innovation. One key component of an SR&ED claim is material costs, which can be refunded as part of the Investment Tax Credits (ITCs). However, determining which material costs qualify and how they should be accounted for can be complex. The Canada Revenue Agency (CRA) provides specific guidelines on the eligibility of material expenditures for SR&ED activities, distinguishing between materials that are transformed or consumed in the process. Understanding these distinctions is crucial for maximizing claims while ensuring compliance with CRA requirements.
The CRA interprets the term “materials” as:
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
Most materials for SR&ED are focused on whether they compose part of the body of the thing:
Raw materials, substances, or other items will qualify as materials for SR&ED under this interpretation if, at a given moment in the prosecution of SR&ED, they compose the body of either:
- a tangible object on which the SR&ED is being carried out; or
- a tangible object that results from the SR&ED that is being carried out.2
If the materials are not part of the body of the thing during the SR&ED process, they are generally not considered eligible material costs for SR&ED.
Additionally, laid-down costs, including transportation, duties, insurance, and other fees incurred to bring materials to the point of use, can also be claimed as part of material costs.3 These costs must be directly associated with materials transformed or consumed in the SR&ED process. Proper documentation and tracking of these expenses are necessary to ensure compliance with CRA guidelines.
Eligible Material Expenditures for SR&ED
As listed in the Materials for SR&ED Policy, various expenditures are eligible, which fall into two categories: consumed or transformed.
Consumed Materials
Material consumed in the prosecution of SR&ED means that the material was “destroyed or rendered virtually valueless as a result of the SR&ED”4.
These materials are used up in the process and no longer hold resale value. For example, catalysts used in chemical reactions that degrade and become unusable would be considered consumed materials. Similarly, if the material loses its structural integrity due to heat treatment and can no longer serve its intended function, it falls into the consumed category.
Transformed Materials
Materials transformed in the prosecution of SR&ED means materials that have been “changed or incorporated into another material or product as a result of the SR&ED and that still have some value either to the claimant or to another party”5.
The CRA further clarifies that transformed materials are those that are incorporated into the product or are modified during the SR&ED process and can still be sold or used for other purposes. For example, if a company is developing a new polymer blend, the base resins and additives that form part of the final composition would be considered transformed materials. If any portion of the newly developed polymer is later sold, the Recapture of SR&ED Investment Tax Credit Policy may apply.
Material Expenditures for SR&ED – Chemical Reagents, Water, and Other Inputs
As listed in the Materials for SR&ED Policy, water, acids, and solvents are not generally considered materials for SR&ED as the CRA generally considers them to be part of the overhead expenditures as they do not compose the body of a thing on which the SR&ED is performed at a given moment in the SR&ED process.
However, in some cases, these substances can be eligible if they become “part of the intermediate or final product, as governed by the chemical equations that the process is based on”6 or “part of the conversion / production process and is integral to the chemical reaction on which the process is based on“7
Water
Water can be an eligible material if it plays a direct role in forming the intermediate or final product. For example, pre-treated process water, such as reverse osmosis or deionized water, is considered an input material if it becomes part of the SR&ED product and is rendered useless after use.
It is essential to differentiate between water used in reactions versus accessory water (e.g., cleaning supplies). Water used for cleaning or maintenance purposes is not an eligible SR&ED material. Proper tracking is crucial to ensure accurate claims, and companies must maintain documentation detailing how water is used in their processes.
Chemical Reagents
Chemical reagents can also qualify if they are directly involved in the chemical transformation of the SR&ED product, or they are the subject of the SR&ED. The CRA does not directly discuss the use of chemical reagents, however, in the Materials for SR&ED Policy, they do discuss when energy is considered to be a material for the purposes of SR&ED:
Where the energy becomes part of the conversion / production process and is integral to the chemical reaction on which the process is based on, or where the energy source is the subject of the SR&ED, the cost of energy source can be claimed as materials consumed in the prosecution of SR&ED expenditure.8
It can be inferred that if a reagent is a part of the conversion / production process and is integral to the chemical reaction on which the process is based on, or if the reagent is the subject of the SR&ED, it can be claimed as a SR&ED material.
Chemical reagents which are incorporated into the intermediate or final product and have no remaining value may be considered a material consumed for SR&ED. For example:
- A reagent that chemically reacts with another substance and is no longer distinguishable in the final product is eligible.
- A reagent that serves only as a medium (such as a carrier solvent that evaporates) is not eligible.
- A reagent that is used in excess but is later recovered and reused may be subject to the Recapture of SR&ED Investment Tax Credit Policy .
Documentation Requirements
There is some ambiguity regarding what constitutes “part of the body of the thing” in cases involving water, reagents, and chemicals. The CRA assesses claims on a case-by-case basis, so supporting documentation is critical. Companies should maintain:
- Detailed chemical reaction equations showing reagent incorporation.
- Mass balance studies tracking material transformation.
- Lab notebooks and test results demonstrating the material’s role in the SR&ED process.
See our article “SR&ED Supporting Documentation – Getting from Point A to Point B” for information on the best way to track your material costs for SR&ED.
Additional Considerations on Material Expenditures for SR&ED
The CRA emphasizes the importance of tracking and classifying materials properly to ensure compliance with SR&ED rules. Some additional considerations include:
Prototype Materials: If materials are used in prototype development, they may be eligible if they are transformed or consumed in the process. The SR&ED while Developing an Asset Policy states:
The expenditures for the development (design, construction, and testing) of a prototype are treated as expenditures of a current nature. These expenditures are attributable to the prosecution of SR&ED.9
If copies or versions of a prototype are constructed either at the same time or one following the other, the application of the rules may change:
The construction of several duplicate copies of a prototype—to meet a need or to establish an inventory after successful testing of the original prototype—is not SR&ED. However, in certain cases, while the work itself is not considered to be SR&ED, the expenditures for the construction of several duplicate copies of a prototype to be used for testing may qualify for SR&ED purposes.
[…]
This means the expenditure[s] can be claimed as materials consumed or transformed when the tests are completed and not when the copies are constructed.10
For a full explanation of the rules surrounding material costs during the development of prototypes see section 4 – Prototypes in the SR&ED while Developing an Asset Policy.
Equipment vs. Materials: Any durable goods, such as lab equipment, are not considered materials for SR&ED.
[…] expenditures such as for the purchase of equipment, data, or a software license, are not expenditures of a current nature. They are rather expenditures of a capital nature.11
As of January 1, 2014, expenditures of a capital nature, including shared-use-equipment, no longer qualify for SR&ED tax incentives.12
Market Value of Transformed Materials: If transformed materials retain significant value and are sold, claimants should adjust their ITC claims accordingly as “the investment tax credit (ITC) recapture rules may apply to recapture all or a portion of the ITC relating to the cost of materials transformed that was claimed.“13
See the Recapture of SR&ED Investment Tax Credit Policy for more information.
Conclusion
Material expenditures for SR&ED claims must relate to either materials consumed or transformed which were integral to the SR&ED process. The CRA’s definitions provide a framework for evaluating eligibility, but proper documentation is essential to support claims. Water, reagents, and chemicals must directly contribute to the composition of the SR&ED product to qualify, and companies should carefully track their usage to maximize claims while remaining compliant with CRA guidelines.