SR&ED Review – What to expect
Updated to Reflect New Policies (2022)*** Some of the policies referenced were updated 2021-08-13. This article has been updated and is accurate as of 2022. *** |
We often get asked what it’s like attending a Scientific Research and Experimental Development (SR&ED) review. While they are extremely rare for our clients, they sometimes happen. This post summarizes the insights from one of our new consultants, who experienced this for the first time. There are many categories that may be reviewed but this post will look deeper at labour and material.
Note: Currently, SR&ED reviews and audits are done via video services (WebEx or similar services).
Background
The reviewers from the CRA are helpful and make education of the program a top priority during the session. They often make suggestions to ensure that future claims will fall into the policy guidelines. They also ask questions about how the claim was assembled and the taxpayer’s knowledge of the program. These questions help the reviewer to gain an idea of how familiar and how involved the taxpayer was with the SR&ED program and their investment tax credit (ITC) submission.
Labour
Timesheets
The reviewers will often request to examine the SR&ED documentation, tracking, and claim preparation process used by the company to ensure that due diligence and commercial work are not included in claimed labour. Many taxpayers submit timesheets to the CRA to show documentation of how SR&ED eligible hours were determined. The reviewer may suggest that future timesheets include what activities were performed as well. These activities should illustrate that the employee was directly engaged in SR&ED. The SR&ED Salary or Wages Policy explains that “Directly engaged refers to “hands-on” work.”1
The reviewer may spend time explaining the difference between an employee who is directly engaged in SR&ED and an employee who is not directly engaged. The SR&ED Salary or Wages Policy further explains:
Generally, employees, including managers and supervisors, conducting experimentation and analysis in the performance of basic research, applied research, or experimental development are considered to be directly engaged in SR&ED.
In addition, employees, including managers and supervisors, are considered to be directly engaged in SR&ED when they are performing support work that is commensurate with the needs and directly in support of the basic or applied research or experimental development work.
Managers and supervisors who supervise the ongoing SR&ED work are also considered to be directly engaged in SR&ED when they are directing the course of the ongoing SR&ED work or when they are providing direct technical input into the SR&ED work. However, any time spent by a manager or supervisor performing non-technological management activities or decision-making functions that do not directly influence the course of the SR&ED, even if it relates to the SR&ED, is not considered to be time the manager or supervisor is directly engaged in SR&ED. In most cases, work performed beyond the first-line level of supervision does not qualify as directly engaged in SR&ED. Where time is claimed for employees beyond the first-line level of supervision, the claimant will be asked to provide details of the duties the employees performed during the time they were directly engaged in SR&ED. The claimant will also have to demonstrate how these duties are “directly engaged,” as described above.2
They emphasized that only the salary of those directly engaged in SR&ED is eligible for SR&ED but under the traditional method those not directly engaged can be claimed as part of the overhead costs. Under the traditional method:
A portion of the salary or wages for clerical and administrative staff providing a service to SR&ED employees may also qualify for SR&ED purposes if the functions performed are non‑technological and aid the ongoing SR&ED claimed in the year, and the salary or wages of the clerical and administrative staff providing the service are directly related and incremental to the prosecution of SR&ED.3
Proxy vs Traditional
The reviewers often explain the difference between the proxy and traditional methods to ensure that taxpayers are aware of the two different methods and that their ITCs may be larger with one of the methods over the other. The traditional method involves calculating in detail to show incremental costs to the overhead that are due to the SR&ED process. They may suggest this method as the proxy method used the SR&ED salaries claimed and add an additional 55% to account for overhead costs. For a more detailed explanation of the difference between the two methods please see Proxy vs Traditional SR&ED Claim: Which Method to Choose? and the Traditional and Proxy Methods Policy.
Materials
Materials consumed vs transformed
The technical reviewer may discuss how material costs can be claimed – as materials consumed or transformed. They may also explain that often with materials transformed one is not sure of the status when submitting a claim, that a later date these may be considered consumed or may be sold and subject to ITC recapture. There are instances when a mould or machine is claimed as part of materials consumed or transformed (not as a capital expenditure). This may happen when it is a specialized piece of equipment for experimentation. Unfortunately, if it is not part of the “thing” and may not qualify as an SR&ED expenditure. The Materials for SR&ED Policy states:
According to the CRA’s 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.4
The Materials for SR&ED Policy policy also explains:
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.
Where the creating of a new process or improving an existing one involves SR&ED, the raw materials, substances, or other items may only qualify as materials for SR&ED if, at a given moment in the SR&ED process, they compose the body of a tangible object involved in testing the new or improved process.5
The financial reviewer may explain that listing material as a capital asset on a taxpayer’s financials would invalidate it as an eligible SR&ED expenditure. If one decides to claim things such as moulds or machines, be sure that they are part of the “thing” and not a capital expenditure as these no longer qualify as an SR&ED expenditure.
The Materials for SR&ED Policy policy also explains:
To be considered an expenditure of a material for SR&ED, the expenditure must first be an expenditure of a current nature. This does not mean that an expenditure that normally would have been considered an expenditure of a capital nature can never be claimed as an expenditure for materials for SR&ED. In a situation where a component part is included in a custom product or a commercial asset, it may be considered an expenditure of a current nature. For example, a new engine, being the subject of the SR&ED, incorporated in a machine that is a commercial asset would be treated as materials for SR&ED. The engine incorporated into this machine could be claimed as a material transformed in the prosecution of SR&ED (see section 6.0) expenditure. It is important to note that when the machine is sold or converted to commercial use, the investment tax credit (ITC) recapture rules may apply to recapture the ITC relating to the cost of the engine.6
Documentation
Documentation of all expenditures including invoices and receipts should be kept and available in case of a review. The T4088 – Scientific Research and Experimental Development (SR&ED) Expenditures Claim – Guide to Form T661 lists various forms of documentation that you may wish to keep. The T4088 also states:
It is important to maintain supporting evidence (for example, information, records, documentation) to substantiate that the scientific research and experimental development (SR&ED) work was performed and allowable expenditures have been incurred. The business environment in which SR&ED is carried out will influence the nature and sources of evidence that are available to support the SR&ED claim. If your SR&ED claim is selected for review, you will be asked during the review to support your claim by providing supporting documentation that were generated as the SR&ED was being carried out. Work for which you have no relevant supporting evidence will likely be disallowed.7
Future Claims
The reviewers may offer advice on documentation including more details in their records in future reporting periods. They may advise that a summary of source documents is preferred as it allows the reviewers to ask for specific documents as required.
Additionally, the reviewers want to ensure that the taxpayer is aware of services offered:
- First Time Claimant Advisory Service (FTCAS)
- Pre-claim Consultation – a non-binding opinion (before work occurs)
- Pre-claim Review – review before the claim is submitted and then it is accepted as filed
- SR&ED Self-Assessment and Learning Tool (SALT) – downloadable PDF
- National Research Council – a way to network/connect with other people.
Conclusion
It can be very interesting to sit in during an SR&ED review. The CRA is finding ways to continue to hold reviews via web conferences. The reviewers are kind and helpful and allow the taxpayer time to talk and send in documentation once the review was over. It is helpful for the taxpayers to be informed of the different services offered for future filings. If you would like to know more please see our articles Pre-Claim Consultation (PCC) vs. Pre-Claim Review (PCR) – SR&ED and What is the Difference Between an Audit and a Review?.