Weighing up the similarities and differences
between SR&ED and U.S. R&D Tax Credits.
If you do any business in the U.S. you may be wondering what differences, philosophically and otherwise, there are between U.S. Research and Experimentation (R&E (or research and development: R&D)) and Canada’s SR&ED tax credits.
What’s the U.S. R&D Tax Credit About?
Essentially, U.S. R&D tax credits seek to reward businesses that pursue innovation activities. The idea behind its impetus is that businesses don’t always profit from their innovations in the long term. One example that is given is that of Bell Labs developing the transistor. The transistor is undeniably something that has improved the world we live in, but Bell Labs lost the ability to exclusively produce transistors years ago.
Therefore, the U.S. government seeks to incentivize new products and features beyond patent law, allowing companies to claim at least some of the money they’ve invested on developing new and improved goods.
A Table Comparison
The following table breaks down some key areas of both Canada and the U.S.’s R&D tax credit systems, and provides commentary drawing out any major similarities or differences in both.
|U.S. R&D||Canada SR&ED||Commentary|
|Year Implemented||1981||Mid-1980s||In Canada, SR&ED has existed since sometime in the mid-1980s. While the US R&E tax credit has been around for a few years longer, it only became a permanent fixture as a tax credit system in 2015, having been granted multiple deadline extensions as a federal tax provision before that.|
|Definition||The research credit is generally allowed for expenses paid or incurred for qualified research. Qualified research must be undertaken for discovering information that is technological in nature, and its application must be intended for use in developing a new or improved business component of the taxpayer.|
Additionally, substantially all of the activities of the research must be elements of a process of experimentation relating to a new or improved function, performance, reliability, or quality.
|The research credit focuses in the following areas:|
- Experimental development or technological advancement.
- Applied research - advancement of knowledge for a practical purpose.
- Basic research - advancement of knowledge for its own sake.
Eligible support work includes: engineering, design, operations research, mathematical analysis, computer programming, data collection, testing and psychological research.
|In the U.S. tax credit system, improving functionality of a product will qualify for a tax credit. This runs counter to the SR&ED program, which generally does not award tax credits to improving functionality of a current product, unless some level of technological uncertainty was involved and it advanced either the state of technology or knowledge.|
Thus, it seems that the U.S. tax claim system is focused on finding new or improved products, while Canada is more interested in finding new knowledge or information.
|Eligibility Tests||There is a four-part test for determining whether research qualifies for the tax credit.|
In general, expenses must be incurred in the course of conducting research that:
- roughly follows the scientific method of inquiry and evidence.
- is “technological in nature” and relies on principles of the physical or biological sciences, engineering, or computer science
- will be used to develop a new or improved product, process, or software that will be sold, leased, licensed, or used by the taxpayer
- seeks to improve the quality, functioning, or performance of a product.
|The method to establish this involves answering the following five questions:|
1. Was there a scientific or a technological uncertainty?
2. Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
3. Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
4. Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?
5. Was a record of the hypotheses tested and the results kept as the work progressed?
|Notice that the U.S. eligibility tests are more open to interpretation. (For instance, how does one roughly follow the scientific method of inquiry and evidence?) Thus, it could be said that the eligibility requirements for the U.S. R&D tax credit are much looser. It appears to be this way to allow research that involves some level of serendipity to qualify as research and development. (Serendipity being the thing that lead to improvements such as penicillin and the ongoing development of magnetic recording tape.)|
The U.S. tax system is also more open to rewarding products that will be commercialized or licensed, which is not a point of Canada’s SR&ED incentive at all.
Compare that to Canada’s SR&ED scheme which prescribes a detailed method of carrying out research. For instance, the research had to have technological uncertainty attached to it, and a hypotheses has to have been followed.
|Costs||Expenses that qualify as QREs include wages and salaries of employees and supervisors who are conducting research, supplies, and a portion of research that is contracted to outside entities. The credit cannot cover depreciable durable assets like buildings and equipment, overhead expenses, or non-wage benefits for personnel.||A qualified expenditure is an expenditure incurred in the tax year by the claimant in respect of scientific research and experimental development carried on in Canada and is:|
- an allowable expenditure (ie. one that does not result in the acquisition of land) of a current nature for SR&ED directly undertaken by the claimant (such as materials consumed as undertaken for SR&ED);
- 80% of an expenditure which is:
-- a contract expenditure for SR&ED performed on behalf of the claimant, and
-- a third-party payment;
-- an expenditure for shared-use-equipment (SUE) acquired before 2014;
-- an allowable expenditure of a capital nature acquired before 2014;
A qualified expenditure can also be a prescribed proxy amount (PPA) of the claimant for the tax year.
|There is at least one major difference between the U.S. and Canadian R&D tax credit systems here.|
In the U.S., expenses include “supplies” -- which are any tangible property other than land or land improvements, and property subject to depreciation. This property can be either qualified research expenses, such as job summary reports, or qualified supplies, such as testing materials and prototypes.
In Canada, the terminology used is “materials”. It needs to be consumed for SR&ED purposes to qualify. However, costs can include the invoice cost, custom and excise duties, transportation, other acquisition costs, and storage costs.
As you can see, “supplies” has a much broader terminology than “materials”, so it would appear that more items would qualify under that definition.
|Rate||Although the R&E credit is referred to as one entity, it actually consists of four different parts: (1) the regular research credit, (2) the alternative simplified credit (ASC), (3) the basic research credit, and (4) the credit for energy research. In any given year, a taxpayer may claim either the regular or alternative simplified credit along with both of the others.||Many different factors are taken into account to determine the tax credit’s final value. These factors include how much salary and overhead, among other things, is claimed.||Both tax credits are complicated. In the U.S., the credits are structured in such a way that research that the taxpayer would have undertaken anyway are not funded. The focus is really on achieving research and development that is unique.|
In Canada, how much you’ll get back also hinges on factors such as applying to provincial research and development tax credits (which will reduce how much you get from the federal government).
In either approach, how much will you get back? It really all depends on what you apply for, in both cases.
As you can see, there are significant differences between the U.S. and Canadian tax credit systems. While they are somewhat similar in spirit, the U.S. draws a wider net when it comes to qualifying research in the hopes of coming up with a new product. Canada, on the other hand, has a systematic means of testing research to come up with new knowledge or approaches.Conclusion
Thinking about setting up a sister corporation in the U.S.? Find out the benefits in our article here.
If you’re looking for more information about both tax credits, or want to apply for either of them, consult the following government forms:
- Instructions for Form 6765 (2016)
- Form 6765, Credit for Increasing Research Activities (PDF link)
- Research Credit Audit Technique Guides, Directives and Guidelines
- T4088 Scientific Research and Experimental Development (SR&ED) Expenditures Claim- Guide to Form T661
- T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim