Raising capital to get your startup off the ground can be challenging, especially when you don’t know what options are available.
The good news is if you’re an early-stage startup dipping your toes into experimental technology, the Canadian government can recoup a good chunk of your R&D costs. The same goes for serial entrepreneurs and executives from various industries who have been chipping away at technological advancement.
Thanks to the federal tax incentive program, Scientific Research and Experimental Development (SR&ED), companies can earn tax credits or cash refunds when they innovate their products and services.
This program provides more than $3 billion in tax incentives to over 20,000 claimants per year. But there are far more benefits to capitalizing on SR&ED than just cashing in the financial benefits.
Why startups should take advantage of SR&ED
With the help of the government backing your innovation, you can get your startup off the ground, finance future projects, and strengthen your competitive advantage. Even if your tech fails, it’s still worth claiming SR&ED credits because you’re given the chance to test your ideas in a way that may not otherwise be possible from a lack of capital.
Startups are rewarded for ideating and experimenting, which can eventually shape up your company to compete in a complex global market. SR&ED claims can also help you articulate your IP, so you can clearly communicate your unique selling propositions to clients and investors, as well as defend it against your competitors.
By taking advantage of SR&ED, you can pave a bright future for your startup and transform the Canadian tech ecosystem.
Who can claim?
The type of return you can get depends on the kind of corporation you are. It really comes down to two major players: Canadian Controlled Private Corporations (CCPCs) or Foreign and/or Publicly Owned Corporations (Non-CCPCs).
CCPCs are private Canadian companies that are generally eligible for an enhanced rate of 35% refundable investment tax credit (ITC) on qualified R&D expenditures of $3 million. Additionally, they can earn a non-refundable ITC at the basic rate of 15% on an amount over $3 million.
Non-CCPCs, on the other hand, can only apply for the 15% non-refundable federal tax credit. It’s worth noting however, that the amount of SR&ED credits you can claim varies by the province and category of expenditures).
Here is a summary of the maximum federal credit rates for a company with $5 million in eligible SR&ED expenditures:
SR&ED is undoubtedly popular within the hi-tech sector, but it’s also applicable to other industries such as oil and gas, agriculture, biotechnology, manufacturing, and more.
A common misconception is that SR&ED is only accessible for large companies, when in fact it’s available for companies of any size, as well as solopreneurs or sole proprietorships. This allows startups from any stage of their lifecycle, including pre-revenue all the way through to commercialization to tap into this resource.
It doesn’t matter how you’re generating revenue either. Whether your company is pulling money from investors or customers doesn’t affect the success of your claim. Instead, SR&ED is tied to the expenses – as long as you’re spending, you can claim.
What expenditures can you claim?
The amount of SR&ED credits you can claim varies by province. There are three categories that qualify for recoverable expenditures:
- Salaries and wages
- Subcontracting fees
Materials must be either consumed or transformed in the process to overcome technical challenges. For instance, engineering prototypes and consumables in biotechnology would qualify. Typically, CCPCs and SMEs can claim back more on their expenditures than Non-CCPCs.
Below are summaries of how much a CCPC and Non-CCPC can claim, according to the provinces in the Prairies.
Note: Unused non-refundable ITCs may be carried back three years or carried forward indefinitely.
How do you qualify?
To ensure your startup gets every penny you can from a project, there are three qualifications to meet for SR&ED. Note that the criteria does not consider things like your startup’s unique value propositions to the market, business need or case. It only has to do with technology.
- Technological uncertainty. This means your startup needs to prove that a qualified person was unable to predict the outcome with their existing knowledge.
- Systematic investigation. You need to show the iterative process of building and testing your project with proper documentation.
- Technological advancement. You need to reveal a need for more technical knowledge, such as a technology, characteristic or capability that does not currently exist and is not readily available in standard practice.
Activities that fall under these three qualifications can include computer programming, mathematical analysis, engineering, applied research, and more.
Work that is not eligible for SR&ED
- Research in the areas of social sciences, arts or humanities
- Front-end development
- Market research, routine data collecting, testing, and processing, and sales promotion
- Activities that develop, customize or change style elements
As Jeff Christie, Chief Revenue Officer, from Boast Capital puts it: “Every good SR&ED claim starts with having the proper bookkeeping and technical tracking. Get something in place that shows your tech work. Not only is SR&ED going to want to see that, but your investors will too.”
For claims to have the best chances of success, here’s what you can do:
- Be proactive - review SR&ED criteria and develop a strategy before you start experimental development
- Document and date all technological uncertainties you try to find a solution for
- Include timesheets, software prototypes, whiteboard photos, meeting minutes, etc. Don’t underestimate the importance of notes captured in emails or between your team
Many companies stop short at submitting a SR&ED claim, believing that only projects with successful outcomes are eligible. However, that is only a myth. If there’s ever a good time to fail, it’s the months before you submit your SR&ED claim, so you can test your assumptions and not sink from the financial burden it requires.
The whole point of this program is to demonstrate the need for further technological knowledge - that the technical challenges your startup faces today can’t be resolved without undergoing a systematic process.
Successful claims are the ones where companies can improve their products with diligent tracking systems and proven project methodologies that ultimately make for a more open development environment.
Case study: How SR&ED tax credit is calculated
Consider a software company in Saskatchewan that’s a CCPC. They have seven developers (one front-end and six back-end). Their salaries are $75,000 per year and have about 58% of R&D time that’s eligible for SR&ED.
Front-end developers aren’t typically eligible for SR&ED since much of their work falls under social sciences (they connect with people on the front-end). They are excluded from the equation.
The software company’s eligible expenditure pool is calculated like so:
$75,000 x 58% x 6 eligible developers = $262,000
With a 64% return on that amount, the company in this example would be eligible for $167,000 worth of refundable investment tax credits.
When should you claim?
Companies must file their SR&ED report with their corporate tax return forms. This means that SR&ED reports are due no later than twelve months after your fiscal year-end, or 18 months after the end of the tax year that you incurred your R&D expenditures.
For example, in the fiscal year of 2018, a startup with a December 31 year-end will have a filing deadline on June 30, 2019. This means their deadline to apply for SR&ED tax credit is in the following year on June 30, 2020.
The turnaround time to process your SR&ED claim can take up to 120 calendar days (or four months) from the day you submit it.
Earn something back for developing cutting-edge research
When we think of successful tech startups, we often imagine the companies making the biggest, most disruptive advances in technology. However, successful SR&ED claimants aren’t necessarily these same companies.
Instead, it’s the companies that pay enough attention to detail in their project methodologies that come out on top with a successful claim. As a tech startup, SR&ED works in your favour when you capture measurable data and key facts about the work your company has performed.
Beyond the generous tax credits you can earn, SR&ED allows your company to truly be transformative. It gives you the opportunity to continually develop cutting-edge products and the best practices to go with it – all without it hurting your company. Test your assumptions against all odds and further elevate innovation in Canada’s tech ecosystem.
Harvest provides finance strategies and fundraising support to help your startup or new venture’s SR&ED claim. Learn more about our Growth Services program.