SR&ED claims for small businesses: how to prepare one

Start by testing whether the work qualifies

SR&ED stands for scientific research and experimental development. To qualify, work must be done in Canada and meet two tests. It must aim at advancing scientific knowledge or achieving a technological advancement, and it must be a systematic investigation or search carried out by experiment or analysis in a field of science or technology.

The first test turns on technological uncertainty: at the start, it was unknown or uncertain whether the result could be achieved with the knowledge available. The CRA is clear that the advancement is measured against science and technology, not against your business. A faster internal process or a product that is new to your customers does not qualify just because it is new to you. The work does not have to succeed, and learning that an approach fails can count as new knowledge.

The CRA publishes a free self-assessment tool and eligibility guidelines. Running a project through them early is cheaper than discovering at filing time that the work was routine.

What is usually excluded

Some activities are excluded even when they sit next to genuine experimentation. The CRA’s list includes market research and sales promotion, quality control and routine testing, style changes, routine data collection, and the commercial production of a new product or the commercial use of a new process.

Activities aimed at acquiring knowledge that already exists are also not eligible. Training, on-the-job learning, hiring an expert to apply what they already know and buying proprietary knowledge all fall in that group. Support work such as testing, design, data collection or computer programming can qualify only when it directly supports the eligible work and is in proportion to what that work needs.

Group the work into projects and describe the advancement

The CRA’s basic steps are to identify eligible work, group it into projects, describe the work including the advancement, calculate the expenditures and then claim the deduction and credit. The description is where small businesses often struggle. It should state the uncertainty you faced, the hypothesis you tried, how you tested it and what you concluded, in plain technical language.

A useful habit is to write a short project note when the problem appears, add dated entries as tests are run and close it with the result. Whoever did the work should write the technical part. The accountant is better placed to handle the financial side, and the CRA recommends involving both senior technical and financial people.

How the costs are built

A claim reports qualifying costs on Form T661 and calculates the credit for a corporation on Schedule T2SCH31. Each year you choose between two methods for overhead. Under the traditional method you identify and justify the overhead you claim. Under the proxy method a notional amount replaces actual overhead, and it counts toward the credit calculation only. The choice is made year by year, the proxy election is made on the T661 when the first claim for the year is filed, and it cannot be changed after filing.

Under the proxy method, current costs include salary or wages for employees directly engaged in the work, to the extent of the time they spent on it, the cost of materials consumed or transformed, and contract work done on your behalf. That is why timesheets matter: a salary is claimable only for the portion that reasonably relates to the eligible work.

Other funding changes the numbers. Government assistance such as NRC IRAP reduces the credit you can earn, and provincial research credits reduce the expenditures you can claim federally. Both must be reported in the claim.

What the credit can look like

The basic investment tax credit rate is 15% of qualified expenditures. Most CCPCs, alone or associated, can earn an enhanced 35% rate up to an expenditure limit. For tax years beginning after December 15, 2024, the maximum limit is $6 million, up from $3 million, and it can be reduced for larger corporations. Associated CCPCs share one limit and allocate it using Schedule 49. Spending above the limit earns 15%.

The credit first reduces income tax payable. Any remainder may then be refunded: for most CCPCs the 35% credit on current expenditures within the limit is fully refundable, and the credit on capital expenditures is 40% refundable. Most other corporations earn a non-refundable 15%, although certain eligible public corporations can now earn the enhanced rate too. An unused credit can generally be carried back 3 years or forward 20.

Here is an illustrative example with round numbers. A CCPC within its limit has $120,000 of qualified current expenditures and no income tax payable. At 35% the credit is $42,000, and because it is on current expenditures the full amount could be refunded. Real claims reduce qualifying costs for assistance and for what the CRA accepts on review.

The CRA also lists an Ontario innovation tax credit, administered by the CRA and refundable at 8% of qualified Ontario expenditures up to its own limit, which is reduced at higher levels of prior-year income or capital. It reduces the federal pool of expenditures. Ask your accountant whether it applies to you.

Keep records while the work happens

The CRA expects your records to show what was done, by whom, when, and how each cost was worked out. Records that are dated, signed and specific to the work carry the most weight, though many kinds are accepted: project plans, experiment designs, lab notebooks, design documents, source code, test results, progress reports, meeting minutes, whiteboard photos, prototypes, timesheets, payroll records, invoices and proof of payment.

For an owner-managed business, the weak spot is usually time. If you and your employees divide days between client work and development work, a simple weekly note of hours by project makes the salary portion defensible. Reconstructing it from memory a year later is difficult.

Deadlines and timing

A corporation’s SR&ED reporting deadline is 12 months after its T2 is due. Because the T2 is due six months after the tax year end, that is 18 months after year end. Once the deadline passes, the CRA will not take any changes to the claim. Processing also waits for the T2, so the CRA recommends sending the two together. Filing at least 90 days before the deadline gives the CRA time to do an initial review and tell you what to fix.

Optional pre-claim approval lets you apply, before starting work, to have up to three projects assessed against the SR&ED definition, and each approval lasts up to three years. It does not replace the claim. Claims that contain only pre-approved projects may receive an accelerated 90-day expenditure review.

Common mistakes and what to discuss with your accountant

Common problems are claiming routine development or customization, describing the business benefit instead of the technological uncertainty, missing timesheets, forgetting to report government assistance, and ignoring associated corporations when sharing the expenditure limit. Claimants remain responsible for accuracy even when someone else prepares the claim.

Before the year ends, raise these questions: which projects plausibly meet the uncertainty test, who will write the technical description, how time will be tracked, which other funding you received, and whether you share an expenditure limit with another company. A conversation with Sora about corporate tax can cover how the claim fits your T2 and cash planning, but the technical case must come from the people who did the work.