All posts by Rob Farrow

About Rob Farrow

accountant, entrepreneur, former chef, occasional artist, angel investor, business advisor, corporate tax specialist

Budget 2019 Increases SR&ED Funding

The 2019 Federal Budget removed the prior year’s taxable income as one of 2 factors used to determine the SR&ED (“scientific research & experimental development”) expenditure limit. All Canadian-controlled private corporations (aka “CCPCs”) are entitled to 35% refundable tax credits on their “SR&ED expenditure limit”.

The SR&ED expenditure limit starts at $3 million and was reduced as taxable income in the preceding year rose above $500,000. For every dollar of taxable income above $500,000, the SR&ED expenditure limit was reduced by $10. This had the effect of eliminating the SR&ED expenditure limit when the taxable income of the preceding year increased to $800,000.

Once that happened the company was only entitled to a 15% non-refundable tax credit.

As a result, in the past practitioners worked to keep taxable income lower using a variety of techniques. This could have consequences that would work at cross-purposes to the public policy intention of the SR&ED program.

Budget 2019 proposes to repeal the use of taxable income as a factor in determining a CCPC’s annual expenditure limit for the purpose of the enhanced SR&ED tax credit. As a result, small CCPCs with taxable capital of up to $10 million will benefit from unreduced access to the enhanced refundable SR&ED credit regardless of their taxable income.

As a CCPC’s taxable capital begins to exceed $10 million, this access will gradually be reduced as shown in the highlighted column in Table 5.

This change will provide a more predictable phase-out of the enhanced SR&ED credit rate, which will more effectively support growing small and medium-sized
firms as they scale up.

This measure will apply to taxation years that end on or after Budget Day.

…from Investing in the Middle Class – Budget 2019

After these changes take effect, the expenditure limit will be reduced only by “taxable capital”. Note that taxable capital remains in the Income Tax Act after capital tax was eliminated. It is used as a proxy for a company’s size. While taxable capital can be complex to calculate, it can be approximated by looking at total assets.

If total assets are less than $10 million, there is no need to calculate taxable capital. The expenditure limit will be reduced in a straight line as taxable capital increases from $10 million. The expenditure limit will be entirely extinguished when taxable capital exceeds $50 million.

Columbus Discovers America

A little over a year ago my partner and I attended a meeting during which CRA’s Research Technology Advisor attempted to describe eligibility for the benefit of our client.

He used the analogy of Columbus setting out for America in 1492. If that were being claimed today we would have to consider the claim in the light of the technological environment at the time. We would need to consider the base level of technology at the time in order to understand whether a technological advancement was attempted.

My partner and I liked the clarity of the analogy and thought that it would be useful for first-time claimants.

Tax Planning for SR&ED

As a former senior manager with one of the largest SR&ED practices in Canada, I remember that other tax practitioners referred to us disparagingly as part of the tax ‘compliance’ function. In the hierarchy of tax practitioners, tax compliance practitioners were considered somehow less ‘sexy’ than US & International Tax, Mergers & Acquisitions and some of the other specialties in the tax practice.

Of course while some of the M&A and International Tax work often involved much larger companies, SR&ED was far more important to  the bottom line of many SME clients.

Consider the case of a 6 year old company with $5.5 million in taxable income – who earned a tax refund of $175K. At standard rates they should have paid at least $1.35 million in tax – for a benefit of more than $1.5 million.


At my old firm we had National Top Tier clients and Local PCS clients (Private Company Services). The so-called Top Tier clients were often staffed by alumni of the Big 4 audit firms. As a result the tax planning was forward-looking and much of it done in-house.

By contrast, PCS clients were more of an afterthought and the PCS  practice resembled smaller, local CPA firms of the kind that typically service startups and early-stage SMEs – except that the rates were higher.

I remember frequently getting calls from local PCS partners with “quick questions” about SR&ED. “Quick question” was unwritten code for – “please don’t put any time on the W.I.P. (work in process). The questions were invariably ‘after-the-fact’ and tax planning involving SR&ED wasn’t possible, since the PCS partners typically wanted to perform the tax planning themselves and didn’t have the SR&ED expertise to understand the SR&ED ‘Expenditure Limit”.

There were some notable exceptions who did interesting work, but most PCS partners looked at SR&ED as an afterthought.

Managing the SR&ED Expenditure Limit is the key to maximizing SR&ED incentives

Simply put, small Canadian controlled private corporations (aka “CCPCs”) start with up to $3 million in available ‘expenditure limit’. These are the expenditures for which companies can earn up to 35% in refundable investment tax credits against. In other words they can receive as much as $1,050,000 in federal tax refunds. Add to that, up to $300,000 in refundable BC tax credits (or similar in most provinces other than PEI), and it’s plain to see that managing the expenditure limit can be important to these smaller CCPCs.

The trouble is that the expenditure limit is determined by the prior year’s taxable income. So managing the expenditure limit requires foresight in managing taxable income the year before companies claim the tax incentive. Given the importance of the SR&ED incentive to companies that use it, this means that good tax planning is essential.

Good Tax Planning is Essential for Companies Wishing to Maximize SR&ED

When taxable income in the prior year exceeds $500K, companies start to lose expenditure limit at the rate of $10 per dollar of taxable income in excess of $500K. So by the time that a company earns $800K, the subsequent year’s refundable tax credit will be zero.

SRED Exp Limit

Tax professionals also need to consider the taxable incomes of all associated corporations. Since the taxable incomes of all corporations in the associated group had to be aggregated. Note that in aggregating taxable incomes, we ignore losses of companies in the associated group.

Stranding Losses in Associated Corporations is Orders of Magnitude More Costly for SR&ED Incentives than it is for Maximizing the Small Business Deduction

Considering how much effort goes in to planning the maximization of the small business deduction, it should be surprising that more effort doesn’t go in to maximize the SR&ED expenditure limit. I can only guess that the people who generally prepare SR&ED claims work mostly after-the-fact and independently from those engaged in tax planning.


Documenting SR&ED in an Agile Environment

As described in an earlier post, the Northwest Hydraulic case from 1998 resulted in a new set of criteria in order to determine the existence of SR&ED. The original 3 criteria were expanded into 5 Questions.


  • Scientific or technological uncertainty: Technological obstacles / uncertainties are the technological problems or unknowns that cannot be overcome by applying the techniques, procedures and data that are generally accessible to competent professionals in the field.
  • Scientific and technical content: A systematic investigation entails going from identification and articulation of the scientific or technological obstacles/uncertainties, hypothesis formulation, through testing by experimentation or analysis, to the statement of logical conclusions. In a business context, this requires that the objectives of the scientific research or experimental development work must be clearly stated at an early stage in the evolution of the project, and the method of addressing the scientific or technological obstacle/uncertainty by experimentation or analysis must be clearly set out.
  • Scientific or technological advancement: The search carried out in the experimental development activity must generate information that advances your understanding of the underlying technologies. In a business context, this means that when a new or improved material, device, product or process is created, it must embody a technological advancement in order to be eligible. In other words, the work must attempt to increase the technology base or level from where it was at the beginning of the project.



In theory the determination of eligibility didn’t change after Northwest Hydraulics. However a careful reading of the 5 Questions makes it clear that there is more of an emphasis on the scientific method:

The method to establish if there is SR&ED involves answering five
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 experiment or analysis?
4. Was the overall approach 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?
Remember: “It is determined that there is SR&ED if the answer to all
five questions is ‘YES’.”
As you can see, there is a greater emphasis on documentation of the hypothesis, experiments, and the results of tests, than there was in the 3 Criteria described earlier.


While the CRA expects that claimants will identify and document SR&ED projects, the reality is that claimants document product development and process improvement projects. These “business projects” include eligible activities, however the eligible portion of development work must first be extracted from the business project.
Typically as practitioners we expect that claimants will do a good job of documenting business projects and managing costs. That only makes good business sense. However documenting SR&ED projects is a different matter.
Most technology companies don’t actually intend to be engaged in SR&ED projects. SR&ED is really a by-product of product development in a quickly changing technological environment.
As SR&ED practitioners we almost always begin by ‘reverse-engineering’ the business projects to identify potential SR&ED. Once potential projects have been identified, we work with development staff, our own technical folks and GOOGLE search to try and determine the base level of technology and try to understand why it wasn’t adequate to meet the company’s business objectives.
Once identified, solving the technological uncertainties becomes a ‘sub-project’ within a larger business project. All we need to do then is to map the activities essential to solve the eligible technological problems, and strip out the ‘routine engineering’ contained in the business project.
The best way to do this is to work with the company’s ‘activity-based costing’ system to allocate costs and activities to the SR&ED project(s).
That might be easy if companies actually used activity-based costing systems.
Instead we need to build our own activity-based system and superimpose it on the claimant’s project management system.


In the past, CRA recommended that claimants ensure that developers prepare detailed timesheets describing eligible activities. That simply isn’t workable, primarily because timesheets (if used) are tied to business projects – not SR&ED projects. What’s more they’re almost never detailed enough to be of any value.


Instead we tend to use the natural tools favoured by software developers and others in managing development projects. For software developers these include software source code repositories and versioning tools like GitHub or Subversion.
These are a natural outgrowth of systematic software development projects, and involve developers logging changes to source code as the work is completed. The associated log files can determine with some degree of accuracy what pieces of source code individual developers worked on – and when.


Another useful source of data is project management software like JIRA, ASANA or HUBBLE. These indicate the intentions of project managers prior to deployment.
Coupling these types of data with detailed payroll records can provide a good substitute for activity-based costing for SR&ED projects. Ideally though, identifying technological uncertainties is best done by technical leads, as soon as they become apparent.
Our technical folks at CALIBR8.ME can assist with building documentation for SR&ED.

Software Eligibility for SR&ED

Of the estimated 20,000 claims for SR&ED submitted in 2017 (Source: Amy Siu – Pacific Region Assistant Director – SR&ED for CRA), fully 50% were for software, and at least 95% represented claims for “Experimental Development”. Presumably most of the eligible work was done by engineers using standard engineering techniques.

Companies considering claiming SR&ED are faced with a great deal of ambiguity and uncertainty. As practitioners we understand this. In the past the CRA has issued sector specific guidance for various industries. Practitioners, claimants and the CRA each relied on these guidance documents in the past. However in the last few years all of these were withdrawn.

In 2017 however, the CRA changed direction and issued a new guidance document for software claimants.

While it is good to know that the CRA continues to be committed to the program, the implementation is still difficult because of the subjectivity of the definition. Claimants must be able to answer “YES” to each of the 5 Questions.

Claimants must be able to answer “YES” to each of the 5 Questions

The method to establish if there is SR&ED involves answering five
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 experiment or analysis?
4. Was the overall approach 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?
Remember: “It is determined that there is SR&ED if the answer to all
five questions is ‘YES’.”
These questions were laid out in the precedent-setting Northwest Hydraulics Case from 1998. Unfortunately the terminology seems more in keeping with the “scientific method” as opposed to an engineering approach.
Since most claimants hire engineers rather than scientists, this can be a problem. For the most part engineers don’t speak about “hypotheses” – even though they actually develop them when doing experimental development.
As practitioners our first task is to determine whether there was a “technological uncertainty”. This isn’t necessarily the same thing as a “technical challenge” – although it may be (I am reminded of the question: How many angels can dance on the head of a pin?). We do this by questioning engineers who most often would rather be doing something else instead of playing word games.
Also we should keep in mind that most engineers are practical people who believe that engineering – if done right – can solve most technical problems. What’s more they typically don’t like to talk about their failures.
As SR&ED practitioners we love talking about failures – because that is often where the SR&ED is. Engineers on the other hand, won’t always admit when things were hard. For many it is simply a matter of pride.
If all of that isn’t hard enough, occasionally we run into Research Technology Associates (aka “RTAs”) who say things like:
“If you are using standard engineering tools and methodologies, you can’t be doing eligible R&D.”
While clearly some RTAs are simply wrong, the process can be frustrating if claimants get off on the wrong track at the outset. Unfortunately there are pockets of incompetence spread throughout the regions. While the CRA does it’s best to identify problems, it can be challenging in a unionized environment, once incompetent staff have achieved a foothold.
The good news for claimants in the Pacific Region, in our experience CRA specialists here are relatively competent and reasonable.