Scientific Research and Experimental Development (SRED) & Investment Tax Credit (ITC)

Scientific Research and Experimental Development (SRED) & Investment Tax Credit (ITC)

Definitions

What is SRED?
  • Qualified Scientific research and experimental development expenditures (SR&ED) get a generous tax treatment in Canada.
  • The government is providing this tax incentive to encourage corporations to invest in research and innovation
What is ITC?
  • ITC is a tax credit given for investing in new capital properties (only in Atlantic provinces & Gaspe) and for investing in scientific research and experimental development (available in all parts of Canada).
  • ITC claimed on qualified capital assets reduces the tax cost of the asset (UCC) in the year following the claim.
Is all the Accounting Research & Development (R&D) = SRED?
Not all accounting R&D is SRED because accounting research doesn’t have to be scientific.Example of Accounting R&D i.e. considered as SRED:
  • Psychology
  • Engineering
  • Design
  • Operations research
  • Mathematical analysis
  • Computer analysis
  • Data collection – not routine
  • Testing
Example of Accounting R&D i.e. not considered as SRED:
  • Market research
  • Quality control
  • Exploring or drilling for oil
  • Style changes
  • Routine data collection
  • Humanities or social sciences
  • Commercial production of a new or improved product
What are the tax advantages of SRED?
  • Current SRED expenditures and most capital expenditures are 100% tax deductible
  • Any allowable expenditure that is not deducted in a year can be deducted in any future year
  • SRED expenditures are also eligible for investment tax credits (ITCs) – The percentage of credit varies with the type of corporation and also how much is refundable and non-refundable. Please check the Summary chart below for rates
  • However this ITC credit reduces the SRED deduction next year and/or increases the taxable income if there is no SRED deduction available (see example at the end of this document)
CategorySRED ExpendituresITC RateRefundable portion of ITC earned onNon-Refundable portion of ITC earned on
Current ExpendituresCurrent ExpendituresCurrent ExpendituresCurrent Expenditures
Canadian-Controlled Private Corporations (CCPCs)Up to the expenditure limit35%100%40%N/A60%
In excess of the expenditure limit20%40%40%60%60%
Other corporations 20%N/AN/A100%100%
Proprietorships, partners of a partnership, and trusts 20%40%40%60%60%

Expenditure Limit:

  • The maximum expenditure limit is $3 million
  • The expenditure limit begins to decrease when the taxable income of the CCPC (along with associated corporations) for the previous tax year is more than $500,000 and becomes nil starting at $800,000.
  • The expenditure limit also begins to decrease when the taxable capital employed in Canada of the CCPC (along with associated corporations) for the previous tax year reaches $10 million and becomes nil starting at $50 million.
Explanation for the Chart above

Special Rule for CCPC’S

If a corporation meets both of the following two criteria, the ITC rate is 35% and 35% * 100% of current expenditures and 35% * 40% of capital expenditures up to the expenditure limit are refundable:

  1. If the corporation  CCPC throughout the year; and 
  2. Previous year taxable income before loss carryback < the SBD limit $500,000 (shared among associated corporations)

If both criteria’s are not met:

  • ITC Rate is 20% and of that only 40% is refundable
  • Refundable = 20% * [ (40% * current)+ (40% * capital) ]
  • Non-Refundable = 20% * [ (60% * current) + (60% * capital) ]

Therefore, for expenditures over the Expenditure Limit (see above) and for individuals and other non-qualifying corporations, an ITC rate of 20% applies; and 20% * 40% of current and capital expenditures are refundable; the remainder is a non-refundable tax credit.

Finally, taxpayers must claim ITCs no later than 18 months after the year-end.

Non-CCPC Corporations (public companies, non CC private companies)

SRED non-refundable credit =  20% * (100% of current + 100%  capital)

Refundable portion = $nil

Non-corporations (individuals, partnerships, trusts) – similar rule to CCPC who are over the $3M limit:

Total SRED = 20% * (capital + current)

Refundable = 20% * (40% current + 40% capital)

Non-Refundable = 20% * (60% current + 60% capital)

 

Example of SRED and ITC CREDIT

If ABC corporation has SR&ED expenditures of $200,000 for December 31, 2009, and net income before SR&ED deduction is $600,000. Assume ABC has $300,000 income in 2010 and no SR&ED expenses. Also assume a 30% tax rate and ITC rate of 20% (for actual ITC rate refer to table above as it is different for each type of corporation).

Required:  Determine the tax liability in 2009 and 2010

December 31, 2009:

Taxable income = $600,000 less $200,000 SR&ED = $400,000

Tax @30% =$120,000

Deduct: ITC = ($40,000) i.e. ($200,000 * 20% ITC rate)

Net Tax $80,000

December 31, 2010:

Taxable income = $300,000 less $0 SR&ED plus 2009 ITC of $40,000= $340,000

Tax @30% =$102,000

Deduct: ITC = ($0) i.e. ($nil SR&ED * 20% ITC rate)

Net Tax $102,000

If 2010 SR&ED expenditure was say $130,000, then taxable income would be $210,000 ($300,000 – $130,000 + 40,000). In addition, an ITC credit of $26,000 (i.e. $130,000 * 20%) can be claimed/deducted in computing the income tax for 2010.

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