David Arsenault, Atlantic Regional Manager for the Canada Revenue Agency's Scientific Research and Experimental Development (SR&ED) Tax Incentive Program, demystifies the parallel worlds of R&D and IP from an SR&ED tax incentive program perspective.
David Arsenault, Atlantic Regional Manager for the Canada Revenue Agency's Scientific Research and Experimental Development (SR&ED) Tax Incentive Program, demystifies the parallel worlds of R&D and IP from an SR&ED tax incentive program perspective.
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(Lisa Desjardins): You're listening to Canadian I.P. Voices, a podcast where we talk intellectual property with a range of professionals and stakeholders across Canada and abroad. Whether you are an entrepreneur, artist, inventor or just curious, you will learn about some of the real problems and get real solutions for how trademarks, patents, copyrights, industrial designs and trade secrets work in real life.
I'm Lisa Desjardins and I'm your host.
The views and opinions expressed in this podcast are those of the individual podcasters and do not necessarily reflect the official policy or position of the Canadian Intellectual Property Office.
If you are an entrepreneur with a company carrying out research activities, you're probably interested in the Scientific Research and Experimental Development Tax Incentive Program. You're probably also doing I.P. searches to learn about existing I.P. and patentability of your invention. But is this work eligible? To get an answer, I'm fortunate to be joined by David Arsenault, the Atlantic Regional Manager for Canada Revenue Agency's Scientific Research and Experimental Development Tax Incentive Program, also called S.R. and E.D. or SRED.
David, welcome to the podcast!
Guest (David Arsenault): Thanks for having me, Lisa. I'm happy to be here.
Lisa: We have a very intriguing conversation ahead of us. I look forward to unpacking how the worlds of I.P. and research and development tax incentives collide, while also clarifying where they do not. Right now, Canadians conducting R and D work are looking to better understand whether the intellectual property components of their work are eligible under the SRED program. But before we dive into that discussion, could you please give us a brief overview of the SRED program at C.R.A. and the kind of work you do?
David: Sure, Lisa. I've worked in the S.R. and E.D. program for over 20 years. For the first 10 years, I was responsible for reviewing S.R. and E.D. claims filed by taxpayers from a broad range of industrial sectors engaged in developing innovative products and processes. I progressed into management and have been a manager for the program in the Atlantic region for the last 12 years or so.
The S.R. and E.D. program is the largest federal program supporting research and development in Canada. We support the Government of Canada's commitment to helping Canadian businesses maintain and enhance their competitive edge in the global marketplace.
On average, the S.R. and E.D. program provides more than 3.4 billion dollars to over 17,000 claimants every year; approximately 2,500 of which are from first-time claimants.
Now businesses can claim various types of expenditures, including salaries or wages, materials, S.R. and E.D. contracts, third-party payments and overhead, resulting in S.R. and E.D. tax incentives. But I think it's safe to say that the majority of claims we receive include salaries or wages, materials and overhead. And those expenditures have to be related to the S.R. and E.D. activities. I'm sure we'll get into more detail on that in a little bit.
I would just finish by saying that we know how important these tax incentives are as a source of financial support for businesses, so the program has been designed to encourage businesses of all sizes and industry sectors to conduct R and D work. The government wants our Canadian businesses to thrive.
Lisa: Can you tell us a bit more about what type of support the program offers specifically?
David: Yes, of course. Currently, corporations, individuals, trusts and partnerships that conduct S.R. and E.D. work in Canada may be eligible to receive support through 2 tax incentives.
First, you can claim a deduction against income, which is just what it sounds like; you can use S.R. and E.D. expenditures to reduce your net income for tax purposes. If you do not need to deduct the S.R. and E.D. expenditures in the year, then you are allowed to accumulate them in a pool and use them in a year whenever it's most beneficial for you. The pool doesn't expire until you use it.
Another component of the program is the investment tax credit. We often refer to that as I.T.C. I.T.C. can be refundable or non-refundable. Depending on the type of business entity, the size, who owns it and how much money they've spent on S.R. and E.D. , the investment tax credit can be 15% or 35% of the qualified S.R. and E.D. expenditures for the year. The credit earned at the 35% rate can be refundable.
Lisa: Can you expand on that a little? What's the difference between a refundable scenario and a non-refundable scenario?
David: Very good question. So, when an investment tax credit is calculated using the rate of 35%, the refundable S.R. and E.D. I.T.Cs. are first applied against income tax payable for the year. Then any remaining amount may be received as a cash refund. So let's say you earned $100,000 of refundable investment tax credits and your income tax payable for the year is $40,000. Assuming you do not owe money in your other CRA accounts, your tax refund will be $60,000.
It is important to note that when there is no income tax payable (income tax owing for the year is nil) when you file your income tax return, as is often the case for early start-ups, the refundable S.R. and E.D. investment tax credit can be an important contributor to cash flow for these corporations.
Now for the non-refundable situation, when an investment tax credit is calculated using the rate of 15%, the non-refundable S.R. and E.D. credits are first applied to any income tax owing. So let's say you earned $100,000 of non-refundable I.T.C. and your income tax payable for the year is $40,000, at the end of the year you will have $60,000 of unused non-refundable I.T.C. So in this case, any unused I.T.C. amount is added to an investment tax credit pool that can be used in the subsequent 20 tax years or carried back 3 years to be applied against income tax payable in those years.
So, in a nutshell, S.R. and E.D. credits, the I.T.Cs. are used to reduce or eliminate the income tax payable of your business. And if you earned a refundable credit, it can be refunded to you when your income tax payable for the year is nil. Listeners can learn more about this through the T4088 S.R. and E.D. guide to form T661, included in the description of this episode.
It's also important to note that qualifying for the program's tax incentives is not linked to any output from the scientific research and experimental development work. In other words, the R and D work you're doing does not need to lead to a successful outcome to be eligible for S.R. and E.D. tax incentives.
And since we will be discussing how intellectual property fits into the world of S.R. and E.D., it's equally important to note that you do not have to own or have registered an I.P. in order to be eligible to earn S.R. and E.D. tax incentives.
To benefit from these tax credits, you have to have incurred the expenditures for the S.R. and E.D. work you had performed in the tax year.
Lisa: Well, that actually brings me to my next question, David. How exactly does the program determine who's eligible to receive support?
David: Yes, I imagine your listeners are keen to hear this part. So, to determine the eligibility of your work, we look to the definition of S.R. and E.D. that's in the Income Tax Act. And the beginning of that definition describes how and why S.R. and E.D. is conducted. The how and the why are 2 key requirements that must be met for work to be eligible.
Now to meet the “how” requirement, the work must be a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis.
To meet the “why” requirement, work must be conducted for the advancement of scientific knowledge, or for the purpose of achieving technological advancement. The key to both is the generation or discovery of knowledge that advances the understanding of science or technology.
An S.R. and E.D. project is a set of interrelated activities that together achieve, or attempt to achieve scientific or technological advancement. All the activities within a project must be related to the same advancement.
Lisa: So, once you've determined whether or not work is considered eligible for the purposes of the S.R. and E.D. program, I imagine you then have to look at which expenditures can be used to calculate the credits.
David: Yes, exactly.
Lisa: Before we get into those details, can I just ask up front. Are I.P. expenditures allowable for S.R. and E.D. tax incentives?
David: The short answer, unfortunately, is no.
Lisa: And why is that?
David: So, being an income tax program, the S.R. and E.D. Tax Incentive Program's design is the responsibility of the Department of Finance. Everything that can be claimed is governed by the Income Tax Act and our policies, procedures and guidelines. And the Department of Finance has designed the program to be very specific about what expenditures are used for calculating the investment tax credit. Generally, these are for direct expenditures incurred while performing S.R. and E.D. .
I.P. can certainly be generated when conducting S.R. and E.D. work. But the work that involves registering and securing the I.P., such as through a patent application would not be considered eligible because it is not work performed in an attempt to achieve scientific or technological advancement. Rather, it is work to protect the scientific or technological advancement that resulted from the S.R. and E.D. work. So usually, this type of cost is referred to as an administrative expense, or a legal expense, and these expenditures are not allowed. This means these I.P. costs would be considered indirect. So, although applying for patents or other I.P. is “work” that you have done, this work wouldn't meet the definition of S.R. and E.D. in the Income Tax Act.
Lisa: Just to close the loop on this, there are a number of potential expenditures related to securing I.P., such as agent fees, fees for consulting I.P. professionals, conducting I.P. searches, and other I.P. research. Based on what you've told me, none of these expenditures would be allowable under the SRED program.
David: Correct, they wouldn't be. Protecting I.P. is a business decision. So, unfortunately, this falls outside the scope of what we consider to be eligible work and allowable S.R. and E.D. expenditures.
Lisa: Would any of these types of expenditures qualify under other provisions of the Income Tax Act?
David: That's a very good question. Yes, for income tax purposes, costs associated with I.P. generation may be deductible or treated as capital. And if they are considered expenditures of a capital nature, they should be included in the appropriate Capital Cost Allowance class, or C.C.A. for short. Each class has a specific percentage rate to calculate the C.C.A. You can think of it as depreciation allowed for income tax purposes that can be deducted from income earned in the year. Listeners can learn more about C.C.A. through our Agency's document called General Discussion of Capital Cost Allowance, as C.C.A. is beyond the scope of the S.R. and E.D. program.
Lisa: Okay, switching gears now for a moment. For those businesses that are eligible for the S.R. and E.D. tax incentives, regardless of whether there's I.P. involved, I'm wondering, what are the implications for businesses that outsource part of their S.R. and E.D. activities? Can they still claim incentives?
David: Potentially, yes, if the activities meet the definition of S.R. and E.D. work. Claimants can claim contract expenditures for S.R. and E.D. work performed on their behalf. But the claimant must show that the contracted work was carried out in Canada and was related to their business.
Lisa: And how do the S.R. and E.D. tax credits interact with other government funding or grants received for the same project?
David: Very good question. If a business receives other government funding or grants, it may impact the tax credit by reducing the amount of qualified S.R. and E.D. expenditures. And just to clarify what we mean by government funding, government assistance is generally assistance from a government, municipality or other public authority whether in the form of a grant, subsidy, forgivable loan, deduction from tax, investment allowance or any other form of assistance other than the federal investment tax credit.
Lisa: Okay, so when we say government funding or assistance, we're not talking about the federal investment tax credit.
David: That's right. But there are provincial R and D tax credits which are calculated first and these are considered to be government assistance as well.
Lisa: Just to make it clear for our listeners, could you help us decipher a grant from a tax credit or deduction?
David: So as mentioned, the S.R. and E.D. program provides 2 incentives. You can deduct S.R. and E.D. expenditures to reduce your income for tax purposes, and you can receive an investment tax credit on qualified expenditures, in the form of a cash refund, or a reduction of tax payable, or both.
So other types of assistance fall outside of the program—namely, grants and other government assistance, which all have different conditions that have to be met in order to receive that financial support. And as mentioned, government funding or grants may impact the amount of the S.R. and E.D. investment tax credit by reducing the amount of qualified S.R. and E.D. expenditures and as a result reducing the amount of the tax credits. Any non-government funding received for performing S.R. and E.D. activities can also reduce the qualifying expenditures.
Another difference is that the S.R. and E.D. tax incentives are claimed at the end of the tax year in which the work was performed, whereas the timing for applying for other types of assistance could vary greatly.
Lisa: Okay, so getting back to intellectual property now. We've established here that I.P.-related expenditures are not allowable expenditures under the SRED program. So how does I.P. fit in with scientific research and experimental development?
David: We can certainly talk about other ways they overlap. It's definitely an important topic in S.R. and E.D. . As you take on research and development work, you may generate new knowledge. And there are times when this new knowledge cannot be registered as an I.P. And there are times when it can. There are also times when your research may not result in a positive outcome, meaning your work was not successful. Even so, in these cases, you may still have conducted work that is eligible for S.R. and E.D. tax incentives.
With that said, you cannot buy someone's knowledge or purchase a right to use someone's knowledge through I.P. or a patent for example, and still earn S.R. and E.D. tax incentives on that expenditure. The straightforward use or application of existing knowledge or technology available to you would simply mean that the objectives of your project can be met with the current level of publicly available scientific or technological knowledge. So this work would not meet the program requirements, as the work is not for scientific or technological advancement. There is a specific provision in the Income Tax Act that disallows this as an expenditure for S.R. and E.D.
An example of a more complicated overlap would be when I.P. is filed, but in relation to a different aspect of the R and D work that is claimed as SRED, or part of the work that is claimed as SRED. Meaning, you could create a new product that involves R and D work for the creation of the product itself. I.P. could fit within—or exist alongside—an S.R. and E.D. project when one portion of a larger business project is S.R. and E.D. , and another portion is not. The business project may involve the creation of a new or improved product and the creation or modification of a manufacturing process to make the product. So it's possible that the process portion of the project requires SRED to accomplish the project objectives, while the product development portion of the project involves the use of existing scientific or technological knowledge. In this scenario, the process portion may be an eligible S.R. and E.D. project, while the ineligible product portion may warrant patent protection based on its novelty.
And I would just add that if you're dealing with more complex scenarios like this, we offer free advisory services that can help you get the information and support you.
Lisa: So, you're saying that I.P. can still be a consideration in certain ways. Could you discuss further what I.P. components you're seeing in S.R. and E.D. claims?
David: Of course. One situation where I.P. ownership plays a role is when S.R. and E.D. work is contracted to another entity. If some or all of the R and D work can be contracted to another party, you might be wondering who is entitled to claim S.R. and E.D. tax incentives—the performer or the payer? And who can earn the investment tax credit? Let me try and answer some of that.
First let's look at whether or not a person who performed the work and incurred the expenditures can file a claim for S.R. and E.D. tax incentives. If a person is being paid to perform S.R. and E.D. work on behalf of someone else, the program would call this a contract payment, the full definition of which is found in the Income Tax Act. In this scenario, the person performing the work would have to reduce their qualified expenditures by the contract payment amount received, which, in turn, would reduce the amount of investment tax credits they would earn. If the person is fully funded, they would not earn an investment tax credit. However, the person who paid for the work technically had S.R. and E.D. performed on their behalf. So, they could claim S.R. and E.D. tax incentives, by claiming S.R. and E.D. contract expenditures and earning the investment tax credit on qualifying expenditures.
Like I said before, the person performing the work could still file an S.R. and E.D. claim, but they would have to apply a contract payment reducing the amount of S.R. and E.D. investment tax credits they will earn. This mechanism, outlined in the Income Tax Act, ensures that there is no double-dipping of the investment tax credit. If the performer incurred excess expenditures beyond the contract payment amount received, then they could only earn an investment tax credit on the excess expenditures incurred.
Now sometimes, a company is paid to deliver a product or service and S.R. and E.D. work is performed to develop that product or service. So in that context you might wonder who can earn the S.R. and E.D. tax credit in this scenario and whether a contract payment applies. Let's start with the contract payment question first. We use 4 criteria to evaluate whether there is a contract payment: contract performance requirements, I.P. ownership, price ceilings vs. risk, and whether it's a contract for service or contract for the sale of a good. So one indication is who owns the I.P., or the new scientific or technological knowledge? If the performer owns the I.P., then often the performer gets to earn the S.R. and E.D. investment tax credit. If the payer on the other hand owns the I.P., and the other party is performing S.R. and E.D. for this I.P.—meaning, they're developing the knowledge—generally the payer ultimately earns the investment tax credit.
In other cases, the performer owns the I.P. being generated, but they grant a payer the right to use the I.P. or knowledge in their business. This could look like granting access to results and reports. With this scenario, the performer would once again be seen as having received a “contract payment.” They would again, need to reduce their qualified S.R. and E.D. expenditures, which would result in less tax credit earned. The payer could then claim a third-party payment expenditure for S.R. and E.D. , and the payer could earn the investment tax credit for this payment. I would just add that this scenario is different than one involving an actual licensing agreement, where the payer purchases a license to make, sell or use the claimed invention in the country where the patent is held.
If any of your listeners would like more information on this, or have questions about a specific case, I would recommend they visit our web page or give us a call. I've tried to give an overview, but every case is different.
Lisa: I think it would be fair to say that anyone with a strategic mindset would carry out their I.P. activities and research at the same time. So how would a company manage this overlap?
David: Excellent question, Lisa. Yes, there can definitely be some common elements in patent applications that can be useful for S.R. and E.D. claims. However, it should be noted that not all elements are identical. Some common elements could be background information, the field of invention and cited references. For example, in a typical mechanical utility patent application, there is a section called “Background of the Invention.” In S.R. and E.D. claims, claimants should provide background information to distinguish the claimed work from the existing scientific or technological knowledge base. In other words, they should explain the limitations or shortcomings in the existing knowledge and explain why those limitations could only be overcome through the performance of S.R. and E.D. . Now with the field of invention, it is something that is described in patent applications and indicated as a science or technology code in S.R. and E.D. claims. And with cited references, this could form part of the prior art search results that accompany patent applications. If included in an S.R. and E.D. claim, these types of references may help provide a better understanding of the background to an S.R. and E.D. claim.
On our end, we do have to take into account the following:
First, the patent application may not necessarily describe the work performed in a tax year. An S.R. and E.D. claim must be filed for work performed and expenditures incurred within a given tax year, within 12 months of the tax return due date.
Second, patent applications are also written in a broad manner. Meaning, exact experimental conditions are not disclosed. Instead, a range is given, and the scope of invention is expanded to make sure the patent rights are secured in such a way that others can't easily circumvent the patent. In S.R. and E.D. claims, a filed project description should include enough details so that it clearly communicates how you think the analyses or experiments performed attempt to achieve scientific or technological advancement in that project.
Third, in patent applications the claim language and the summary of the invention section are often written by lawyers or patent agents to provide the broadest patent protection possible. Preferred and alternative embodiments of a claimed invention are included in a single patent application, whereas the rule of thumb in S.R. and E.D. claims is that each individual project description should apply to the resolution of a single uncertainty. There can be relevant sub-projects in some cases, but the general rule is 1 uncertainty for each different project description.
Next, the patent protection is available to an invention if it is: a) new, or a first in the world, b) it's useful, or solves a problem, and c) it's non-obvious to a person skilled in the field of invention. A patent application or granting of a patent may not necessarily mean that there is an advancement in scientific knowledge or technology. One can apply for a patent or receive a patent for an invention without advancing scientific knowledge or technology as long as it is new, useful and non-obvious. Patents are about novelty, not the advancement of science or technology. A novel invention may be arrived at by combining different aspects of known technologies in a new way. But this would not be S.R. and E.D., since the result came from the use of existing technologies.
And finally, a patent application can be useful to the claimant for completing their project description in part 2 of form T661 for the SRED claim. It can also help the C.R.A. in understanding whether the how and why requirements of S.R. and E.D. eligibility that we talked about earlier are met.
Lisa: Well, thank you David. There certainly seems to be a lot of overlap there. I'm glad we're still able to find ways that I.P. and SRED tax incentives can kind of interact. It sounds like there are some administrative synergies by combining the administration of both patenting and SRED.
So, let's say I'm an entrepreneur and I want to file a claim for S.R. and E.D. tax incentives. What do I do?
David: A great place to start would be to visit our web pages where you can easily find step-by-step instructions on how to prepare your claim, how to calculate your expenditures, how to submit your claim and what to expect after you've submitted your claim.
We also have some great free support services that can help businesses throughout the claim process. There's our quick and easy Self-Assessment and Learning Tool, which takes only roughly 30 minutes to complete. It can help you find out, up-front, if your R and D project is likely to qualify for tax incentives and calculate your potential claim amount.
Now, if you would like to discuss your specific situation, you can request a free pre-claim consultation with an S.R. and E.D. specialist. As long as you are beyond the planning stages and have either started the work or are about to start the work, you could be eligible for this service.
If you are in the early planning stages of your project but not quite ready to file a claim, our outreach program can help. We can offer your business a free one-on-one information session, or you can attend one of our webinars to help you learn about and connect with the program.
We also have an advisory service for first-time claimants, which occurs after a claim is filed and one of our specialists will go over some of the details with the claimants. The goal of this service is to educate new claimants so they're more comfortable filing claims in the future.
Now, if you have any questions about the program or need some help, we definitely encourage businesses to contact us or check out our web pages to learn more about the program and the services we offer. Our web page is Canada.ca/taxes-sred. On this website, you'll find some valuable information about the program and you'll also find contact numbers for calling us, which vary depending on the region you're in.
Before we go, I'd like to add that by the time this episode is released, listeners can now access the latest on public consultations recently launched by the Department of Finance, regarding the review of the S.R. and E.D. program and the creation of a patent box regime. The review will help shape legislative modifications to ensure the S.R. and E.D. program is effective in encouraging R and D that benefits Canada, while exploring opportunities to modernize and simplify the S.R. and E.D. program. The government is also seeking input on the creation of a patent box regime, to help encourage the development and retention of I.P. stemming from R and D work conducted in Canada. This is certainly an exciting time for those exploring the overlap between SRED and I.P.
Lisa: Absolutely, very exciting times. David, it has been such a pleasure to talk with you today. Thank you so much for taking the time to demystify the intersection—or I would almost say the parallel universes of SRED and I.P.! Thank you.
David: Thank you, Lisa.
Lisa: You've listened to Canadian I.P. voices, where we talk I.P. In this episode David Arsenault, S.R. and E.D. program manager at the Canada Revenue Agency in the Atlantic Region explains what kind of work and expenditures could qualify for tax incentives under the S.R. and E.D. program. Open the description to this episode for links to the Self-Assessment and Learning Tool that David mentioned, as well as the S.R. and E.D. eligibility guidelines and other resources to better understand how the program works.