Canada vs America: Which Country Offers the Best R&D Incentives?9th June 2021
Canada is known for its maple syrup, dedicated hockey fans, and some of the most attractive R&D tax incentives in the world. The Scientific Research and Experimental Development (SR&ED) tax program pours more than $3 billion into a system that reaches more than 20,000 claimants a year. So, if you’re a Canadian company or a foreign company doing SR&ED in the Great White North, you may be qualified to take a sip.
The SR&ED program is designed to reward companies conducting technological or scientific experiments and research to create new materials, processes, devices, or products. To qualify, projects generally must focus on one of the following:
- Computer programming
- Data collection
- Psychological research
- Computer programming
- Mathematical analysis
- Operations research
While America’s R&D tax credit is designed to promote the creation of new or improved products, services, techniques, formulas, computer software, and inventions, it’s less focused on promoting specific industries. Canada’s incentives, however, clearly target advances in science and technology. “In the U.S., the R&D tax credit can be used on developing new or improved products, whereas Canada’s program is more focused on new technologies, scientific knowledge, and pushing the boundaries of an industry forward,” explains CrossBorder Solutions’ Director of R&D Tax Incentives Rahim Walji.
What’s the benefit?
Canada’s SR&ED is a very generous program. It allows you to pool all your qualifying SR&ED investments and deduct the sum from your income for the current year or a future one. You also have the option of taking the SR&ED investment tax credit (ITC) to pay your tax bill.
If you’re a Canadian private company, you can take a refundable tax credit worth 35 percent of qualifying SR&ED expenses up to the first $3 million. You can earn an additional 15-percent tax credit on the amount that exceeds $3 million. Even better: 40 percent of that additional credit amount is refundable. To put this into perspective, a private Canadian company that invests $5 million in SR&ED can earn a tax credit of $1,170,000.
Other types of companies, including foreign ones, can get a tax credit worth 15 percent of qualified expenses. In the same $5-million scenario, you’d get a $750,000 tax credit.
You can also apply any unused SR&ED credits to tax bills three years back or 20 years forward, which really adds to the value of the credit. Compare that to R&D tax credits in the U.S., which are only seven-to-10 percent of qualified expenses.
Just like some states in the U.S. offer their own R&D tax incentives, Canadian provinces offer their own SR&ED perks. These tax credits can range from 3.5 percent to 30 percent. So, it’s definitely worth looking into R&D incentives if you have business in a particularly tax-friendly province.
Types of R&D tax incentives in Canada and the United States
In the United States, the R&D tax credit is the only R&D incentive offered, and there are two ways to calculate it. You can choose to take the regular or alternative simplified R&D credit calculations, depending on which benefits your company most.
However, Canada’s SR&ED system is broader. Along with tax credits, it also offers access to grants, loans, and financial support. For example, you can apply for the Strategic Innovation Fund (SIF), a federal program that offers loans to companies conducting qualifying projects. These projects must meet the following goals:
- Speed up commercialization of innovative products, services, or processes.
- Contribute to the growth of firms in Canada.
- Attract large-scale investments to Canada.
- Contribute to large-scale, national innovation.
According to the Canadian government, “scientific research and experimental development” means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis.” This includes the following:
- Basic research conducted for the advancement of scientific knowledge without a specific practical application in view.
- Applied research conducted for the advancement of scientific knowledge with a specific practical application in view.
- Experimental development conducted to achieve technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto.
To determine if you qualify for the SR&ED program, the Canadian government recommends answering these questions:
- Was there a systematic investigation or experimentation to answer a question in the field of science or technology?
- Did you form a hypothesis in answering that question?
- Did the overall approach to answering this question involve systematic investigation and search?
- Were most of your efforts aimed at answering this question?
- Did you keep a record of all related testing, experimentation and results?
SR&ED vs R&D Qualifying Expenses
|R&D Tax Credit (U.S.)||SR&ED (Canada)|
|Wages: directly engaged, supervising or supporting||Wages: Directly engaged or first-line supervising|
|Contractors (65% of wages): Directly involved or supporting R&D||Contractors (80% of wages): Directly involved with your SR&ED efforts|
|Supplies: Used or consumed||Supplies: Used, consumed, transformed or absorbed|
|Overhead: Expenses related to land or buildings used for R&D don’t count.||Overhead: Depends on how you claim your SR&ED credit.|
Calculating Canada’s Credit:
As in the U.S., Canada offers two ways to calculate the SR&ED credit: The traditional method and the proxy method. If you’re claiming your SR&ED credit using the traditional method, which most companies use, you need to track and identify your overhead costs and then determine how these are eligible.
However, companies conducting labor intensive projects may prefer the proxy method. This method can be thought of as a way to factor in overhead costs without tracking and calculating these expenses directly.
With the proxy method, you come up with a base salary which is the total wages of people directly involved in SR&ED. You multiply that by 55 percent to get the Prescribed Proxy Amount (PPA). You then add that to your base salary and all other SR&ED expenses to get your total qualified expenses. In some cases, this would net you a higher credit. Just like in the U.S., choosing between the regular and simplified R&D credit can mean a big difference in tax credits. So, it’s important to do the math.
Foreign companies Performing R&D in Canada
If you have a subsidiary or are thinking of starting one, Canada is quite welcoming to those engaging in SR&ED. Subsidiaries in Canada can get a 15 percent, non-refundable credit based on qualifying SR&ED expenses.
You can earn a refundable 35 percent SR&ED credit if you’re a foreign company that establishes a subsidiary through a private Canadian company. In this case, you’d enjoy many of the same perks as a private Canadian corporation. So that means a 35-percent credit on the first $3 million of eligible expenses and a 15-percent tax credit on the excess. So, if you spend $5 million on qualified SR&ED expenses, you’d get a $750,000 tax credit.
Overall, the Canadian SR&ED tax program is worth giving a close look. And keep in mind that reporting and filing the right paperwork is key to maximizing your savings. Technology can always help.
To learn more about R&D Tax credits in this generous jurisdiction, check out our podcast: R&D Tax Credits in Canada.