PLEASE NOTE: THIS INFORMATION WAS ORIGINALLY SUBMITTED BY COOPERS & LYBRAND, CANADA
Canadian tax legislation provides for income tax credits for qualified research and development ("R&D") expenditures. These credits are computed at rates of 20% or 35% of R&D expenses, and in certain cases a portion can be currently refundable when they exceed the corporation's income tax liability. Unused credits may be carried back three years or forward for up to ten years and applied to reduce income taxes incurred in those years.
To claim R&D tax credits, taxpayers must be able to satisfy Revenue Canada that their research and development activities qualify. Earlier this year, Revenue Canada released draft guidelines for R&D tax credits in the area of software development. On a technical level, the guidelines do not represent any change in the laws governing R&D tax credits. But, on a practical level, the changes are substantial.
First, the guidelines are much more strict with requirements for eligibility, project description and documentation. Second, Revenue Canada has indicated that the principles in the guidelines will be extended to all areas of R&D and that it has changed its approach to auditing claims currently in process.
NEW CLAIMS PROCESS
What does this mean for you? It means that Revenue Canada probably won't process your R&D claims if you file them in the same manner you once did and that your project documentation will have to more clearly demonstrate a systematic, scientific approach to your work.
In the past, Revenue Canada reviewed R&D claims using both technical and financial audits. The technical audit usually involved a visit to the taxpayer's facilities to assess technical eligibility for the R&D tax credit. If deficiencies were found in the project description, a technical advisor worked with the taxpayer to prepare a report containing the appropriate information. Revenue Canada also worked with taxpayers if project documentation was insufficient.
Given the increase in the number of R&D claims being filed, Revenue Canada will no longer assess claims this way. Consequently, many claims are now being assessed for technical eligibility based only on a "desk review" of the project description and financial auditors are being asked to review and assemble back-up technical documentation.
As a result, the project description has become much more critical to the success of your R&D claim. But the complications don't stop there. Revenue Canada is placing special emphasis on defining what is and isn't considered to be an eligible R&D project and the line between the two is often a very fine one.
ELIGIBILITY DEFINED
To be considered eligible, the project must seek an advance in an area of science or technology. This implies gaining technical or scientific knowledge that didn't previously exist rather than simply doing something for the first time. Consequently, doing work in an area that's known in the industry, or whose results are easily available to qualified individuals, is usually not eligible.
However, if an advance has been achieved by someone else, it doesn't mean that a similar project of yours won't qualify. If your competitor's work is proprietary, it won't likely be available knowledge in the industry. Assuming the remaining R&D criteria are present that there's some technical uncertainty of achieving the advance and a systematic "scientific" approach to resolving the uncertainty your project will also qualify.
INADEQUATE PROJECT DESCRIPTIONS
According to Revenue Canada, most project descriptions don't adequately deal with technical issues, and they usually fail to focus on scientific or technological advances and uncertainties. Instead, project descriptions often describe "business projects" and focus on "products." Your approach to preparing project descriptions must be reviewed to ensure that you're providing the information that Revenue Canada expects.
DOCUMENTATION REQUIREMENTS
In addition to the focus on project descriptions, Revenue Canada has also indicated that it is enforcing significantly more strict requirements for documentation to support an R&D claim. These documentation requirements address both the science and cost elements of the R&D claim.
"Documentation" often means different things to different people, but Revenue Canada has clearly defined its expectations: At the time the work is performed, written documents memoranda, project notes, workbooks, etc. must indicate the technological objectives of the project; the advancements being sought; the reasons for the particular approach undertaken; the activities or experimentation performed to resolve technological uncertainties; and an analysis of the results of the activities or experimentation.
Revenue Canada also indicates that "dated documents or records, however informal, created at or about the time that the work was carried out must be present as evidence of the work performed....If there is no document or record to substantiate the project, the claim will be rejected." Consequently, your R&D documentation practices must also be reviewed to ensure that they meet Revenue Canada's new requirements.
Coopers & Lybrand R&D tax advisors are available if you need help with a claim already in process or with any future claims you plan to file.
The information provided herein is for general guidance on matters of interest only. The application and impact of laws, regulations and administrative practices can vary widely, based on the specific facts involved. In addition, laws, regulations and administrative practices are continually being revised. Accordingly, this information is not intended to constitute legal, accounting, tax, investment or other professional advice or service.
While every effort has been made to ensure the information provided herein is accurate and timely, no decision should be made or action taken on the basis of this information without first consulting a Coopers & Lybrand professional. Should you have any questions concerning the information provided herein or require specific advice, please contact your Coopers & Lybrand advisor, or:
David W. Steele PricewaterhouseCoopers 145 King Street West Toronto, Ontario M5H 1V8 Canada Fax: 1-416-941-8415 E-mail: Click Contact Link
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