11 Aug SR&ED: Defending the claim
It’s 1 p.m. on a busy Wednesday afternoon, your company is pumping on all cylinders and ready to launch your next great feature. Next you receive an unexpected call on your phone, caller ID reads, Canadian Revenue Agency (CRA). A notification like this can be somewhat scary and unclear as to what is really being expected of you next.
Before the audit
Now before the scenario of being audited becomes reality, let’s take a step back to the SR&ED basics: what is it? How it works? What do I need to do to get some form of credit?
SR&ED was designed as an incentive program to help encourage Canadian companies to take forward looking risks and invest in new R&D. SR&ED seeks to support organizations with a tax credit eligible when they develop or improve new or existing products, materials, devices or processes. There are two forms of SR&ED eligible activities., First, Applied Research,; which advances scientific knowledge which has a practical application at the end of experimentation; and Second, Basic Research; which is performed without an immediate practical application in mind.
Other expenses which can be added to the claim include:
- Salaries or wages of employees involved with the SR&ED claim
- Material costs which were transformed or consumed for SR&ED experimentation
- Contracts which were part of SR&ED activities
- Facility costs, purchase, lease expenses
- Purchasing or renting of SR&ED equipment
Protecting yourself in an audit
The SR&ED program was created to help small-to-medium enterprises (SMEs) receive tax credits for doing innovative research and development in Canada. Unfortunately, like many incubator support programs, the temptation to abuse has become a major problem over the years, and the CRA has responded by insisting on higher standards of evidence to back up claims. But you, the noble entrepreneur, doth have nothing to hide. How can you ensure that the government agrees?
Here is a checklist of what to do when you are under the audit magnifier:
- Item one: Get back to them quickly. The faster you get into contact with the CRA the better informed you will be about what kind of paperwork they require to address your claim.
- Item two: Figure out why you’re being audited. It is best to understand why you are being audited by taking a careful look at the request for information letter. If you can get the right information to the CRA ASAP,you may satisfy their requirements right away; at the very least, your organization will be in better shape in the event of a full audit.
- Item three: Give someone the task of finishing the matter. It’s surprising how often firms get bogged down after a CRA information request, dropping the ball and leaving halfway through the process – a sure-fire recipe for disaster. Make sure to designate an individual high-up in the company hierarchy to deal with the matter and see it through to the end.
- Item four: Make sure to present your case rationally. Empathy for the auditor can go a long way in easing the audit process. All requests for information should be indexed and placed into an organized folder displaying information requests and subsequent information on the next page. If you can make your auditor’s job easier, they’ll likely repay you.
- Item five: It’s all about Quality mixed with some Quantity. An in-depth look at item four is actually showing proof of the experimentation/research working as it should. If your experiment was a “smoke and mirrors” charade, the auditors will come down on you hard.
- Item six: Curtains up, lights on. The CRA reviewers may request a meeting with you on-site to do a thorough investigation and analysis of your claim. Ideally, you should know everything about your claim and audit inside out. If you can anticipate the questions the auditor might have, you’ll put yourself in a much better position for the final verdict.
- Item seven: Find the man or woman in charge. The best person to communicate with the auditor is the individual who knows what the SR&ED claim is about and has been with the company since day one of the SR&ED project.
- Item eight: Know your auditor. CRA auditors come from a variety of backgrounds, and may not be fully versed in the most technical aspects of your SR&ED project. On the other hand, they often have enough experience in the broader field to recognize true advancements if explained at the proper level, and some technical detail will need to be communicated to demonstrate the experimental value of the work. It’s a good idea to get as much information about your auditor as you can before the scheduled meeting and speak in a way they will understand without glossing over important details; otherwise, it could be game over for both of you.
- Item nine: Stimulate and prolong dialogue. If it turns out that the auditor doesn’t understand your specific project due to a lack of domain knowledge, you must be able to stimulate conversation and perhaps challenge the bias of the individual. Understand why they think this way and try to establish a convincing case for the novelty of your approach within the field. Take an educational approach rather than an aggressive one, exploring their thought process together until the message starts to click.
- Item ten: It’s an experience, learn from it. For the all the destruction and chaos individuals say SR&ED audits are; at the end of the day it’s a learning experience. SR&ED plays an important role in the Canadian innovation economy and the CRA is trying its very best to catch those who abuse the system. If they are able to catch cheaters and reward the noble entrepreneurs, than that money saved can be re-invested into making new Canadian innovators stronger and more resilient to global players
There you have it. A comprehensive guide on what to do when that email you weren’t expecting pops up in your inbox. One more thing, just breathe easy and relax, they’re just people on the other side.