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					                        SR&ED
               Accounting Considerations

                  Larry Johnson, BSc, CA




                         November 26, 2003

                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
     Where Tax & Science Meet


• Canada’s largest tax incentive program

• Also one of the most Underused

• Professional advisors often fail to identify
  client activities that may be eligible


                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                  SR&ED Benefits
• Federal & Provincial benefits
   – Federal option to deduct 100% of SR&ED
     expenditures
   – Can claim ITC’s to reduce tax payable
   – BC, MB, NB, NFLD, NS, ON, QC, SK
• Flexible deductions
   – Current and capital items
• ITC’s
   – Enhanced rates for CCPC’s
   – Refundable



                                                                            www.mnp.ca
 C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                   SR&ED Benefits

• Cash refunds as a financing source
• Lower after tax R & D
• Promoted by CCRA
•    Forms and guides
•           Brochures
•           Interpretations
•           Policies and guides
•           Sector specific guides



                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
  Program Requirements
            SR&ED claims have 2 Components

  1) The technical submission (the science report)
        -     describes and supports the eligible activity


  2) The related tax schedules
        -   detail the qualifying expenditures and calculate the
        resulting ITC’s



                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
        Program Requirements
• The technical submission is clearly the most
  important part of the claim because:
  - If the science activities are not accepted as eligible under the
   program, the entire claim is disallowed and the resulting ITC is
   also disallowed
   - The SR&ED expenditures stem from the eligible SR&ED
   activities identified in the report
   - Acceptance or rejection of SR&ED is not a black-or-white
   decision and considerable judgement may be required to
   interpret the merits of a project
   - Accountants are not scientists or engineers – they can help
   identify opportunity, but CCRA experts can confirm eligibility


                                                                               www.mnp.ca
    C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
Defining SR&ED
• Important to distinguish between R&D and
  SR&ED
• R&D can be many things, but SR&ED is
  defined in the ITA and has a narrower scope
• CCRA has developed eligibility criteria through
  a co-operative effort with industry and the
  accounting profession
   – Information Circular 86-4R3 forms the
     cornerstone for the criteria for eligibility
   – Circulars and Bulletins for guidance found at:
   – http://www.ccra-adrc.gc.ca/taxcredit/sred/menu-e.html



                                                                            www.mnp.ca
 C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
               Defining SR&ED
SR&ED defined in ITA as a
“systematic investigation or search that is carried out in
a field of science or technology by means of
experiment or analysis”

The claimant must demonstrate that a proper scientific
approach was followed
       - trial & error not a scientific approach

First year claimants may be allowed some leeway (ie
cut some slack)
                                                                               www.mnp.ca
    C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
              Defining SR&ED
• Claims should be properly executed

    – ie before undertaking a possible SR&ED
      activity:


           • Undertake proper planning procedures
           • Develop a hypothesis
           • Document all procedures for all testing
             and results

                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
  Eligible Fields of Science
   • Basic Research
         • An advancement of scientific knowledge
           without a specific practical application


   • Applied Research
         • An advancement of scientific knowledge with
           a specific practical application

   • Experimental Development
         • A technological advancement for the purpose
           of creating a new product or process

                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
  Eligible Fields of Science
   • Most people perceive only basic and applied
     research as eligible
         • Eg developing a cure for cancer


       Only 10 % of all SR&ED claims are research
       based

   • Experimental Development with a
     commercial focus accounts for 90% of all
     eligible and allowed SR&ED claims


                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
    Defined Ineligible Activities
• Market research and sales promotion
• Quality control and routine testing
• Social sciences
• Prospecting, exploring or drilling for
  minerals, petroleum or natural gas
• Style changes
• Routine data collection



                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
              Criteria for Eligibilty
• To be eligible, the project must meet three
  criteria as set out in IC 86-4R3

    – Technological uncertainty

    – Technological advancement

    – Technological content




                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
     Technological uncertainty
• Must demonstrate that the project is not
  just an application of existing technologies
    – ie you don’t know in advance that a result
      was attainable
• Easy to demonstrate in research
• Experimental development can result in:
    –   A totally new concept
    –   A new way of doing things
    –   An incremental improvement
    –   A failure
• All can be eligible

                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
        Technological uncertainty

      • Need to distinguish between routine
        engineering and SR&ED
           • Reinventing the wheel doesn’t
             qualify
           • Commercial uncertainty relates
             to marketing and doesn’t qualify



                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
  Technological Advancement
     • The project must contribute technological
       advancement to the appropriate area of
       science and/or engineering
     • The result of the research or
       development must lead to new or
       improved technologies that could benefit
       others




                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
            Technological Content
 • Activity must be carried out with a scientific
   method:
       – Identify a hypothesis
       – Set out to follow a logical series of steps to
         prove it
       – All activities must be properly documented
       – Must be able to prove the work was planned
         and organized




                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
           Technical Submissions
  • A properly prepared technical submission
    must:
        – Clearly identify the activity
        – Indicate how the project meets the definition
          of SR&ED
        – Fully describe how it meets the eligibility
          criteria

        CCRA has many Science Officers, but can’t
         cover all bases – the project description
         should stand on its own!

                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
       Technical Submissions
• It is extremely important that the technical
  submission identify the area of science.
    – Recently an improperly prepared biotech claim
      was assessed as a computer software claim
      because one minor aspect of the claim involved
      setting up a computer database.
    – CCRA assigned a computer scientist to assess
      the claim and it was rejected because there was
      no advancement of computer science.
    – All the biotech work, which may have been
      eligible, was rejected.



                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
              Technical Submission

     • Each Fiscal Year must stand on its own
            – Just because a claim has succeeded in
              a prior year is no guarantee that it will
              continue to be eligible in the future
            – Do not take claims for granted




                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
   Identifying SR&ED Activities
• Indicators to consider in determining eligible SR&ED activity:
   – Were qualified engineers and scientists involved in the
      project?
   – Were applications made for patents?
   – Does the product or process have to meet industry
      standards?
   – What is the industry? (CCRA identifies 12 technology
      sectors)
   – Did the company retain the intellectual property rights to
      any subcontracted work?
   – Is the company trying to develop a new process or product
      with no precedent?
   – Is this an improvement that requires new technologies to
      succeed?
   – Did the company go through steps that failed?
                                                                             www.mnp.ca
  C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
               Accrued Expenses
• Normal accrual accounting is now permitted

• Tax credits are earned in the year that the work is
  performed but are only paid if the expenditure is
  paid within 180 days of the year end, otherwise
  the credit is received when the expenditure is
  paid

• All accrued expenses must be reported on the
  T661 of the year in which the expense was
  incurrred to qualify for ITC’s

                                                                            www.mnp.ca
 C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
         SR&ED Best Practices
• Motivate staff to record eligible activities

• Emphasize the importance of the program to the
  company
   – Reduce tax and increase cash flow


• Individual incentives
   – Bottom line = bonus
   – Increased tax credits could increase R & D Budget


                                                                            www.mnp.ca
 C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
         SR&ED Best Practices
• Develop an R & D system that segregates eligible activities
  from routine R&D
• Separate the technological issues from product
  development
• Use coding for R&D projects and sub-codes for tasks and
  activities
• Develop documentation that ties activities to the project
  plan
• Develop a time system to capture eligible activities


                                                                              www.mnp.ca
   C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                   Documentation
• Possible sources of Evidence of Advance, Uncertainty
  or Content
   – Feasibilty studies, reviews of existing technology,
     beta products
   – Internet searches
   – Search for generally available info (library)
   – Project plan – objectives, hypothesis, plan, budget,
     staffing, deadlines
   – Notebooks and logs
   – Defect logs
   – Minutes of meetings
                                                                             www.mnp.ca
  C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                   Documentation
• Possible sources of Evidence of Advance,
  Uncertainty or Content
    – Designs, plans sketches, charts
    – Photographs, videos, prototypes
    – Internal correspondence (emails, memos)
    – 3rd party documentation – vendors, suppliers,
      contractors
    – Personnel qualifications




                                                                            www.mnp.ca
 C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                 Financing Issues
•       Many Canadian technology companies rely on
        refundable ITC’s as a significant source of capital
    –    But a company must retain its status as a Canadian
         Controlled Private Corporation (CCPC) to be eligible for the
         maximum benefits
•       Many growing technology companies carry forward
        non-capital losses, SR&ED pools and ITC’s
•       A CCPC can be eligible for the $500,000 capital
        gains exemption or ABIL’s
•       These tax benefits are only available if the
        company retains its status as a CCPC

                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                      Financing Issues

• If a technology company is contemplating a sale
  of shares to become public or foreign controlled it
  should plan carefully to avoid losing the unused
  tax advantages available to CCPC’s

• The tax issues facing technology firms raising
  capital can significantly affect the outcomes for all
  concerned. Professional advice should be
  obtained before any financing deal is finalized


                                                                             www.mnp.ca
  C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S
                            Thank You

Please do not hesitate to contact any of our offices if you
   have questions about any of this material.

Or contact Larry Johnson, BSc, CA at the Medicine Hat
   office at 527-4441.




                                                                           www.mnp.ca
C H A R T E R E D A C C O U N T A N T S & B U S I N E S S AD V I S O R S

				
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