SR&ED is a federal tax credit program administered by the Canada Revenue Agency (CRA) that supports innovation in Canada. For eligible companies, it can provide much-needed capital to offset research expenditures and may open doors to lending facilities, such as SR&ED financing offered by RBCx.
Key Points:
- SR&ED enables companies that perform research and development in Canada to potentially qualify for tax incentives that reduce their income tax payable or earn a refund.
- For most small- to medium-sized Canadian controlled private corporations, refundable and non-refundable ITCs can be earned at an enhanced (higher) rate.
- Founders can prepare their SR&ED claim on their own, but many choose to work with a SR&ED consultant to ensure proper documentation and to ease a potential CRA review process (a typical occurrence for first-time SR&ED claimants).
- SR&ED financing is offered by financial institutions and third party providers that can offer advanced access to a portion of the funds you’ll receive through your SR&ED claim rather than waiting to receive your refund from the government.
- SR&ED financing can benefit your startup by providing access to non-dilutive capital, extending your runway ahead of an equity raise, and potentially accelerating your R&D cycle.
For early stage tech startups, the quest to access capital to fund rapid growth isn’t easily scratched off the to-do list. In the pre-seed and seed stages, venture capital is often out of reach. Yet, without that venture capital backing, obtaining a loan from financial institutions is a no-go for cash-burning startups with barely a year or two of operating history. This makes Canada’s SR&ED program a panacea for young innovative startups that invest in research and development. Not only can the federally-run program provide an infusion of capital to offset research expenditures, it may also open doors to lending facilities, such as SR&ED financing offered by RBCx, which may have the added advantage of boosting your ability to attract and pitch investors.
This article will cover the basics on:
- What is SR&ED?
- How does SR&ED work?
- What are SR&ED investment tax credits (ITC)?
- Explaining SR&ED eligibility
- What is SR&ED financing?
- The key benefits of RBCx’s SR&ED financing
What is SR&ED?
SR&ED is a federal tax credit program administered by the Canada Revenue Agency (CRA) that supports innovation in Canada. Commonly pronounced “shred”, it stands for Scientific Research (SR) and Experimental Development (RD), and enables companies that perform research and development to potentially qualify for tax incentives that reduce their income tax payable or earn a refund.
The program is widely used by businesses across Canada. Over the past three years, more than 20,000 SR&ED claims have been filed each year resulting in over $4 billion doled out annually via tax credits.
Who is eligible for SR&ED?
To be eligible to receive SR&ED tax incentives, companies must perform their research and development in Canada. The work must also meet two requirements:
It must be conducted for the advancement of scientific knowledge or for the purpose of achieving a technological advancement (the “why”), AND
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 (the “how”).
What’s a SR&ED ITC?
Companies that file a SR&ED claim can earn an investment tax credit (ITC) on the research and development expenditures that qualify for that year. For most small- to medium-sized Canadian controlled private corporations, refundable and non-refundable ITCs can be earned at an enhanced (higher) rate. Larger corporations such as public or foreign-owned companies, may only qualify for non-refundable ITCs at a basic (reduced) rate.
A non-refundable ITC will reduce your income tax payable. For a refundable ITC, however, the government will cut you a cheque for the amount claimed if there is no tax payable.
What work is eligible for SR&ED?
As previously mentioned, to be eligible for SR&ED, the work must be conducted for the advancement of scientific knowledge or for the purpose of achieving a technological advancement AND must be a systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis.
The “Why”
The first requirement answers why the SR&ED work is being done. Eligible SR&ED work must generate or discover new knowledge that moves the understanding of science or technology forward. In other words, the work is being done because it tries to overcome the uncertainty by generating or discovering new scientific or technological knowledge. That being said, you do not have to achieve your goal in order to gain new knowledge. It’s important that the knowledge gained advances the understanding of science or technology; it does not have to advance your business or business practices.
The “How”
The second requirement (a systematic investigation or search) answers how your SR&ED work is completed. The investigation or search must be carried out in a field of science or technology by means of experiment or analysis versus a systematic approach or established techniques, and must include:
- Defining a problem
- Advancing a hypothesis towards resolving that problem
- Planning and testing the hypothesis by experiment or analysis
- Developing logical conclusions based on the results
SR&ED covers four categories of eligible work:
- Basic research – Aims to advance scientific knowledge without a specific practical application in view
- Applied research – Aims to advance scientific knowledge with a practical application in view
- Experimental development – Aims to generate or discover technological knowledge or know-how to develop or improve materials, devices, products, or processes
- Support work – Must be commensurate with the needs and directly in support of one of the other categories of SR&ED work: basic research, applied research or experimental development
When to apply for SR&ED
Your SR&ED claim can only be processed once the CRA has received your income tax return for the year. The SR&ED reporting deadline is 12 months after the due date of your income tax return. The claim is typically processed within 60 calendar days of the date the CRA receives your completed claim and your income tax return. If your claim is selected for a CRA review, the claim will typically be processed within 180 calendar days of the date the CRA receives your completed claim.
How to apply for SR&ED
Your SR&ED claim must be organized by project. A SR&ED project is the collection of all the activities that, together, achieve or attempt to achieve a scientific or technological advancement. The project ends when the new knowledge is gained; however, it’s important to note your work may still be eligible if you did not achieve the results you sought. Although a SR&ED project may span two or more tax years, each claim should only include the project expenditures incurred during the tax year for which you’re filing.
Proper documentation is key as claimants are responsible for the accuracy of the information in the SR&ED claim as well as maintaining records throughout all phases of the work. Your documentation must show: what work was done, who was involved with the work, when they did the work, and how the expenditures were calculated. Examples of documentation include accounting records, photographs and videos, prototypes, and progress reports.
When determining which expenditures may be eligible for SR&ED, keep in mind there must be a direct link from each expense to specific SR&ED work, staff, or machinery/equipment. Expenditures may include salaries, training costs, travel and moving expenses, and more as long as there is a direct relationship between the expenditure and the SR&ED work, staff or machinery/equipment. The Government of Canada website offers the Self-Assessment and Learning Tool (SALT) to help you understand if your work may qualify as SR&ED, estimate the amount of ITC you may be eligible to claim, the kinds of information needed to complete a claim, and the types of records you may need to support your claim.
While founders can prepare their SR&ED claim on their own, many choose to work with a SR&ED consultant to ensure proper documentation and to ease the CRA review process should you be selected for one. First-time SR&ED claimants typically undergo a CRA review. If selected, you will be required to gather the necessary information for the CRA to make a decision about your claim. This typically requires sharing in-depth knowledge of the work and the company’s finances, and could result in adjustments to your claim.
A CRA review is different from a FTCAS (First-Time Claimant Advisory Service) which applicants are often selected for after submitting their first claim. This is an online meeting that provides an overview of SR&ED, discusses your current claim, as well as provides guidance to support your future claims. It is not a review of your current claim to determine eligibility.
What if I get other government funding?
Provincial or territorial funding can increase your overall claim for ITCs. Although other government R&D funding and assistance will not prevent your work from being eligible for SR&ED tax incentives, they will reduce the amount of ITC you can earn through SR&ED. Most provincial and territorial SR&ED programs are administered by the CRA but have a provincial and federal tax component. Quebec and Alberta are exceptions where the federal refund component is administered by the CRA and the provincial tax component is administered by those respective provincial tax authorities. In Alberta and Quebec this can result in the federal and provincial components of SR&ED being received or reviewed at different times.
What is SR&ED financing?
SR&ED financing is offered by financial institutions and third party providers who can provide advanced access to a portion of the funds you’ll receive through your SR&ED claim, so you don’t have to wait to receive your refund from the government. This is paramount for rapidly scaling startups like Calgary-based ZeroKey, which has developed patented and breakthrough technology to bring the world’s most accurate real-time location system to market.
“When businesses focus on innovation, one of the key factors separating success and failure is often time-to-market,” says ZeroKey co-founder and CEO, Matthew Lowe. “By leveraging the accrued SR&ED ITC that would otherwise be illiquid, businesses can amplify their SR&ED activities and innovate faster, getting their innovations and products to market faster.”
For high growth companies seeking liquidity, SR&ED financing is a straightforward lending facility that is not reliant upon what stage your startup is in. RBCx offers SR&ED financing for eligible companies across all startup stages at competitive interest rates. The eligibility and loan to value ratio depends on your history of successfully filed SR&ED claims and whether your current claim has been filed or assessed, as well as other factors.
The benefits of SR&ED financing
For most companies, accrued SR&ED claims are among the longest lasting accounts receivables – often well over a year. If you could access some of that capital sooner, how could that help your business? From accelerating your R&D cycle to providing more certainty around cash flow to strengthening your company’s position before a raise, there are several benefits to eligible companies.
“The biggest thing we looked at when comparing SR&ED ITC financing products was how the available capital fit into our business model to help us accelerate our business,” says Lowe. “With RBCx’s tranched approach, we could deploy more capital at critical points to achieve better financial performance before our year end, ultimately driving increased shareholder value.”
Here’s a breakdown of some of the ways RBCx SR&ED financing may be an attractive option for your startup.
Non-dilutive capital
SR&ED financing by RBCx offers quick access to capital that does not dilute your ownership. This can be especially valuable to pre-seed and seed stage startups that may not typically qualify for loans offered by financial institutions due to their risk profile. Unlike venture debt, which isn’t available until there is a venture capital financing, SR&ED financing is not stage-specific and can unlock non-dilutive funding sooner. Non-dilutive capital enables the company the freedom to choose how to best utilize the funding, such as iterating upon the product, scaling, or key hirings.
Extend runway ahead of an equity raise
When it comes to raising equity financing, timing matters. It’s always better to raise from a position of financial strength, and having a cushion of non-dilutive capital on your balance sheet going into an upcoming round helps. SR&ED funding can also be invested in areas of the business that help raise your valuation before further dilution in the next round. Having a material lending facility from a financial institution – particularly in the case of early stage startups – can also be a positive signal to potential investors that you’re building a relationship and track record with a bank.
Accelerate your R&D cycle
For companies that require ongoing research and development to further their business, funds received through SR&ED financing can help accelerate research and development (although the SR&ED refund, once received, will pay off the loan). This can potentially increase the SR&ED expenditures accrued and, in turn, your tax refund while accelerating your R&D cycle—no small feat in the competitive landscape of tech startups where innovation is paramount.
For ZeroKey, it was RBCx’s flexibility and customizable approach to SR&ED financing that set them apart. “We had an excellent experience with RBCx. We evaluated several credit products from other lenders but found the flexibility and features of the RBCx offering to stand above,” says Lowe. “The tranched approach allows scaling of the available credit as the risk decreases to the creditor, enabling earlier access to more capital.”
To learn more about SR&ED financing and find out if it’s right for your startup, reach out to your RBCx Advisor. RBCx offers support to startups in all stages of growth, backing some of Canada’s most daring tech companies and idea generators. We turn our experience, networks, and capital into your competitive advantage to help you scale and make a meaningful impact on the world.
