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Are Startups at a higher risk of a SR&ED audit during COVID?

Knowledge Base:

 


 

Since the introduction of Temporary Wage Subsidy and Canada Emergency Wage Subsidy, several corporations have managed their workforce resources by reducing headcount, reducing hours, and/or reducing salaries. One thing is more certain than not, is that firms have migrated from the traditional in-person work environment to work-from-home resulting in significant reductions of overall business expenses. This may result in reduction or elimination of other typical P&L line items:

  1.   Lease/Rent reduction, or omission during 2020 and outwards
  2.   Utility Bills, and bills related to communication resources (internet, phone etc)
  3.   Use of office resources (printer, paper, stationary supplies etc)
  4.   Travel (Air, Ground, On-site, Offsite, client meets, specific purpose travels, testing, meeting suppliers etc)
  5.   Meals and Entertainment

From SR&ED claim perspective, all of the above items fall under the “Overhead” category which can be claimed for SR&ED expenditures under either the “Traditional Method” or the “Proxy Method”. For this study, the focus is establishing a potential impact on clients who select the Proxy Method (over 95% of the clients indeed select the Proxy Method).

 

Why is there a risk of SR&ED Audit?

A SR&ED audit can occur due to a number of reasons ranging from a random file selection, financial risk, or risk from the science standpoint.

Although the financial risk factor has not been differed much over the past few years, we anticipate that in future it may become a significant factor in the wake of COVID especially for startup corps as their overhead business expenditures may have reduced since COVID hit.

As we know, the Proxy Method allows for a 55% Gross-up of the SR&ED Qualified Salary Expenditures to account for the Overhead costs. However, the overhead amount calculated under the 55% Proxy has a limit which is dependent upon the total business expenditures made in the year. Of course, the overhead under the 55% Proxy calculation can not artificially exceed the actual expenditures that the business incurred that year. If the Federal SR&ED Form T661 is filed showing SR&ED overhead expenditures higher than the business expenditures reported on the P&L, it is going to cause a flag at CRA due to the financial risk, pushing the file into an audit.

This is especially the case for Start-Up Costs who are often relying on cost cuts to optimize cash flows. The reduction to overall business expenses and the every-growing need for cash flow produces the year-end focus on SRED optimization, where it can be easily forgotten that the potential SRED overhead under the Proxy Method may no longer be appropriate.

 

What can the companies do to manage the risk?

If the overall business expenditures aside from the SR&ED Salary and Contract costs have significantly reduced due-to or not-due-to COVID, it is important to highlight this to your SR&ED Finance Team so they can complete an assessment to study whether it is still feasible to file the claim under the Proxy Method, or switch to the “Traditional” method where all expense line-items can be studies to see if they qualify for SR&ED.

The team at Flow Ventures is vastly experienced to study, analyze, and guide on the safest course of action from strategy standpoint by ensuring that your SR&ED Claims are always optimized, year-over-year under the companies’ every evolving financial situation.

 Written by: 

Adnan Hamid

Director of Finance, Flow Ventures

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