New SR&ED Policy Guidelines: Understanding the “Why” and “How” requirements for work to be eligible for SR&ED tax incentives
On August 13, 2021, the Canada Revenue Agency (CRA) finally made official what they have been piloting for a number of months with companies: the removal of the “5 Questions” methodology, introducing new guidelines to their Scientific Research and Experimental Development (SR&ED) policy. Although the definition of SR&ED given in the Income Tax Act has not changed, the new guidelines feature simplified explanations of the program requirements, and clear guidelines on the eligibility of work. It is important to note that this will not change what work is eligible. The new guidelines merely provide a more flexible framework for evaluating SR&ED.
The guidelines on the eligibility of work for SR&ED tax incentives policy is now broken into two sections: Why and How SR&ED is conducted. They are the two key requirements that must both be met for work to be eligible as SR&ED.
The "Why" requirement
“Work must be conducted for the advancement of scientific knowledge or for the purpose of achieving technological advancement . The key to both is the generation or discovery of knowledge that advances the understanding of science or technology.”
Technological advancement, be it radical or incremental, is a key objective of the SR&ED program. A scientific or technological uncertainty must be present, whereby it is unknown or uncertain whether a given result or objective can be achieved due to an insufficiency in the scientific or technological knowledge sources that are reasonably available to you publicly or within your business.
An attempt to resolve scientific or technological uncertainty rather than circumventing it with a workaround using available knowledge is therefore considered an attempt to achieve scientific or technological advancement.
“If you try to resolve the uncertainty and your work is an attempt to generate or discover new scientific or technological knowledge, your work will meet the "Why" requirement.”
Also, the success or failure in meeting your objectives is not relevant when assessing whether your work meets the “Why” requirement.
The "How" requirement
Although businesses follow their own practices, procedures, design methods, techniques, and standards this alone does not meet the eligibility for SR&ED tax incentives.
“It is important to distinguish between a systematic approach to carrying out work and the approach that is a systematic investigation or search called for in the definition of SR&ED. The latter approach includes:
- Generating an idea consistent with known facts, which serves as a starting point for further investigation towards achieving your objective or resolving your problem. Your idea may be expressed as a possible solution to a problem, a proposed method or an approach. This can be referred to as a hypothesis.
- Testing of the idea or hypothesis by means of experiment or analysis. The idea can evolve and change as a result of testing.
- Developing logical conclusions based on the results or findings of the experiment or analysis.
- Keeping evidence that is generated as the work progresses.”
The work must take the form of a systematic investigation. The CRA is keen to see that the principles of the scientific method are followed, including formulating the hypothesis, testing the hypothesis, and conclusions of the work. It is an iterative process, and while documentation is not submitted with a claim, it is important to keep a record of it in case your claim is reviewed or audited by the CRA.
For more information on SR&ED documentation best practices, access our guide below:
What does this replace?
The new “Why” and “How” requirements for work to be eligible for SR&ED tax incentives replace the older Eligibility of Work for SR&ED Investment Tax Credits Policy methodology - commonly known as "The 5-Questions".
Step 1: Determine if there is SR&ED
To do this the eligibility of work performed was evaluated and determined based on the following five questions:
- Was there a scientific or a technological uncertainty?
- Did the effort involve formulating hypotheses specifically aimed at reducing or eliminating that uncertainty?
- Was the overall approach adopted consistent with a systematic investigation or search, including formulating and testing the hypotheses by means of experiment or analysis?
- Was the overall approach undertaken for the purpose of achieving a scientific or a technological advancement?
- Was a record of the hypotheses tested and the results kept as the work progressed?
What is the same?
Step 2: Determine the Extent of Eligible Work
This step remains the same under both regimes. Once the CRA has determined if there is indeed SR&ED eligible work undertaken, the applicant must then also demonstrate that the work they are including (and the associated costs) were all related to the claimed SR&ED project(s). Evidence of the extent of work is an absolute necessity to substantiate that the extent of work claimed is indeed correct.
For more information about the SR&ED tax credit program and how Flow Ventures can help support your company’s growth, please contact us below!