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Introduction – SR & ED Tax Credit

The Scientific Research and Experimental Development (SR &
ED) Tax Credit can be a powerful tax planning tool for Canadian
business owners. Since 1944, Canadian corporations could deduct
their research development expenditures against their revenue.
However, capital expenditure incurred for research and development
purposes were not deductible at the time. Over the years the
Canadian Parliament has introduced various reforms to enable
corporations to deduct capital expenditures incurred for research
and development purposes. The term SR & ED was introduced in
the 1985 budget to denote eligible capital expenditure that can be
deducted from the taxpayer’s business income. Various
amendments have been made to the program since 1985, with the
latest statutory amendment being made in 2013.

CRA’s recent publication SR & ED claims made by
physicians and Medical Professional Corporations – Information for
Claimants
clarifies CRA’s position regarding how SR &
ED can be claimed by medical professionals working through either a
Medical Professional Corporation (MPC) or a Health Care Entity
(HCE). An MPC is a corporation incorporated for the purpose of
practicing medicine which does not offer the physicians limited
liability for medical malpractice related liabilities but does
offer the typical tax advantages offered by incorporating. HCE is
defined widely as an entity or a number of persons that provide
medical services to the public through contractual agreements with
physicians.

SR & ED – Section 37 of the Income Tax
Act

Before examining CRA’s new guideline regarding SR & ED
tax credit for medical professionals, let’s examine the general
structure of SR & ED.

The rules regarding Scientific Research & Experimental
Development tax credits are set out in two provisions of the Income
Tax Act. Section 37 lays out the rules for the calculation of
one’s SR & ER pool, while Regulation 1800 lays out the
criteria for expenditures to qualify as one’s SR & ER pool.
The sub-provisions of Section 37 work to make sure the
taxpayer’s SR & ER pool is only increased when there is an
expenditure that is incurred for SR & ER activities.

The pool method of calculation means all expenses over time go
in the pool, any amount can be claimed any year, and once it is
claimed, it cannot be claimed again. The Income Tax Act will
sometimes make references to qualified SR & ED expenditure
pool. The qualified SR & ED expenditure pool only refers to
eligible SR & ED expenditure incurred within the tax year and
is not to be confused with the taxpayer’s general SR & ED
expenditure pool.

As mentioned above, one of the main purposes of the SR & ED
tax credit is to make research and development capital expenditure
deductible. Section 37(1) allows a taxpayer to claim a full
deduction for Research and Development expenditures in Canada even
where they would otherwise be on account of capital and prohibited
by Section 18(1)(b) of the Income Tax Act or not incurred
to produce income and prohibited by Section 18(1)(a) of the
Income Tax Act.

Additionally, a taxpayer can claim an Investment Tax Credit in
the amount of 15 to 40 percent of a taxpayer’s annual SR &
ED expenditure for the year minus any provincial research
assistance received in the year. Generally, a Canadian-controlled
private corporation (CCPC) can earn a refundable ITC at the
enhanced rate of 35% on qualified SR&ED expenditures of $3
million. A Taxpayer can also earn a non-refundable ITC at the basic
rate of 15% on an amount over $3 million. However, if a taxpayer is
a CCPC that also meets the definition of a qualifying corporation,
a taxpayer also earns a refundable ITC at the basic rate of 15% on
an amount over $3 million and 40% of the ITC can be refunded. For
what qualifies a corporation as a CCPC, see our article on this
issue. (https://taxpage.com/definitions/canadian-controlled-private-corporation/)

Under Section 37, the taxpayer is entitled to include the
following expenditures into the taxpayer’s total of all amounts
of SR&ED expenditures for the current year

  • Expenditures on any scientific
    research and experimental development carried out directly by the
    taxpayer.

  • Expenditures on any scientific
    research and experimental development incurred on behalf of the
    taxpayer

  • Payment to a corporation or an
    approved institution such as a university to carry out the research
    in which the taxpayer is entitled to exploit the result.

In addition to regulation 1800 of the Income Tax Act, case law
has provided important criteria in the determination of whether an
expenditure qualifies for SR & ED. In C. W. Agencies Inc.
v. R
, the Court has identified five criteria that are useful
in determining whether an activity constitutes SR&ED:

  1. Was there a technological risk or
    uncertainty which could not be removed by routine engineering or
    standard procedures?

  2. Did the person claim to be doing SRED
    formulate hypotheses specifically aimed at reducing or eliminating
    that technological uncertainty?

  3. Did the procedure adopted accord with
    the total discipline of the scientific method, including the
    formulation, testing and modification of hypotheses?

  4. Did the process result in
    technological advancement?

  5. Was a detailed record of the
    hypotheses tested, and results kept as the work progressed?

CRA Guidance on SR& ED claim by Medical
Professionals

CRA recognizes most research and experimental undertakings by
medical professionals will qualify for the SR & ED by virtue of
Regulation 1800 as well as the case law on SR & ED. Therefore,
CRA’s recent guideline is mostly concerned with the eligibility
under Section 37 in claiming SR &ED when several medical
professionals collaborate with each other.

MPC and HCE are separate taxable entities

In claiming SR & ED tax credit as a medical professional,
the taxpayer should be aware that both an MPC and an HCE are
separate taxable entities from the medical professionals they
employ. The employee, including the director of an MPC or an HCE,
is not entitled to personally claim the SR & ED for qualifying
expenditures incurred by the MPC or HCE.

Furthermore, if an HCE is publicly funded, then it is not a
taxable entity while still a separate entity from its employee.
Therefore, if a publicly funded non-taxable HCE incurs qualifying
SR & ED expenditures, then no one is entitled to claim them
unless they incurred their own SR & ED expenses on behalf of
the HCE. Their eligible SR & ED amount will be their personal
expense for SR & ED activity minus the compensation they
received for the SR & ED activity they performed.

Salaries to Employees can be deductible

If employees are carrying out qualifying SR&ED activities on
their employer’s behalf, then salaries paid to employees by
either a corporation (MPC or HCE) or an unincorporated practitioner
count towards SR & ED expenditures directly incurred by the
taxpayer.

However, payments to other sole proprietors to perform SR &
ED activities do not qualify for SR & ED deduction because sole
proprietors do not fall under the approved institution list under
Section 37. On the other hand, the sole proprietor in this
situation would be eligible to claim SR & ED credit in the
amount of their expenditure incurred for the SR & ED activity.
However, the total amount that can be claimed may be reduced by
provincial research assistance or compensation they received in
relation to the SR & ED activity.

Tax Tip – Seek Professional Advice If You are
Engaging in Collaborative Medical Research

The CRA Guideline also provided some brief suggestions of
documentation required to claim SR & ED. In reality, claiming
SR & ED can often be a complex process. If you are a medical
professional engaged in collaborative research, it can be helpful
in retaining professional advice to ensure you maximize your SR
& ED Tax credit. Our experienced Toronto Tax Lawyer can work
with you to ensure the relevant documents are prepared to meet the
demands of any possible CRA tax audits.

The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.

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