In the second segment of our “grey” area discussion, we explore the circumstances of a contractual agreement for work between 2 SMEs, and the solution to the SME that is eligible to claim the R&D tax relief based on qualified activities.

Specifically, an SME may contract work with another SME to carry out work or a service. As a result, a grey area exists to which SME can make a claim; the SME who pays for the work or the SME that performs the work. HMRC will not allow R&D tax relief to be claimed by 2 companies so which SME is the rightful claimant?

In making this determination, an SME needs to review a variety of factors and make judgement, as the eligibility requirements for this grey area are not clearly defined.
The main criteria to review and analyze, include the following:

1. Who will own the Intellectual Property (IP)?
2. Who takes the business risk under the contract? Is it a fixed price contract or time and materials?
3. Is it a contract for services or goods?

Let’s look at an example, SME A contracts with SME B. The contract is for SME B to provide a software solution that has new or improved functionality but the specifications of the software design is set by SME A. The contract is set at a fixed price and there is a guarantee that the solution will meet certain functional requirements. In addition, there is no mention in the contract or any discussion surrounding the know-how SME B acquires in developing this software.
Essentially, this contract is for SME A to acquire a finished good. SME B retains any IP it develops or knowledge it has generated from development, and SME B is taking the business risk on the contractual agreement (ie, if they go over budgeted costs, they are incurring the losses). In this particular circumstance, SME B is the rightful claimant.
If the contract, however, mentions that SME A retains the IP, SME B was paid time and materials regardless if the software functioned appropriately, and SME B had no right to use the knowledge obtained from the developed solution, then SME A would be the rightful claiman and claim the amount paid to Company B for R&D tax relief.

There are, however, many situations that are not clearly defined, as the example stated. There are circumstances where a written contract does not exist or there could be situations where the criteria favour both parties. In these situations, judgement to determine the correct R&D assessment is necessary by RDP Associates Ltd. as we are the worldwide leader in R&D tax relief.

If you have any circumstances where these issues exist, please contact Lauren Parker at lparker@rdpassociates.com for more details.
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The 2012 budget introduced an “above the line” tax credit for the R&D tax relief programme that is to begin April 1, 2013, with a minimum tax rate of 9.1%. Companies in a loss position will continue to claim payable credits. The Government will be consulting on the detailed design of the improved tax credit scheme shortly, and final tax relief rates will be determined following consultation.

This new piece of legislation was not unexpected as it had been raised as part of the consultation process in 2011. While many details have yet to be finalized, we have listed the main points that have ultimately improved the R&D tax relief programme:

• Currently, under the large company scheme, the equivalent R&D tax relief benefit is less than 7.5% of the gross R&D spend, and would fall as corporate tax rates drop. By introducing a 9.1 % R&D credit, the overall benefit to large companies will be increased.

• More importantly for some large companies, it is anticipated that the credit will be refundable. This will be a huge win for large companies in loss situations that could not take immediate advantage of R&D tax relief.

• There is little mention as to whether and how these changes will affect the SME scheme for R&D tax relief. One option would be to maintain the SME scheme as it currently exists. However, if an “above the line” credit is to be brought in, one can only hope that the credit granted to SME’s will approximate the tax benefit they are currently receiving. Effective April 1, 2012, the R&D uplift will increase from 100% to 125% and at a 20% SME corporate rate, the equivalent tax credit is approximately 25%. The Government has indicated that they intend to maintain the R&D benefit for SME’s.

As RDP will be participating in the consultation process, we will keep you informed regarding this matter.
If you have any questions please feel free to contact Lauren Parker at 416-368-9341 x 299 or email lparker@rdpassociates.com
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This is the first of a series of specific issues in the R&D Tax Relief arena. Within the programme, there are “grey” areas, which we intend to explore further over the next few months. To determine and maximize expenditures in these areas requires a clear understanding of the CIRD guidelines, as well as what HMRC considers being a reasonable submission. Companies submitting R&D Tax Relief claims may be grossly under claiming or unknowingly triggering a query from HMRC.

The grey areas we will be exploring are as follows:
1. How to differentiate between experimental production and commercial production and what expenditures are eligible for R&D Tax Relief?
2. Which Company is permitted to make the R&D claim where a contract is in place; the company paying for the service or the company performing the service?
3. What Qualified Indirect Activities (QIA’s) are permitted to be claimed?
4. What documentation is necessary to support R&D claims?

There are several additional grey areas and if you would like RDP to address them, let us know and we will add them to the list. We hope this stimulates discussion, so please send us your thoughts.

Commercial Versus Experimental Production
HMRC is concerned that companies claim for materials that are not linked to R&D activities. This can be evidenced in hindsight where trial runs are facilitated and the resulting product is sold. Typically, these types of issues occur in manufacturing companies. The issue is where one draws the line between experimental production and commercial production.
Companies claiming R&D Tax Relief, in most cases, do not know when commercial production began. As a primary rule, commercial production is not an eligible R&D activity. However, caveats do exist regarding qualified activities in commercial production. One example of this occurs when a trial run is facilitated to test the validity or resolve the technological uncertainty of a new product design.
If a Company is carrying out a test run or developing a prototype, the labour effort associated will likely qualify as an eligible R&D expenditure if some technological uncertainty exists. However, materials are not so concrete in determining R&D eligibility. Materials must be consumed, scrapped, or destroyed in the process of R&D experimentation or trial runs. Materials that are subsequently sold on commercial terms will not qualify.
Prototypes have a variety of definitions to different people. For purposes of R&D tax relief, prototypes are typically those pieces of equipment or product that have no commercial value or production use. They tend to sit in the corner after development and either gather dust or are used for R&D testing. The materials or parts used to develop a true prototype will qualify as R&D expenditures.

Since there are several circumstances associated with this particular grey area, the best way to obtain the right answer is to direct your questions to RDP Associates Ltd., and we will answer them at no charge. Please send your email to Lauren Parker at lparker@rdpassociates.com

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RDP has compiled an overview for all significant R&D tax credit programs for countries around the world. If you are an international company or have international clients developing new products or processes in other countries, please contact us and we can send you this international overview. If you require more detailed information on any one country please contact us and can either provide more detailed information or assist to assess eligibility of specific work done in that country.

For information on International R&D Tax Credits contact Lauren Parker at lparker@rdpassociates.com

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The Federal Budget delivered yesterday proposes many changes to the SR&ED program. In general, the Government promises to; “Streamline and improve the SR&ED tax incentive by removing capital from the expenditure base, making it more cost-effective through design improvements and a measured rate reduction, and providing greater predictability through administrative improvements”. The following are the highlights of changes proposed in the 2012 budget. For more specific details, please see our full analysis at: RDP- Budget 2012- Changes to the SR&ED Program

SR&ED Investment Tax Credit Rate

• The general 20% SR&ED investment tax credit (ITC) rate of 20% will be reduced to 15%
• The enhanced 35% SR&ED ITC rate remains unchanged, as does the phase out of the $3M expenditure limit

SR&ED Capital Expenditures

• The exclusion of expenditures of a capital nature  from eligibility for SR&ED deductions and investment tax credits, applicable to property acquired on or after January 1, 2014, including expenditures of a capital nature included in contract fees

SR&ED Overhead Expenditures

• Reduction of the rate at which the prescribed proxy amount is calculated from 65% to 60% for 2013 and to 55% after 2013.

SR&ED Contract Payments

• Disallowance from the expenditure base for investment tax credits, the profit element of arm’s length SR&ED contracts. For simplicity, it is proposed that this be achieved by way of a proxy, under which only 80% of the cost to a payer of arm’s length SR&ED contracts will be eligible for SR&ED investment tax credits. This measure will apply to expenditures incurred on or after January 1, 2013.

Contingency Fees

• The government will be conducting a study to understand why firms choose to hire consultants on a contingency fee basis and to determine whether action is required. Stay tuned for a survey from RDP to get your opinion on the matter!

New R&D Funding

• Over $1.5 Billion in new grants encouraging Innovation, Research, Education and Training.

If you have any questions or comments please do not hesitate to contact us at 416-368-9341.

In anticipation of perhaps the most important changes to the SR&ED program in many years, RDP will be on hand on March 29th and March 30th to answer any questions on how the Federal Budget measures will affect your SR&ED claim.
While we will be emailing out information on the changes as soon as we can, you can call in or contact anyone on our Budget team as follows;

• Arne Luik, 416-313-2973 or aluik@rdpassociates.com
• Nick Coulthard, 416-313-2997 or ncoulthard@rdpassociates.com
• Andrea McPhail, 416-313-2992 or amcphail@rdpassociate.com
• Christine Tzimika, 416-313-2991 or ctzimika@rdpassociates.com
• Brian Cookson, 416-313-2971 or bcookson@rdpassociates.com
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In an ongoing effort to provide value added services to trusted advisors, we are introducing a new free service.

If you have any question on R&D tax credits contact us and RDP will reply within 24 hours.

Having 25 years of experience filing thousands of successful R&D claims, RDP is able to advise our trusted advisors on a variety of topics including but not limited to the following:

1. Does a particular industry qualify for R&D tax relief?
2. Does a particular business qualify for  R&D tax relief?
3. Does a particular project or activity qualify for R&D tax relief?
4. Are employee costs allocated to R&D projects reasonably?
5. What is HMRC’s position on a particular issue?

Whatever the question, just ask!

The best way to ask a question is to email Lauren Parker at lparker@rdpassociates.com

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HMRC released commentary and draft legislation on December 6^th, 2011 regarding certain R&D tax credit measures that are expected to be part of the Finance Bill of 2012. Consultations have been going on since November 2010. While a number of items have been raised as part of this process, draft legislation has been now been introduced in the following areas:

For the SME scheme only:

1. The R&D tax relief uplift increases from 100% to 125% beginning April 2012, giving all SMEs a total tax relief of 225% on allowable R&D expenditures.
2. For all expenditures that have been incurred after April 1, 2012, a reduction in the rate of a payable tax credit will be 11%.
3. The removal of vaccine research relief for SMEs also occurs after April 1, 2012.
4. The abolition of the PAYE/NIC limit will have effect for accounting periods ending on or after 1 April 2012.
5. The clarification of what constitutes a company being a ‘going concern’ will apply to claims for relief made on or after 1 April 2012.

For the SME and Large company schemes:

1. The removal of the £10,000 minimum expenditure will have effect for accounting periods ending on or after 1 April 2012.
2. The revised definition of an “externally provided worker” will have effect for expenditures incurred on or after 1 April 2012.

The current draft legislation associated with the Finance Bill of 2012 allows all SMEs to generate approximately a 25% tax credit on eligible R&D expenditures. Approximately only 7,000 SMEs filed R&D tax relief claims in 2011 and with the proposed draft legislation, this is now becoming a program that SMEs cannot afford to ignore or ensure they are claiming as well as maximizing all eligible projects, activities and costs.

Furthermore, many SME’s in a tax loss position could not receive a cash refund due to the restriction PAYE amounts.

Essentially the government is proposing to move to an “above the line” scheme, meaning the scheme will be converted to a credit system where the credit will be recognized as a reduction in costs. This means that the credit will be given income recognition and not just an adjustment to the tax provision.

However, the most important aspect under the new proposed rule is that an “above the line” credit typically requires the company receive the benefit of the credit within a reasonable period. Thus it is anticipated there will be a cash benefit to those companies previously precluded from realizing the benefit due to losses, which would also include Large Scheme companies in loss positions.

The R&D tax relief program should be something every company developing new products or processes needs to seriously consider.

RDP will continue to monitor the draft legislation proposal and keep you informed.

If you have any questions please feel free to contact Lauren Parker at 416-368-9341 x 299 or email lparker@rdpassociates.com.

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Are you in the process of selecting and implementing digital hardware or software? If so, you could eligible for a  grant up to $99,999.00 through the Digital Technology Adoption Pilot Program (DTAAP).

Digital technology can be defined as: “any system that uses parts which contain or make use of binary or digital logic. This can be in hardware or software. Basic binary logic has only two states 1 or 0 i.e. ON or OFF. A combination of logic cells can make simple to highly complex circuits or integrated circuits. Most systems making use of digital technology have a micro controller or processor, some form of storage plus a running internal program for decision making or processing, e.g. computerized shipping doors, RIF scanners, programmable Rabbit, sorting technologies”

If believe your organization may qualify or have any questions please contact Christine Tzimika at:  ctzimika@rdpassociates.com or (416) 368-9341 x248

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The Report to review the federal support to R&D in Canada, by an expert panel commissioned by the federal government, was issued on October 17, 2011.

As a firm, we can not disagree with the recommendations. However, it is unfortunate that the government has not kept any statistics on programs such as SR&ED or IRAP to determine if each has been effective or whether one has outperformed the other in encouraging Innovation and R&D among Canadian companies.  Without this analysis, it is more difficult to recommend a direction.

As it affects our clients, the recommendations are as follows:

• The SR&ED program for small and medium sized enterprises (SME’s) should change on 2 fronts. First, the eligible costs should be reduced to labour only (that is, eliminate costs for materials and capital) and increase the SR&ED tax credit %. This is to simplify the preparation time and costs. Secondly, phase out the refundable feature for any particular SME, over time. For example, an SME might receive cash in the form of a refundable Tax credit in the first year, but the refundable feature will be reduced until it is eliminated in say, year four. This means they don’t want to fund SME’s who are continually in a loss position.

• Create an Industrial Research and Innovation Council (IRIC) to deliver innovation programs. The report suggests that IRAP be moved under this program and any funding to SME’s that are reduced under the SR&ED program (point 1 above), be added to IRAP’s budget. So if the SME would otherwise receive an SR&ED Tax refund under the old system, this reduction in funding would be added to IRAP’s budget. IRAP will then continue to directly fund, by way of grants, SME’s that qualify for direct funding.

• Create a national commercialization voucher program as a pilot program. The purpose is to help SME’s connect with approved providers of commercialization services in post-secondary, government, non-profit and private organizations.

In addition to the above, the recommendations include better program evaluation; an innovation concierge service; funding provided to the BDC to provide more risk capital and program consolidation.

This report now needs to be reviewed by the federal government who will then decide whether to implement these recommendations. The Minister in charge has provided no timeline as to when this will be done.

If you have any questions please direct them to Lauren Parker at 416-368-9341 x 299 or email lparker@rdpassociates.com.

www.rdpassociates.com | www.innovationnpd.com