When it comes to maximizing your Scientific Research and Experimental Development (SR&ED) tax credits in Canada, contractor expenses can be a significant component. However, there are specific rules and limitations involved in claiming these expenses. In this blog post, we’ll break down how to properly claim contractor fees under the SR&ED program and share tips to help ensure your claim stands up to CRA scrutiny.

Can You Claim Contractor Fees?

Yes—assuming you have an eligible SR&ED project. However, not all contractor expenses qualify.

What Qualifies?

To be eligible:

• The contractor must perform SR&ED work in Canada on behalf of your business and the contractor must be a Canadian taxable supplier.
• You can only claim arm’s-length contractors who are directly engaged in SR&ED work subject to a limitation.
• The work must be related to your project’s scientific or technological uncertainty, or in other words, SR&ED activity carried out by the contractor on your behalf.
• You must have documentation that outlines the nature of the work, timelines, deliverables, and payments.

Important Rules to Remember

1. Contract work done in Canada

There are two tests here. The first test is that contract work must be done in Canada. Quite often we are asked how CRA would know where work is done if a contractor is a Canadian company but in turn uses staff or contractors outside of Canada? First of all, there are look through rules, which state you need to verify where the work is done. If the SR&ED work is ultimately done outside of Canada (even where there is a string of contract arrangements through a number of companies) then the work will not qualify for SR&ED. On review, CRA will ask for documentation to prove where the work was done.

The second test is that the contractor must a “taxable supplier”. If the contractor is a corporation, it must be resident in Canada for tax purposes and file Canadian corporate tax returns. Similarly, if the contractor is an individual, they must be resident in Canada for tax purposes and file Canadian HST/GST and personal tax returns. For example, a US citizen and resident that carries out SR&ED work in Canada will not be an eligible contract fee SR&ED expenditure. 

2. Arm’s-Length Requirement

Only contractors dealing at arm’s length from your business are eligible to be claimed. In addition, only 80% of the eligible SR&ED contractor fee can be claimed.  Quite often we see that the owner of a company making a SR&ED claim, also owns a related management company. The owner charges a fee from their management company to the SR&ED company. In this case the SR&ED company can not claim the fees paid to the owner’s management company. The management company however could make a SR&ED claim if it had SR&ED expenditures or it could transfer any eligible SR&ED costs to the SR&ED company under special rules.

3. SR&ED Work on Behalf of

To qualify, the payer can claim contractor fees if the contractor is carrying out basic research, applied research, experimental development, or support work, on behalf of the payer. SR&ED support work, done by the contractor must be commensurate with the needs and directly in support of the basic research, applied research, or experimental development work performed by or on behalf of the payer. This can require judgement, for example does a support activity include the cost of an electrician to power up a prototype equipment?

Also, it often arises that a determination needs to be made as which Canadian company can make the SR&ED tax credit claim; the company paying for the work or the company performing the work. There are number of tie-breaker rules, but the 2 main ones are :

a) who owns the IP and

b) who is taking the business risk under the contract.

For example, Company A the payer engages Company B to undertake work. Under the contract, Company A retains all IP and know how for any work done by Company B. In addition, Company A pays Company B on a time and materials basis. Under this arrangement Company A contracted Company B to carry out SR&ED on its behalf. Company A can claim the contractor fees of Company B and Company B cannot make a SR&ED claim on the work it performs for Company A unless its costs exceed the contract payment received from Company A. In this case Company B can claim the excess of SR&ED costs over the payment received from Company A.

4. Contractors doing SR&ED work on behalf of foreign companies

When a Canadian company undertakes work for a foreign company and the work undertaken qualifies as a SR&ED project, then the payment received by the Canadian company from the foreign company does not have to be netted against the eligible SR&ED costs of the Canadian company. This is because the foreign company cannot make a SR&ED tax credit claim in Canada. Even though the Canadian company is re-imbursed by the foreign company for the work and gives us any IP rights to the foreign company, a SR&ED claim can be made by the Canadian company.

5. Documentation

To support the position of claiming contractor fees, it is recommended the payer keep the following documents:

• The scope of SR&ED work performed
• Milestones and deliverables
• Time spent on eligible SR&ED activities
• Proof of payment

The CRA expects this information to determine the legitimacy of your claim.

Final Thoughts

Contractor fees can be a valuable component of your SR&ED tax credit claim—if handled correctly. However, there are a number of pitfalls and opportunities. RDP has been assisting companies for over 38 years with SR&ED tax credit claims.

Please contact us for assistance.