Expense Categories Overview
| Category | Examples |
|---|---|
| Salary & Wages | Engineers, scientists, lab technicians directly involved in SR&ED |
| Materials Consumed | Raw materials used up or destroyed during testing |
| Materials Transformed | Materials incorporated into prototypes that cannot be sold |
| Contract Expenditures | Third-party R&D labs or consultants (must be Canadian) |
| Overhead | Heat, light, maintenance (via Proxy or Traditional method) |
| Capital Expenditures | Equipment, machinery used 90%+ for SR&ED (eligible again as of Dec 2024) |
| Third-Party Payments | Universities or research institutes performing SR&ED on your behalf |
Salary & Wages
What Can Be Claimed
- Base salary for time spent on SR&ED activities
- Taxable benefits (health insurance, car allowance, etc.)
- Bonuses related to SR&ED work
- Employer's share of CPP, EI, and other statutory contributions
Time Allocation
Employees rarely spend 100% of their time on SR&ED. You must:
- Track actual time spent on SR&ED activities
- Maintain timesheets, project logs, or other documentation
- Be prepared to justify allocations during CRA review
Only claim the percentage of salary that corresponds to actual SR&ED work. If an engineer spends 40% of their time on qualifying R&D, claim 40% of their total compensation.
Who Qualifies
| Eligible | Not Eligible |
|---|---|
| Engineers performing R&D | Administrative assistants |
| Scientists conducting experiments | Sales personnel |
| Technicians supporting SR&ED | HR staff |
| Technical project managers | General management |
| Programmers developing new technology | IT support for routine operations |
Materials Consumed
Materials consumed are those that are used up, destroyed, or rendered valueless during SR&ED activities.
Examples
- Chemicals used in experiments
- Electronic components destroyed during testing
- Raw materials consumed in failed prototypes
- Testing samples that cannot be reused
Requirements
- Materials must be directly attributable to SR&ED
- You must be able to document the cost and usage
- Materials used for commercial production do not qualify
Materials Transformed
Materials transformed are those incorporated into a prototype or product that cannot be sold at fair market value.
Key Distinction
| Materials Consumed | Materials Transformed |
|---|---|
| Used up or destroyed | Incorporated into something |
| No longer exist | Still exist but not sellable |
| Full cost claimable | Cost minus any resale value |
Examples of Materials Transformed
- Components built into a prototype that will be scrapped
- Materials incorporated into test equipment
- Parts used in a one-off device for internal testing
- Raw materials transformed into unsellable test products
Important Rules
If the prototype or product can be sold, leased, or used commercially, you cannot claim the materials as SR&ED expenditures. You must subtract any proceeds or fair market value.
Calculate the claim:
Claimable Amount = Cost of Materials - Proceeds from Sale (or Fair Market Value)
Documentation Required
- Purchase invoices for materials
- Records showing materials were used in SR&ED
- Evidence that prototypes were not sold (or documentation of sale proceeds)
- Bill of materials for prototypes
Contract Expenditures
When you hire third parties to perform SR&ED on your behalf — meaning you control the work and it's performed as if you did it yourself.
Arm's Length vs Non-Arm's Length
| Type | ITC Eligibility | Deductible |
|---|---|---|
| Arm's Length | 80% of contract amount | Yes |
| Non-Arm's Length | Not eligible for ITC | Yes (deductible only) |
Non-arm's length contractors (related parties, family members, companies you control) do not qualify for Investment Tax Credits. Only the deduction is available.
Eligibility Requirements
- Work must be performed in Canada
- The contractor performs SR&ED work on your behalf (you control the work)
- You must document the arrangement and the SR&ED performed
What Qualifies
- R&D consulting services
- Laboratory testing services
- Engineering design for SR&ED projects
- Technical analysis and experimentation
What Does NOT Qualify
- General IT consulting (non-R&D)
- Legal or accounting services
- Marketing research
- Foreign contractors or work performed outside Canada
80% Rule (Arm's Length Only): You can claim 80% of arm's length contract expenditures for ITC purposes. If you pay an arm's length contractor $100,000, your qualified SR&ED expenditure is $80,000.
Overhead Costs
You have two methods to calculate overhead: Proxy Method or Traditional Method. You must choose one method per tax year when filing your SR&ED claim.
Proxy Method (Most Common)
The Prescribed Proxy Amount (PPA) simplifies overhead calculation by using 55% of the salary base (in effect since 2014).
Calculation: PPA = Salary Base × 55%
The salary base includes salaries and wages of employees directly engaged in SR&ED activities in Canada. Special rules apply for specified employees (shareholders or their relatives) which may limit amounts included.
Key Points:
- No tracking of actual overhead costs required
- Investment tax credits (ITCs) are earned on the PPA
- The PPA is not deductible from income — it's only used to calculate ITCs
- Actual overhead expenses are deducted as ordinary business expenses
Traditional Method
Claim actual overhead and other expenditures directly related and incremental to SR&ED.
Eligible Costs:
- Rent for SR&ED workspace (proportional allocation)
- Utilities (heat, light, power) for SR&ED areas
- Equipment maintenance and repairs
- Insurance for SR&ED facilities/equipment
- Supplies not directly consumed in SR&ED
Requirements:
- Must specifically identify and allocate all overhead costs to SR&ED
- Detailed records and justification required for each expenditure
- Overhead must be directly related and incremental to SR&ED activities
Most companies use the Proxy Method because it's simpler. Consider the Traditional Method only if your actual overhead costs significantly exceed 55% of your salary base and you can document them thoroughly.
Third-Party Payments
Payments to approved entities to conduct SR&ED — different from contract expenditures because you do NOT control the actual work performed.
Key Difference from Contracts
| Contract Expenditures | Third-Party Payments |
|---|---|
| You control the SR&ED work | You do not control the work |
| Work done "on your behalf" | Work done independently |
| 80% eligible (arm's length) | 100% eligible |
| Reported on lines 340/345 | Reported on line 370 |
Eligible Recipients
- Universities - Approved Canadian post-secondary institutions
- Colleges - Canadian colleges with R&D capabilities
- Research institutes - CRA-approved organizations
- Hospital research facilities
Requirements
- Payment must be to an approved entity
- The SR&ED must be carried out in Canada
- Work must be related to your business
- You must have the right to exploit the results of the SR&ED
Special Treatment
- 100% of payments are claimable (vs. 80% for arm's length contracts)
- Eligible on a cash basis — when the payment is made, not when work is performed
- May qualify for enhanced tax credit rates
If you're contracting a university to perform specific SR&ED work under your direction, that's a contract expenditure (80% rule applies). If you're making a payment where the institution conducts SR&ED independently and you get rights to the results, that's a third-party payment (100% eligible).
Capital Expenditures
As of December 16, 2024, capital expenditures are eligible again for SR&ED income deductions and investment tax credits!
What Qualifies
Capital property acquired on or after December 16, 2024, used all or substantially all (90% or more) for SR&ED activities in Canada:
- Machinery and equipment for R&D
- Laboratory equipment
- Testing apparatus
- Specialized tools for SR&ED
Shared-Use Equipment
If equipment doesn't meet the 90% SR&ED usage threshold but is still used partly for SR&ED, it may qualify as shared-use equipment — allowing a proportional amount of the cost to be eligible.
Refundability for CCPCs
For Canadian-Controlled Private Corporations (CCPCs) eligible for the enhanced 35% tax credit:
- Credits on capital expenditures are partially refundable (up to 40%)
- Credits on current expenditures remain fully refundable up to the expenditure limit
What Cannot Be Claimed
The following expenses do not qualify for SR&ED:
Excluded Costs
- Administrative overhead not directly related to SR&ED
- Sales and marketing expenses
- Quality control for routine production
- Training (unless directly related to SR&ED project)
- Patent filing fees and legal costs
- Routine software maintenance
- Foreign contractor payments
- Land and buildings (land is never eligible; buildings have specific rules)
Documentation Best Practices
To support your expense claims:
- Maintain contemporaneous records - Keep records as expenses occur
- Link expenses to projects - Show which SR&ED project each expense supports
- Keep invoices and receipts - Original documentation for all purchases
- Track time allocation - Document how employee time was split
- Photograph prototypes - Visual evidence of materials transformed
- Document disposal - Records of destroyed or scrapped materials
Good documentation is your best defense during a CRA review. The burden of proof is on you to demonstrate expenses are directly attributable to SR&ED.