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Canada’s SR&ED Tax Credit For Startups

Canada’s SR&ED tax credit (Scientific Research and Experimental Development or “SR&ED”) is one of the most under-appreciated government benefit scheme for Canadian startups. Indeed most Canadian founders have actually never heard of the R&D tax credit before. Unfortunately, they are missing on up to 35% of their R&D costs paid back in cash..!

In this article we’ll explain you what exactly is the SR&ED tax credit for startups in Canada, why it’s especially relevant for startups and how it works.

Is your startup eligible for the SR&ED tax credit? How much can you claim? What does it mean for your runway? We will cover:

What Is Canada’s SR&ED Tax Credit?

Canada’s Scientific Research and Experimental Development (SR&ED) is a tax credit program to encourage businesses, including startups, to invest in R&D.

Although most entrepreneurs aren’t aware of the SR&ED program, it is the largest tax incentive federal program in Canada. Indeed, since its creation, the program has provided over $3 billion in tax incentives to more than 20,000 companies.

What’s more is that the program is incredibly attractive for all types of businesses: corporations, trusts, partnerships and even individuals can benefit from SR&ED.

The tax credits come in 3 forms: a tax deduction, a tax credit or a cash refund.

As such, Canada’s SR&ED tax credit has become increasingly popular amongst startups, especially tech startups, as it allows them to significantly reduce their cash burn and extend their runway. Indeed, companies don’t necessarily need to be profitable to benefit from SR&ED.

As long as you’re spending in qualifying R&D (see more on that below), you can claim tax credit under SR&ED. Also, good news is that you can indefinitely carry forward tax credits to use them when your startup turns a profit..!

Finally, SR&ED tax credit can be claimed up to 3 fiscal years in the past. So if you’re just discovering SR&ED today, you can still claim back the past 3 years’ qualifying R&D expenditures.

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Is Your Startup Eligible?

Virtually all Canadian companies can be eligible. Yet, the rate they can claim depends on the type of corporation:

  • Canadian Controlled Private Corporations (CCPCs) can claim up to 35% investment tax credit on qualified R&D expenditure of up to $3 million as well as an additional 15% on amounts over $3 million
  • Non-CCPCs (public and other private corporations) can claim only up to 15% investment tax credit on qualified R&D expenditures

Note that the exact rates vary slightly depending on the province you’re applying in. The percentages shown above are the maximum federal tax credit rates you can obtain.

So, as long as you’re spending in qualifying R&D, and whether your startup is a CCPCs or foreign-owned corporation, you are eligible to claim tax credit under the SR&ED scheme. The only difference is the rate you will be able to claim back.

What is qualifying R&D?

Qualifying R&D defines the type of expenses you can claim back under the SR&ED tax scheme.

To qualify, the work must be conducted in Canada and be either basic research, applied research or experimental development.

Are you still confused? No problem, Canada’s tax body has created a very useful online tool, the “Self-Assessment and Learning Tool” to assess whether your project includes SR&ED work.

What R&D expenses can you claim?

If some of your business expenses are considered as qualifying R&D under SR&ED, you can claim expenses such as:

  • Salary or wages
  • Materials costs
  • Subcontractor expenses
  • Overhead and other expenditures directly related to SR&ED work, staff or the machine/equipment related used by the staff to perform the work

How Much Can You Actually Get?

As explained above, CCPCs can claim up to 35% of their qualifying R&D expenses up to $3 million, and 15% over $3 million spend. However, if your startups is foreign-owned for instance (non-CCPC), you will only be able to claim back 15%.

Yet, the scheme is all the more attractive for startups. Indeed, if you are a CCPC with under $500,000 income (taxable income), you also are a qualifying corporation under SR&ED. This means that any R&D expenditures over $3 million can be either:

  • Received as tax credit at a rate of 15% (like any other CCPC); or
  • 40% can be paid back as cash, at a rate of 15%

Case Study

The different rules of SR&ED and their variations by province can be confusing at first. Let’s use the example of a loss-making tech startup below:

Fiscal year
R&D expenses$4,500,000
of which qualifying expenses$3,500,000
Other expenses $5,000,000
Total expenses$9,500,000
Corporate taxes$0
Net profit / (loss)$(3,500,000)

First, let’s assume the business is a CCPC. Therefore, because its income is less than $500,000 (actually negative here), the company is a qualifying corporation under SR&ED.

Secondly, the company isn’t yet turning a profit. So it can’t use the tax credit to offset its corporate taxes. Instead, what the startup can do is:

  • Carry forward 35% of the qualifying R&D expenses up to $3 million: $1,050,000 in tax credits to offset against future corporate taxes when the company makes a profit
  • Get 40% of its qualifying R&D over $3 million paid back in cash, at a rate of 15%: $500,000 x 40% x 15% = $30,000 paid in cash; OR carry forward $500,000 x 15% = $75,000 in tax credits, on top of the $1,050,000 above

In the future, the startup will then be able to reduce its corporate tax expense by up to $1,050,000 (or $1,050,000 + $75,000) thanks to the SR&ED tax credit scheme.

Why Does It Matter For Your Runway?

Understanding how Canada’s SR&ED tax credit works for startups can help you save significant amount of money. Indeed, if used correctly, the SR&ED tax credit can save startups up to 35% of their R&D expenses per year, decreasing cash burn and significantly improving cash runway.

That’s why founders should always be mindful of taking into consideration potential SR&ED tax credit benefits in their cash flow forecasts.

Yet, don’t be too optimistic either: you can’t reasonably assume all your R&D expenses qualify under the scheme. Indeed, if you’re too optimistic, you might have some bad surprises down the road.

So when it comes to forecasting tax credits in general, make sure to ask your accountant whether you qualify to avoid mistakes.

Note: most startups capitalise a part of their R&D expenses. Indeed, there are clear advantages to capitalise your R&D expenses as a startup. If you aren’t familiar with R&D capitalisation, you might be missing on significant savings. For more information, read our article here.

More Free Resources For Canadian Startups

We have lots of free resources for Canadian startups. Have a look at our articles below:

Expert-built templates for tech startups

  • Investor-friendly
  • Easy-to-use Excel & PPT templates
  • CPA-developed financials
  • 30+ charts and metrics