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:
- Was there a technological risk or uncertainty which could not be removed by routine engineering or standard procedures?
- Did the person claim to be doing SRED formulate hypotheses specifically aimed at reducing or eliminating that technological uncertainty?
- Did the procedure adopted accord with the total discipline of the scientific method, including the formulation, testing and modification of hypotheses?
- Did the process result in technological advancement?
- 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.