How does the SR&ED tax credit work in Canada? Complete guide for businesses

What Is the SR&ED Tax Credit?

How the Program Works

• A tax deduction for your R&D expenditures from taxable income (reducing your taxable profit).
• An SR&ED investment tax credit (ITC) calculated on those same eligible expenses. This credit reduces your tax owing and, if it exceeds your liability, can be refunded (especially for qualifying small businesses).

SR&ED Eligibility Criteria

1. Scientific or Technological Advancement The project must aim to achieve a scientific advancement or technological know-how. In other words, your work must seek to resolve a scientific or technical uncertainty and generate new knowledge—for example, developing a novel algorithm or an innovative process to improve an existing product. The key is that there is a genuine objective of progress through innovation, not simply applying established knowledge.
2. Scientific or Technical Uncertainty and Difficulty The project must involve a scientific or technical uncertainty at the outset. SR&ED work is undertaken precisely because there is no certainty that the intended outcome is achievable with current knowledge. There must be a complex problem whose resolution is not known in advance (if you are merely following a known recipe, it’s not SR&ED). For instance, questioning whether it’s possible to significantly boost software performance beyond a known limit, or formulating a new material with unprecedented properties, entails an uncertainty to be resolved through research.
3. Systematic Investigation The work must be carried out systematically, following a rigorous research or experimental method. Concretely, an SR&ED project should include steps such as defining the problem, formulating a hypothesis or potential solution, conducting experiments or tests to validate the hypothesis, then observing results and drawing conclusions. This iterative trial-and-error scientific process is intrinsic to SR&ED. It’s not enough to have a vague idea—you must document a methodical approach to solve the technical problem.
4. Scientific or Technological Field The work must fall within scientific or technological domains. Pure scientific research (without immediate application), applied research (with practical purpose), or experimental development (creating/improving products, processes, or technologies) are eligible. In contrast, certain activities are explicitly excluded: social sciences or humanities research, market studies, routine quality control, aesthetic improvements, or simple bug fixes without technical challenge do not qualify.
5. Performed in Canada To claim SR&ED, the R&D work must be carried out in Canada. Salaries and expenses incurred abroad are not eligible (with very limited exceptions). The program’s goal is to stimulate innovation within Canada.

SR&ED–Eligible Expenditures

• Salaries and Wages Salaries of employees working directly on eligible R&D projects—scientists, engineers, programmers, lab technicians, etc.—typically represent the largest component. You may include the portion of compensation corresponding to time actually spent on SR&ED. Accurate time tracking is therefore essential.
• Materials Consumed or Transformed Costs of supplies and materials used in experiments are eligible. If materials are consumed (destroyed or fully used in R&D), you can claim the full cost; if transformed (incorporated into a prototype or product that may be sold), you generally claim only the non-recoverable portion. For example, metal used for a prototype later sold cannot be fully claimed, whereas lab consumables destroyed in tests are fully eligible.
• Contract Expenditures (Third-Party R&D) Payments to external contractors or consultants for eligible R&D work performed in Canada can largely be included. Usually, you may claim up to 100% of the contract cost (provided the contractor does not itself claim SR&ED). In some cases, the CRA may adjust (e.g., consider 80% as eligible to exclude the contractor’s profit margin), but outsourced R&D can form part of your claim. Retain clear contracts and invoices documenting the work performed.
• Overhead and Other Related Expenditures R&D incurs indirect costs—electricity for labs, rent for R&D space, office supplies, etc. SR&ED allows you to claim a portion of overhead tied to the project via two methods:
  1. Traditional Method: Identify and calculate actual indirect costs attributable to SR&ED (e.g., 10% of electricity if R&D occupies 10% of facilities).
  2. Proxy Method: Claim a flat 55% of eligible R&D salaries as an overhead proxy. This simplified approach avoids detailed cost-by-cost calculations and is often preferred by SMEs.
• Payments to Third-Party Research Organizations Funding provided to an eligible research body (e.g., a university or research center) for work relevant to your project may be partially eligible—often capped at 80% of the payment. Consult CRA guidelines or an expert for details.

How to Claim SR&ED: Form T661 and Submission Process

1. Identify SR&ED Projects and Expenditures At fiscal-year end (or continuously), list projects matching SR&ED criteria. Group your work into coherent SR&ED projects, each with objectives, uncertainties, and a description of work performed. Compile all eligible expenditures (salaries, materials, contracts).
2. Complete Form T661 This CRA form, “Claim for Scientific Research and Experimental Development Expenditures,” is the heart of your claim. You’ll detail each project’s technical objectives, work performed, challenges encountered, how you overcame them, and results. You’ll list expenditures by category, calculate totals, and compute the ITC. Clear, concise technical descriptions demonstrating advancement, uncertainty, and systematic experimentation are critical.
3. Attach Tax Schedules For corporations, SR&ED claims accompany your T2 corporate return. In addition to Form T661, complete Schedule T2SCH31 to calculate and report the federal ITC. Provincial SR&ED credits require corresponding provincial forms (e.g., the RD form in Québec, Ontario’s provincial schedule, etc.). For individuals or partnerships, T661 attaches to the T1 return with relevant schedules.
4. Respect Filing Deadlines You have 18 months from the end of the fiscal year in which work was performed to file your SR&ED claim. For a December 31, 2024 year-end, the deadline is June 30, 2026. Late filings forfeit the credit—no extensions are granted. Ideally, file SR&ED with your initial tax return (within six months of year-end) to avoid delays and minimize risk.
5. Submit to the CRA Electronic filing (with your T2 return) allows you to attach T661 and schedules digitally. Some businesses still file technical reports on paper or via the CRA’s SR&ED online portal. Keep copies of all submitted documents.
6. Acknowledge Receipt and Follow Up The CRA will acknowledge your claim. Processing typically takes 60–120 days for straightforward small-business claims. If you hear nothing after several months, contact the CRA’s SR&ED program. Claims undergo separate scientific/technical review by CRA science advisors and financial review by tax auditors.

SR&ED Documentation and the Role of an SR&ED Consultant

• Project plans, objectives, and initial hypotheses.
• Meeting minutes, lab notebooks, or project journals noting tests, issues, and results.
• Test data, simulation reports, source code, prototypes built and tested.
• Emails or internal reports describing technical challenges and decisions.
• Time-tracking records showing employee hours on SR&ED tasks.
• Invoices and contracts for materials and third-party services.

SR&ED Consultant

• Technical and Tax Expertise: Consultants know CRA eligibility criteria and how to craft persuasive project descriptions, choose the right terminology, and ensure all eligible costs are claimed.
• Time Savings: They conduct targeted interviews with technical teams, draft T661 sections, and compile schedules—freeing your staff to focus on core business.
• Maximizing Your Claim: Consultants identify overlooked expenditures (e.g., support-staff involvement) and advise on the best overhead method, project grouping, and presentation to optimize credits.
• Audit Support: If the CRA audits your claim, consultants can represent you, respond to inquiries, and defend your eligibility with technical evidence.
• Success-Fee Models: Many work on contingent fees—paid as a percentage of the credit obtained—aligning their incentives with yours.

SR&ED Refunds and Innovation Tax Credit

• The ITC first reduces your tax owing.
• If the credit exceeds your liability, eligible companies receive the balance as a refund by cheque or direct deposit.

Strategies to Maximize SR&ED Credits

1. Build SR&ED into Project Planning Identify technical uncertainties before starting. Inform teams so they document experiments and trials as part of R&D.
2. Train and Engage Your Teams Ensure engineers, programmers, and technicians accurately track time and report SR&ED tasks. Precise data lets you claim higher percentages of salaries.
3. Audit All Eligible Expenditures Review budgets for cloud-service fees, software licenses, or small-scale experiments—anything that supported R&D—and validate with an expert.
4. Choose the Best Overhead Method For most SMEs, the 55% proxy is simpler and often advantageous. If you incur high indirect costs, compare both methods annually.
5. Partner Early with a Consultant Engage an SR&ED expert for your first claim to establish best practices; you can later internalize the process once you’re comfortable.
6. Combine Funding Wisely Plan grants (e.g., NRC IRAP) to cover initial stages, then tap SR&ED for remaining costs. Remember that grants reduce eligible SR&ED expenses.
7. Be Audit-Ready If the CRA requests clarification, respond promptly with detailed documentation. Demonstrating good recordkeeping can smooth the review.

SR&ED vs. Other R&D Financing in Canada

Conclusion and Practical Tips

• Confirm Eligibility: Review your projects for SR&ED criteria (advancement, uncertainty, experimentation). Consult CRA guides or a specialist if in doubt.
• Organize Early: Set up time-tracking and documentation processes at project kick-off. Train teams to distinguish and record R&D tasks.
• Meet Deadlines: File within 18 months of year-end (ideally with your initial tax return). Late filings are ineligible.
• Leverage Resources: Use CRA’s online guides, seminars, and industry workshops.
• Consider External Help: Engage experienced SR&ED consultants or specialized tax professionals to optimize your claim.
• Stay Informed: Watch for changes in federal and provincial incentives, and new targeted credits (e.g., for AI, green innovation). As your company grows, consider dedicating at least one team member to manage SR&ED and other funding opportunities.