SR&ED Creativity… Just Be Careful

I came across the following blog post recently: “SREDing Sweat Equity”.   It describes a maneuver to use SR&ED to enable paying yourself a salary during the early stages of your company’s development.  Part of my work at Axxiton Consulting involves helping companies to maximize SR&ED claims by identifying eligible projects & activities, analyzing and documenting projects & activities to claim for SR&ED, and establishing processes to help assure repeatable success.  So I found the aforementioned blog post interesting.  But I have the following observations:

The proposed maneuver is quite interesting.  SR&ED is a great program, and I’ve seen some companies survive the economic downturn solely due to SR&ED — it literally kept the lights on so that the companies survived until the the economy recovered.  However, companies need to make sure they don’t see SR&ED as an entitlement.  They still need to demonstrate technological advancement.  It must be credible and documented. And they need to be aware of the rules – both for claiming SR&ED credits and for paying their employees.

SR&ED can help keep the lights on during an economic downturn

The first problem I see with the proposed maneuver is this:  Specified employees (i.e. a person who owns 10% or more of company or who does not deal at arm’s length w/the company) can only claim up to 75% of the time (and presumably salary) for which they were directly involved in SR&ED for the Prescribed Proxy Amount (PPA) top-up when computing SR&ED.   That reduces the SR&ED-eligible expenditures in the example from $70K to $52.5K for the PPA.  Max SR&ED credits for the $70K salary will therefore be about $43K in Ontario.

Steve & Steve

Another problem is that an entrepreneur is unlikely to expend 100% of their time on SR&ED activities.  In fact, companies that claim all of their principals’ time as being for SR&ED might trigger increased scrutiny of their SR&ED claim as a result. If you do so one year, you can’t count on getting away with it every year.  Be careful here:  If you mysteriously claim exactly 100% on SR&ED activities year after year, someone’s going to decide to take a more careful look (even if you claim 90% and deem it to be 100% under the “all or substantially all” rule).   Be realistic.  As a founder, some of the time you spend on your company will be for bizdev, financing, admin, etc..

Another important point is this:  Suppose you do pay yourself with an IOU, the company must still withhold and pay remittances for personal tax, CPP and EI.  In the blog’s example, using 2011 tax rates, that would be $15,180 in tax and $6,323 for EI and CPP.  That’s $21,503 you need to come up with in cold, hard cash to pay the government while you’re waiting for the SR&ED cheque to arrive.  I believe you can wait up to 180 days into the subsequent fiscal year to pay the salary if it is a bonus, but there are two problems here:  First, bonuses to specified employees will be scrutinized by the CRA to make sure they are not based on profits.  Bonuses paid on profits to specified employees can’t be included in your SR&ED claim.  Second, you don’t know how long it will take to process your SR&ED claim, nor do you know how much of your SR&ED claim will be accepted by the CRA.

IOU

So… now you’re in a situation where you’ve paid salary via an IOU of $70K.  You’ll net about $21.5K in cash (SR&ED claim = $43K, Remittances paid to Receiver General = $21.5K).  That assumes that the entire SR&ED claim will be approved.  And you hope it will be approved in a timely manner so that you aren’t out of pocket $21.5K while you wait for the $43K cheque to arrive.

Just be aware of the risks.  Don’t file frivolous SR&ED claims.  Claim legitimate SR&ED.  Document, document, document!  The best damned thing you can do is to methodically record your time spent each day, and that of your employees.  Always have supporting documents for your claim. (See http://bit.ly/aSsSh6 for my thoughts on this point).