BATEMAN MACKAY Chartered Accountants
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R & D - The Learning Curve

Many of the readers of this newsletter will have filed an SR & ED claim and enjoyed the resultant value of tax credits. In this article I want to share an effect I have noticed over many years. This affects both new filers and clients who have not had a review of their SR & ED performance for a number of years.

To review, an SR & ED investment is worth a 35% or 20% federal tax credit and a provincial incentive in most provinces.The theme of tax complexity is here, as well, as this is a taxable tax credit. The after tax benefit of $100 SR & ED investment is a tax offset of $15 for large corporations to $41 for some private corporations, which can even become refundable in certain situations.

The most important part of an SR & ED claim is the description of the work. There are three required aspects to this description; the legs of my research stool:

1. Technological advancement leading to a departure from standard practice;
2. Technological uncertainly leading to alternatives;
3. Research performed on the alternatives and documented by the retention of documents.

It is a complex management paradigm shift to record false starts, things learned and general failures, as well as successes from a technical point of view. Following the updateable Word document form contained on our web site can greatly assist this documentation challenge. This format helps speed up the learning curve of adopting SR&ED documentation into the management processes of a corporation.

The Learning Curve idea is focused in two facts; SR&ED is a future orientated idea and the rules of the game change consistently.The effect is most clearly seen in a new filer.Imagine that the client has a December 31^st year-end and the time is May 2001.The rules allow a new filer to make an SR&ED claim for fiscal 2000 by June 2001 when the tax return is due.Also, a change can be made in the fiscal 1999 claim by filing an amendment by June 30, 2001. In practice, the client will remember a small part of what actually happened for 1999, as seen in the chart, and a lot more for 2000.The surprising thing is that even 2001 and 2002 fiscal years will show improvement from a review performed in 2001, ostensibly only on the past, since the SR&ED documentation is now in the management process in a future oriented manner.

This effect is clearly shown in the pictorial graph on this page.Since the review of practices occurs in 2001 for the earlier years, the early part of 2001 is not changed by the knowledge of how to inter-react with the rules. The year 2002 shows improvement because the review occurs totally before that fiscal year and a different type of Learning commences.

This graph and this effect also assumes that the actual qualifying level of SR&ED is not increasing! The documentation finally approaches this correct level after a review.

There are several reasons for this effect from my experience of over 22 years in this area of the tax law.

First is the naturally conservative memory of a scientist.Time recorded “real-time” for remembered projects is a lot more accurate and it is usually more valuable, as depicted in the curve.

Second is the lack of memory of specific small building blocs necessary to the overall achievement of an SR&ED project. These efforts are called activities in a correctly documented SR&ED claim. All costs are documented at this activity level and grouped into projects for filing as a finalized claim. Omitting, by forgetting it, the cost of an activity is the reason future years are documented with more expenditure than older ones.

Third is the effect of documenting the whole day.Scientists and engineers who only document R&D and omit the rest of the day artificially “control” the R&D time by reducing it. In my experience, I have seen this effect look after an improvement in the claim of 15%.

The reason I have focused on the scientist and his memory in this short piece is that claims are mostly labour. Therefore, correct documentation of the labour component will make the overall claim much better.

In conclusion, I would suggest that there are a few lessons in this brief piece.

1. Get your SR&ED claim reviewed by a specialist in the area. If this is not done annually, the frequency of change in the area would encourage you to do it every three years at an extreme minimum, to keep the learning curve from costing you real money.
2. Implement a time record system that records whole days and encourages researchers to allocate their time for the whole day, over all their activities. The goal is documentation, not a lawyer’s time-docket level of accuracy.
3. Review the activities, building into an SR&ED project on a quarterly basis, to not miss essential activities that would otherwise fail to be documented. We will be communicating ideas to help this point in the future.

In conclusion, the SR&ED claim is a tax-reducing asset of the corporation.Like most assets, it needs periodic review, optimization, maintenance and care to return the optimum dollar of tax reduction from the research investment.

We would be pleased to help any reader of this letter review the optimum nature of their SR&ED tax filings.