BATEMAN MACKAY Chartered Accountants
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The Proxy Decision

One of the more complex decisions to make in an SR&ED claim is in how to claim overhead expenditures. The choices are filing a “Proxy method” or “Traditional method” claim.

The decision on which method to use must be considered before collecting data and compiling the file, as each method contains different elements and the data is assembled differently. Currently the biggest difference in required data is in the labour area. If you are electing “Proxy” the labour cost is limited to those directly involved in the R&D effort (otherwise known as the “directly engaged rule”).

An example of this is the chemical researcher who is actually holding the test tube and performing the test with his direct supervisor. The chemist is obviously directly involved but what about the supervisor? If a senior level person is involved in SR&ED the challenge is to prove that that person directly supervised or performed the SR&ED. This example can be applied to any other industry. This rule is not designed to eliminate the corporate president from the R&D claim if that is where the technical ideas come from but it must be clear how the senior is involved.

Further, if you are claiming proxy the actual labour cost must be net labour cost. This is the R&D portion of all employee costs, with the exception of specified employees, which are employees who own more than 10% of the corporation. The net amount of their cost must be used, which means no benefits and bonus payments are deducted from the labour cost for the specified employees.

So why would you claim the traditional overhead method? The “directly engaged” rule is relaxed. This means that the R&D group admin person not involved in the Science other than as a supporting role would now be eligible. Further any person in the corporation whose efforts can be “attributed” to the R&D effort is eligible. Examples of attributable staff would be purchasing, personnel, payroll and senior executives. In addition benefits for specified employees are NOT excluded from the claim.

The only remaining challenge is to attribute overhead in an acceptable manner. You can calculate a percentage of total factory floor space cost in relation to costs attributed to a dedicated R&D lab. For example, the lab may cover 5,000 square feet of a 20,000 square foot factory, which would attribute 25% of overhead costs to the claim.

You can also calculate using personnel hours involved in R&D as a percentage of total personnel hours times things like telephone costs. For example if total personnel hours in a year are 50,000 hours and the company logs 25,000 hours for R&D, then 50% of overhead costs are calculated. These overhead expenditures and their attribution each reviewed for reasonability and method of allocation.

In addition, Regulation 2902, which prescribes unallowable expenditures, must be reviewed for the list of expenses that are not allowed at all before this calculation can be considered complete. This list is extensive and contains for example, rent, accounting, legal, capital depreciation costs, interest expense, penalties and certain membership fees.

At this point it is worth pointing out that in December 1992 when the proxy rule was introduced one of the chief reasons was to reduce audit time spent ‘discussing’ the various possible expenditures that may be included.

CCRA will now accept a traditional overhead claim but in the words of one senior official “it better not come out to 65%”. In other words there should be a clear reason overhead is higher than proxy. Few employees and many consultants or very high cost prototypes are reasons to claim the traditional overhead method.