Gross Negligence Penalty on Overstated SR&ED Claims Policy

Date: 2025-01-28

On this page

• 1.0 Purpose
  • 1.1 Background
• 2.0 Overview
• 3.0 Situations when the CRA can apply a penalty
• 4.0 Amounts the penalty can apply to
  • 4.1 Understatement of income
  • 4.2 Deduction of an overstated ITC
  • 4.3 Refund of the overstated refundable ITC
• 5.0 Examples of the calculation of the penalty
  • 5.1 Example 1: Understated income and Part I tax payable – ITC at the rate of 15%
  • 5.2 Example 2: Understated Part I tax payable - ITC at the enhanced rate of 35%
  • 5.3 Example 3: Overstated refundable ITC refund claimed
• Appendix A: References
  • A.1 Legislative references

1.0 Purpose

The purpose of this document is to clarify the CRA's position on the gross negligence penalty when it administers the SR&ED provisions in the federal Act.

This document gives an overview of:

• The gross negligence penalty under subsection 163(2) of the Act
• How the SR&ED program calculates that penalty

As well, this document clarifies when the CRA will consider applying a penalty to an overstated SR&ED claim.

1.1 Background

General knowledge of the SR&ED tax incentives is necessary to understand how the gross negligence penalty applies to an overstated SR&ED claim. Here is a brief reminder of what the SR&ED tax incentives are:

• A deduction from the claimant's pool of deductible SR&ED expenditures, and
• An SR&ED investment tax credit (ITC)

The claimant includes their allowable SR&ED expenditures for the year in their pool of deductible SR&ED expenditures. At the end of their tax year, the claimant can take a deduction from their pool of deductible SR&ED expenditures to reduce their net income in the tax year or any following tax year.

Next, the claimant calculates their ITC on their qualified SR&ED expenditures. The claimant can deduct the ITC earned in the tax year to reduce their Part I tax payable in the same tax year.

If there is a remaining ITC, the claimant can deduct it from their Part I tax payable in any of the three prior tax years or, in most cases, in the next 20 tax years.

Certain claimants may earn a refundable ITC in the tax year. After their Part I tax payable for the year is reduced to zero, these claimants can claim the remaining portion of that ITC as a refund.

For more information on the pool of deductible SR&ED expenditures, see the Pool of Deductible SR&ED Expenditures Policy. For more information on the ITC and the refundable ITC, see the SR&ED Investment Tax Credit Policy.

2.0 Overview

The gross negligence penalty is a civil penalty. This penalty can be applied to every person who knowingly or under circumstances amounting to gross negligence has made or participated in, agreed to, or accepted the making of a false statement or omission in a return, form, certificate, statement, or answer filed or made for a tax year.

The CRA has the burden of establishing the facts and evidence that show, on a balance of probabilities, that the claimant made a false statement or omission knowingly or under circumstances amounting to gross negligence. The expression balance of probabilities means more likely than not. For the CRA, it is not enough to show that there is a false statement or omission in an income tax return. The CRA must also show that more likely than not the false statement or omission was the result of more than a simple oversight or a misunderstanding of the Act.

The amount of the gross negligence penalty for an overstated SR&ED claim is the greater of:

• $100

• 50% of the total of:

  • The understated Part I tax payable reasonably attributable to the false statement or omission made knowingly, or under circumstances amounting to gross negligence, plus
  • The refund of the overstated refundable ITC claimed by the claimant

3.0 Situations when the CRA can apply a penalty

The CRA may apply the gross negligence penalty as part of the review of an SR&ED claim that the claimant filed with:

• An initial income tax return (the review is conducted either before or after the first assessment of that return), or
• An amended income tax return to include an SR&ED claim or change a previous one

The CRA will consider charging a gross negligence penalty in the following situations:

• The claimant participated in the overstatement of amounts on which SR&ED tax incentives are being claimed.
• The claimant included amounts in respect of a project, and there is clear evidence that the claimant knew the project did not involve SR&ED activities.
• The claimant described the performance of SR&ED activities that did not take place, or did not take place in the year, and claimed normal business expenses as SR&ED expenditures in respect of the alleged activities.
• The claimant continued to claim amounts that do not qualify for SR&ED tax incentives after being advised in writing that these types of amounts do not qualify, and the amounts in question are not under objection or appeal.
• The claimant continued to miscalculate the SR&ED tax incentives after being advised in writing of the proper calculation, and the basis of the calculation is not under objection or appeal.
• The claimant continued to claim unsubstantiated amounts for the SR&ED tax incentives after being advised in writing what is required to support these types of amounts.

4.0 Amounts the penalty can apply to

When the CRA encounters one of the situations described in section 3.0, it determines on the balance of probabilities whether the claimant made a false statement or omission knowingly or under circumstances amounting to gross negligence.

When the CRA meets this burden of proof, it can calculate the gross negligence penalty on the following amounts:

• The understated amount of Part I tax payable reasonably attributable to the false statement or omission resulting from:
  • An understatement of income (see section 4.1), or
  • A deduction of the overstated ITC from their Part I tax payable (see section 4.2)
• And the refund of the overstated refundable ITC claimed by the claimant (see section 4.3)

4.1 Understatement of income

In general, an understatement of income happens if a claimant:

• Understates a taxable amount or fails to report it, or
• Deducts from income an amount that is not deductible under the Act, such as a personal expenditure or a false invoice.

In the context of an SR&ED claim, an expenditure disallowed in an SR&ED claim can still be deducted from the claimant's income if it constitutes a business expenditure. Then the claimant's income is not understated. However, if the expenditure that was disallowed is not a business expenditure, the claimant's income may be understated.

For example, if a claimant records a personal expenditure in their books and records and wrongly claims it as an SR&ED expenditure. The claimant's pool of deductible SR&ED expenditures becomes overstated.

If the claimant deducts an amount from their overstated pool of deductible SR&ED expenditures, the CRA will consider that their income is understated. This is because the CRA considers, for the purpose of the gross negligence penalty, that the overstated expenditures in the pool of deductible SR&ED expenditures are deducted first. The understatement of income causes in turn an understatement of Part I tax payable on which a penalty is calculated.

When a claimant reports a net loss, the understatement of income does not generate an understatement of Part I tax payable. In these cases, the legislation deems the claimant's taxable income for the tax year not to be less than zero. It allows the CRA to calculate the gross negligence penalty on the theoretical Part I tax payable attributable to the understatement of income.

For penalty purposes, when the CRA calculates the understatement of Part I tax payable, it only considers the deductions that were taken on the income tax return under review. It does not consider any new or additional deduction the claimant may ask for afterwards. An example of this situation is presented in section 5.1.

Let's continue with the example above to illustrate a particular situation that may happen. Let's suppose that the claimant chose in Tax Year 1:

• Not to deduct an amount from its overstated pool of deductible SR&ED expenditures, and
• To deduct an amount of overstated ITC against Part I tax payable for Tax Year 1 (or any of the three prior tax years)

In Tax Year 2, the claimant deducts the ITC used in Tax Year 1 from their overstated pool of deductible SR&ED expenditures.

The CRA will consider the remaining overstatement in the pool of deductible SR&ED expenditures to be equal to:

• The amount of overstated expenditures included in the pool of deductible SR&ED expenditures in Tax Year 1
• Minus the overstated ITC deducted from the pool of deductible SR&ED expenditures in Tax Year 2

It should be noted that a penalty would be calculated for the overstated ITC deducted from Part I tax payable in Tax Year 1. This is the subject of the next section.

4.2 Deduction of an overstated ITC

In the context of an SR&ED claim, an understatement of Part I tax payable can happen if a claimant deducts an amount of overstated ITC, no matter at what rate the claimant earned the ITC. For an example of the gross negligence penalty calculation involving each of the two ITC rates, see sections 5.1 and 5.2.

For the purpose of calculating the gross negligence penalty, when the claimant deducts an ITC from Part I tax payable in the year or any other tax years (ITC carryback or carryforward), the CRA considers that the claimant deducted the overstated ITC first. This means that for the CRA the claimant deducted their overstated ITC before any other ITC:

• Available at the beginning of the tax year
• Transferred or allocated to them in the tax year
• Earned during the tax year

For an example of the gross negligence penalty involving an amount of ITC available at the beginning of the tax year, see section 5.1.

When the claimant carries an overstated ITC back or forward to a different tax year, the CRA will calculate a gross negligence penalty for each tax year the claimant deducted the overstated ITC from Part I tax payable.

For more information on the deduction, carryback, or carryforward of an ITC, see the SR&ED Investment Tax Credit Policy.

4.3 Refund of the overstated refundable ITC

For certain claimants, an SR&ED claim may result in the refund of the refundable ITC in the year it is earned. The amount of refund these claimants can ask for is limited to the refundable ITC still available after Part I tax payable for the current tax year has been reduced to zero.

For details of how the gross negligence penalty might apply to an ITC that is deducted from Part I tax payable, see section 4.2.

The overstated refundable ITC may result from:

• A false statement or omission made knowingly or under circumstances amounting to gross negligence, or
• A simple oversight or a misunderstanding of the Act

When the gross negligence penalty applies to the refund of the refundable ITC, the CRA calculates the penalty on the entire overstated refund no matter what caused the overstatement.

For an example of this situation, see section 5.3.

For more information on refundable ITC, see the SR&ED Investment Tax Credit Policy.

5.0 Examples of the calculation of the penalty

In each of the following examples, the claimant has chosen the proxy method and the federal income tax rate is 20%. To keep the examples simple, we did not take into account any government assistance, including any provincial R&D tax credits.

For more information on the proxy method, see the Traditional and Proxy Methods Policy. For more information on the provincial R&D tax credits and government assistance, see the Assistance and Contract Payments Policy.

5.1 Example 1: Understated income and Part I tax payable – ITC at the rate of 15%

Comparative claim data

Calculation of the pool of deductible SR&ED expenditures	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Salary or wages of employees directly engaged in the SR&ED	300,000	300,000	0
Plus: Cost of materials consumed	300,000	200,000	100,000
Total allowable SR&ED expenditures	600,000	500,000	100,000
-	-	-	-
Pool of deductible SR&ED expenditures at the end of the prior year	0	0	0
Plus: Total allowable SR&ED expenditures (from above)	600,000	500,000	100,000
Minus: Deduction claimed in the year	600,000	500,000	100,000
Pool of deductible SR&ED expenditures at the end of the year	0	0	0

Comparative claim data 2

Calculation of the SR&ED ITC	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Total allowable SR&ED expenditures (from above)	600,000	500,000	100,000
Plus: Prescribed proxy amount (55% of salary or wages)	165,000	165,000	0
Total qualified SR&ED expenditures	765,000	665,000	100,000
-	-	-	-
ITC at the beginning of the tax year	7,000	7,000	0
Plus: Current year ITC (15% of total qualified SR&ED expenditures)	114,750	99,750	15,000
Minus: ITC deducted from Part I tax in the year	114,750	106,750	8,000
ITC closing balance	7,000	0	7,000

Comparative claim data 3

Calculation of the Part I tax payable	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Income	5,000,000	5,000,000	0
Minus: Deduction from the pool of deductible SR&ED expenditures (from above)	600,000	500,000	100,000
Minus: Other deductions	3,826,250	3,826,250	0
Net income	573,750	673,750	100,000
-	-	-	-
Taxable income	573,750	673,750	100,000
-	-	-	-
Part I tax otherwise payable (20% of the taxable income)	114,750	134,750	20,000
Minus: ITC deducted from Part I tax in the year (from above)	114,750	106,750	8,000
Part I tax payable	0	28,000	28,000

False statement for section 5.2

The claimant recorded in their books and records a $100,000 expenditure that is neither a business expenditure nor an SR&ED expenditure and included it in their SR&ED claim as material consumed.

The CRA's review showed that the claimant made this false statement knowingly or under circumstances amounting to gross negligence. Therefore the claimant is subject to a gross negligence penalty for making this false statement. The amount of penalty depends on the amount of understated Part I tax payable reasonably attributable to this false statement.

Impact on income and Part I tax payable

This false statement caused the claimant's pool of deductible SR&ED expenditures to be overstated by $100,000 and the current year ITC to be overstated by $15,000, which is the amount of ITC calculated on that same $100,000 (15% of $100,000).

For the purpose of calculating the gross negligence penalty, the CRA considers that the overstated amounts are deducted first. In practical terms, it means that the first $100,000 of deduction the claimant took from their pool of deductible SR&ED expenditures was made of the overstated expenditures without any consideration for any other expenditures in the pool of deductible SR&ED expenditures. Similarly, the first $15,000 of ITC they deducted from Part I tax payable came from was made of the overstated ITC, without any consideration for the $7,000 of ITC available at the beginning of their tax year.

By taking a $600,000 deduction from their overstated pool of deductible SR&ED expenditures, the claimant understated their taxable income by $100,000 and their Part I tax payable by $20,000 (20% of $100,000).

Also, by deducting the ITC of $114,750, the claimant understated their Part I tax payable by an additional $15,000 (15% of $100,000).

In addition to disallowing the overstated expenditures of $100,000 and the related ITC of $15,000, the CRA also calculated the gross negligence penalty on the understated Part I tax payable of $35,000 ($20,000 + $15,000) reasonably caused by the false statement made knowingly or under circumstances amounting to gross negligence.

The claimant asked for an additional deduction of $100,000 of available capital cost allowance to offset the increase to their net income caused by the disallowed expenditures. The CRA accepted this request. However, this request does not affect how the CRA calculates the penalty.

Calculation of the gross negligence penalty

5.2 Example 2: Understated Part I tax payable - ITC at the enhanced rate of 35%

Comparative claim data 4

Calculation of the pool of deductible SR&ED expenditures	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Salary or wages of employees directly engaged in the SR&ED	400,000	200,000	200,000
Plus: Cost of materials consumed	240,000	220,000	20,000
Total allowable SR&ED expenditures	640,000	420,000	220,000
-	-	-	-
Pool of deductible SR&ED expenditures at the end of the prior year	0	0	0
Plus: Total allowable SR&ED expenditures (from above)	640,000	420,000	220,000
Minus: Deduction claimed in the year	640,000	420,000	220,000
Pool of deductible SR&ED expenditures at the end of the year	0	0	0

Comparative claim data 5

Calculation of the SR&ED ITC	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Total allowable SR&ED expenditures (from above)	640,000	420,000	220,000
Plus: Prescribed proxy amount (55% of salary or wages)	220,000	110,000	110,000
Total qualified SR&ED expenditures	860,000	530,000	330,000
-	-	-	-
ITC at the beginning of the tax year	0	0	0
Plus: Current year ITC (35% of total qualified SR&ED expenditures)	301,000	185,500	115,500
Minus: ITC deducted from Part I tax in the year	301,000	185,500	115,500
Minus: Refundable ITC refund claimed	0	0	0
ITC closing balance	0	0	0

Comparative claim data 6

Calculation of the Part I tax payable	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Income	5,000,000	5,000,000	0
Minus: Deduction from the pool of deductible SR&ED expenditures (from above)	640,000	420,000	220,000
Minus: Other deductions	2,760,000	2,980,000	220,000
Net income	1,600,000	1,600,000	0
-	-	-	-
Taxable income	1,600,000	1,600,000	0
-	-	-	-
Part I tax otherwise payable (20% of the taxable income)	320,000	320,000	0
Minus: ITC deducted from Part I tax in the year (from above)	301,000	185,500	115,500
Part I tax payable	19,000	134,500	115,500

False statements

The claimant overstated their SR&ED claim by claiming $200,000 of normal salary expenditures as SR&ED salary or wages. The facts showed that the claimant made this false statement knowingly or under circumstances amounting to gross negligence. Therefore, the claimant is subject to a gross negligence penalty for making this false statement. The amount of penalty depends on the understatement of Part I tax payable reasonably attributable to this false statement.

The claimant also overstated their cost of materials consumed in performing SR&ED by claiming $20,000 of business expenditures as SR&ED expenditures. However, this false statement resulted from a simple error. It was not made knowingly or under circumstances amounting to gross negligence. Therefore, the claimant is not liable to a gross negligence penalty on this false statement.

Impact on income and Part I tax payable for section 5.2

These two false statements caused the claimant's pool of deductible SR&ED expenditures to be overstated by $220,000. However, when the claimant deducted their entire overstated pool of deductible SR&ED expenditures, it did not create an understatement of income. This is because the overstated expenditures that the CRA disallowed in the SR&ED claim were business expenditures deductible from the claimant's income for the year.

The overstated $200,000 of salary or wages caused the prescribed proxy amount to be overstated by $110,000 (55% of $200,000). Together the overstated salary or wages and the overstated prescribed proxy amount caused the current year ITC to be overstated by $108,500 (35% of ($200,000 + $110,000)).

By deducting an amount of ITC that includes the overstated ITC of $108,500, the claimant understated their Part I tax payable by $108,500.

In addition to disallowing the overstated ITC, the CRA calculated a gross negligence penalty on the understated Part I tax payable reasonably attributable to this false statement.

The false statement on the material consumed also caused an overstatement of the current year ITC that the CRA disallowed. However the CRA did not calculate a gross negligence penalty on the understated Part I tax payable reasonably attributable to this false statement because it was not made knowingly or under circumstances amounting to gross negligence.

Calculation of the gross negligence penalty for section 5.2

5.3 Example 3: Overstated refundable ITC refund claimed

Comparative claim data 7

Calculation of the pool of deductible SR&ED expenditures	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Salary or wages of employees directly engaged in the SR&ED	400,000	200,000	200,000
Plus: Cost of materials consumed	240,000	220,000	20,000
Total allowable SR&ED expenditures	640,000	420,000	220,000
-	-	-	-
Pool of deductible SR&ED expenditures at the end of the prior year	0	0	0
Plus: Total allowable SR&ED expenditures (from above)	640,000	420,000	220,000
Minus: Deduction claimed in the year	0	0	0
Pool of deductible SR&ED expenditures at the end of the year	640,000	420,000	220,000

Comparative claim data 8

Calculation of the SR&ED ITC	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Total allowable SR&ED expenditures (from above)	640,000	420,000	220,000
Plus: Prescribed proxy amount (55% of salary or wages)	220,000	110,000	110,000
Total qualified SR&ED expenditures	860,000	530,000	330,000
-	-	-	-
ITC at the beginning of the tax year	0	0	0
Plus: Current year ITC (35% of total qualified SR&ED expenditures)	301,000	185,500	115,500
Minus: ITC deducted from Part I tax in the year	0	0	0
Minus: Refundable ITC refund claimed	301,000	185,500	115,500
ITC closing balance	0	0	0

Comparative claim data 9

Calculation of the Part I tax payable	Filed by the claimant ($)	Revised by the CRA ($)	Difference ($)
Income	5,000,000	5,000,000	0
Minus: Deduction from the pool of deductible SR&ED expenditures (from above)	0	0	0
Minus: Other deductions	5,600,000	5,820,000	220,000
Net loss	600,000	820,000	220,000

The facts are the same as in Example 2 (see section 5.2) but with these differences:

• The claimant reported a net loss, so the claimant has no Part I tax payable to deduct the ITC from
• The claimant claimed a refund for the entire refundable ITC earned in the year

Impact on income and Part I tax payable for section 5.3

As explained in Example 2, the false statements did not cause the income to be understated because the expenditures that the CRA disallowed in the SR&ED claim were business expenditures deductible from the claimant's income for the year.

Also, the claimant did not deduct any ITC from Part I tax payable since they reported a loss.

Impact on the refundable ITC refund claimed

As noted in section 4.3, for the purpose of calculating the gross negligence penalty, the CRA includes in the calculation any refund of the overstated refundable ITC claimed by the claimant, no matter what caused the overstatement. In this example, since the claimant is subject to a gross negligence penalty, the CRA calculated the penalty on the entire refund of the overstated refundable ITC they claimed which is $115,500.

Calculation of the gross negligence penalty for section 2.0

Appendix A: References

A.1 Legislative references

Income Tax Act	Description
Subsection 37(1)	Pool of deductible SR&ED expenditures
Paragraph 37(1)(e)	Reduction of the pool of deductible SR&ED expenditures by ITC previously deducted and/or refunded (other than an ITC allocated from a partnership)
Subsection 127(5)	Deduction of investment tax credit
Subsection 127(9)	Definition of investment tax credit
Subsection 127.1(1)	Refundable investment tax credit
Subsection 127.1(2)	Definition of refundable investment tax credit
Subsection 163(2)	Penalty – False statements or omissions
Paragraph 163(2)(a)	Penalty – Understated tax reasonably attributable to a false statement or omission
Paragraph 163(2)(d)	Penalty – Overstated refundable ITC refund claimed
Subsection 163(2.1)	Interpretation – Taxable income and understatement of income
Subsection 163(3)	Burden of proof for penalties
Subsection 248(1)	Definition of scientific research and experimental development