SR&ED Overhead and Other Expenditures Policy

Date: October 14, 2022

Table of contents

• 1.0 Purpose
• 2.0 Overview
  • 2.1 Meaning of the term “overhead and other expenditures”
• 3.0 Expenditures directly attributable to the prosecution of SR&ED in Canada
  • 3.1 Meaning of the term “directly related to the prosecution of SR&ED”
    • 3.1.1 Expenditures that may be directly related
    • 3.1.2 Expenditures that are not directly related
  • 3.2 Meaning of the term “incremental expenditure”
    • 3.2.1 Determining whether a particular expense meets the incremental test
• 4.0 Applying the “directly related” and “incremental” tests
  • 4.1 Salary or wages of clerical and administrative staff providing a service to SR&ED employees
  • 4.2 Contract costs – Other than an SR&ED contract
  • 4.3 Employer's share of related benefits
    • 4.3.1 Related benefits for clerical and administrative staff providing a service to SR&ED employees
  • 4.4 Retiring allowance
    • 4.4.1 Application of the "directly attributable" tests to retiring allowances
    • 4.4.2 Examples
  • 4.5 Expenses related to the selection and hiring of SR&ED personnel
  • 4.6 Lease costs of equipment used less than 90% of the time for SR&ED
  • 4.7 Other expenditures that may qualify as SR&ED overhead and other expenditures
    • 4.7.1 Cost of telephone, cellular telephone, and Internet
    • 4.7.2 Expenses for travel to and lodging in Canada to do testing at a customer location
    • 4.7.3 Cost of training in Canada
    • 4.7.4 Cost of utilities
    • 4.7.5 Cost of periodical subscriptions
    • 4.7.6 Cost of waste disposal
    • 4.7.7 Fees paid to volunteers to participate in clinical studies and other related costs
    • 4.7.8 Expenses related to health and safety
  • 4.8 Expenditures directly related and incremental but that are also prescribed expenditures
    • 4.8.1 Fees for preparing SR&ED claims
    • 4.8.2 Cost to attend conventions or conferences
    • 4.8.3 Interest expenses
• 5.0 Expenditures directly attributable to the provision of premises, facilities or equipment
  • 5.1 The cost of the maintenance and upkeep of premises, facilities or equipment
    • 5.1.1 Common areas
  • 5.2 Other expenditures directly related to the provision of premises, facilities or equipment and that are incremental
• 6.0 SR&ED overhead and other expenditures incurred for work performed outside Canada
  • 6.1 SR&ED overhead and other expenditures related to support work performed outside Canada
    • 6.1.1 Example: Transportation costs
  • 6.2 SR&ED overhead and other expenditures for work outside Canada that does not constitute SR&ED
  • 6.3 SR&ED overhead and other expenditures that relate to permissible salary or wages for SR&ED work performed outside Canada
• Appendix A – References
  • A.1 Legislative references
  • A.2 Jurisprudence
• Appendix B – Revisions
  • B.1 Explanation of changes

1.0 Purpose

The purpose of this document is to clarify the position of the Canada Revenue Agency (CRA) regarding scientific research and experimental development (SR&ED) overhead and other expenditures when administering the SR&ED legislation under the federal Income Tax Act and the Income Tax Regulations.

The information in this document applies to all claimants, including dedicated SR&ED performers.

2.0 Overview

SR&ED overhead and other expenditures can only be claimed under the traditional method when calculating SR&ED expenditures. For more information on the traditional method, refer to the Traditional and Proxy Methods Policy.

When using the traditional method, overhead and other expenditures are entered on line 360 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim. This line is also used to enter the portion of salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED, but who are not directly engaged in SR&ED. This policy document does not discuss these salary or wages. For more information on salary or wages, refer to section 8.4 of the SR&ED Salary or Wages Policy.

When a claimant elects to use the proxy method to calculate SR&ED expenditures, overhead and other expenditures are not included in the pool of deductible SR&ED expenditures or in the calculation of qualified SR&ED expenditures for investment tax credit (ITC) purposes. Instead, the proxy method involves calculating a notional amount for overhead and other expenditures called the prescribed proxy amount (PPA). The PPA is not included in the pool of deductible SR&ED expenditures, and it cannot be deducted when calculating income for tax purposes. However, an ITC is earned on the PPA since it forms part of the qualified SR&ED expenditures. For more information on the PPA, refer to the Prescribed Proxy Amount Policy.

2.1 Meaning of the term “overhead and other expenditures”

Within the context of the SR&ED program, the term “overhead and other expenditures” is often used to refer to certain expenditures of a current nature that may be directly attributable to the prosecution of SR&ED in Canada as per paragraph 2900(2)(c) (see section 3.0 and section 4.0), or directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada as per subsection 2900(3) (see section 5.0). Overhead and other expenditures on Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim consist of these directly attributable expenditures.

It is important to not confuse SR&ED overhead expenditures with the term “overhead expenses,” which is commonly used under the generally accepted accounting principles in Canada. The accounting rules generally refer to overhead as an indirect cost. These indirect costs may or may not be allowable expenditures for SR&ED. This document explains which overhead and other expenditures are allowed for SR&ED purposes.

Legislative Reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative References Income Tax Regulations
Subsection 2900(2) Expenditures directly attributable to the prosecution of SR&ED – Traditional method
Subsection 2900(3) Expenditures directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method

3.0 Expenditures directly attributable to the prosecution of SR&ED in Canada

As per paragraph 2900(2)(c) of the Regulations, some expenditures of a current nature, or portion of expenditures, other than those otherwise identified in the other paragraphs of the same Regulations can be directly attributable to the prosecution of SR&ED in Canada.

The directly attributable tests that apply to SR&ED overhead and other expenditures are discussed below as well as definitions for the terms “portion” and “prosecution” used in these tests.

Directly attributable tests

In order to meet the requirements to be directly attributable to the prosecution of SR&ED under the Regulations, an expenditure, or a portion of the expenditure, must satisfy two tests.

1. The expenditure must be directly related to the prosecution of SR&ED in Canada (see section 3.1).
2. The expenditure would not have been incurred had such prosecution not occurred (incremental) (see section 3.2).

Portion

As per the Regulations, a portion of an expenditure can also be directly attributable to the prosecution of SR&ED. This means that it is not necessarily the entire amount of the expenditure that has to be directly attributable to the prosecution of SR&ED. For the purposes of the directly attributable tests, the portion of the expenditure that can be allocated to SR&ED work has to be determined on a reasonable basis.

Prosecution

The Webster's Dictionary meaning of “prosecution” is “to carry on; engage in.” Therefore, the expenditure should allow the claimant to carry on or engage in SR&ED. This determination is a question of fact. Consequently, an expenditure incurred after an SR&ED project has ended will generally not be considered to have been incurred to allow the claimant to carry on or engage in SR&ED. A retiring allowance is an example of an exception to this general rule.

Legislative Reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

3.1 Meaning of the term “directly related to the prosecution of SR&ED”

To be directly attributable to the prosecution of SR&ED, an expenditure, or a portion of the expenditure, must first be an expenditure directly related to the prosecution of SR&ED in Canada. This means that any indirect portion must be excluded. However, the terms “portion” and “directly related” used in the Regulations indicate that some portion of expenditures might meet the directly attributable tests, and that this determination will be based on a finding of fact.

The dictionary definitions of the terms “direct,” “directly,” “relate,” and “related” are:

1. Direct means proceeding from one point to another without deviation or interruption; straight.
2. Directly means in a direct manner; without an intervening step or intermediary.
3. Relate means to show a logical or causal connection between; to have relationship or connection (between two things).
4. Related (as the past tense of “relate”) take the meaning expressed in item 3 above.

To be considered, an expenditure must connect with (that is, be related to) one of the three elements listed below, and there must be no intervening step or intermediary between them and the expenditure (that is, directly). These elements are:

• the SR&ED work;
• the SR&ED staff; or
• the machinery / equipment used by staff to perform SR&ED.

There must be a direct linkage of the expenditure to specific SR&ED work, staff, or machinery / equipment. When there is an intervening step between the expenditure and the SR&ED work, staff, or machinery / equipment, the expenditure is not an expenditure on or in respect of SR&ED, although there may be an indirect relationship.

When an expenditure may be allowed as an SR&ED overhead and other expenditures because of its direct linkage to, no overhead related to that expenditure can qualify for SR&ED purposes. These types of expenditures are indirectly linked to the prosecution of SR&ED. The table below illustrates the concept of direct linkage, using as an example the salary or wages of hands-on employees and clerical employees providing a service to these employees.

The claimant must use a rational method for linking the expenses to the prosecution of SR&ED, and must be able to show that the method is reasonable. A method that arbitrarily connects the expenditures with the SR&ED work will not be considered reasonable.

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

Other Reference
98 DTC 1710 Ergorecherche et Conseils Inc. v. The Queen. This case was cited by the judge in 2000 DTC 2177 Quantetics Corporation v. The Queen.

3.1.1 Expenditures that may be directly related

Whether an expenditure is directly related to the prosecution of SR&ED is a question of fact. The list below provides some examples of expenditures that may be considered to be directly related to the prosecution of SR&ED:

• Salary or wages of clerical and administrative staff providing a service to SR&ED employees (for example, services rendered by staff in human resources, accounting, and purchasing) if the functions performed are non‑technological and aid the ongoing SR&ED claimed in the year (see section 4.1)
• Contract costs – other than an SR&ED contract (see section 4.2)
• Employer's share of related benefits (see section 4.3)
• Retiring allowance (see section 4.4)
• Moving expenses related to the relocation of SR&ED employees to another facility – for more information on expenses related to the selection and hiring of SR&ED personnel, refer to section 4.5
• Lease costs of equipment used less than 90% of the time in SR&ED (see section 4.6), for costs incurred prior to 2014
• Other expenditures, such as:
  • long-distance telephone charges – for more information on expenses relating to telephone, cellular telephone, and Internet, refer to section 4.7.1
  • expenses for travel and lodging (see section 4.7.2)
  • cost of training in Canada (see section 4.7.3)
  • cost of utilities (see section 4.7.4)
  • cost of periodical subscriptions (see section 4.7.5)
  • cost of waste disposal (see section 4.7.6)
  • fees paid to volunteers to participate in clinical studies (see section 4.7.7)
  • expenses related to health and safety (see section 4.7.8)

Also, some expenditures may be directly related to the prosecution of SR&ED (as well as incremental), but they will not earn investment tax credits (ITCs) as they are prescribed expenditures under the Regulations. This means that these expenditures could be included in the pool of deductible SR&ED expenditures but will not be qualified expenditures for the purposes of calculating the ITC amount. These include:

• Fees for preparing SR&ED claims (see section 4.8.1)
• Cost to attend conventions or conferences (see section 4.8.2)
• Interest expenses (see section 4.8.3)

3.1.2 Expenditures that are not directly related

Certain expenditures, including salary or wages, that relate to the general administration or management of a business are generally not allowable for SR&ED purposes. These costs are not directly related to the prosecution of SR&ED; they are related to the carrying on of a business.

Expenditures incurred in the following departments or divisions of the business are generally not directly related to the prosecution of SR&ED. This list is not exhaustive since the determination of whether an expenditure is directly related to the prosecution of SR&ED is a question of fact. These include:

• corporate management (general administration of the business, including the functions of planning (non-technological), direction, control, co-ordination, systems, and other functions at a managerial level)
• human resources (other than evaluating, recruiting, and hiring SR&ED personnel when the work is performed by human resources staff (see section 4.5) and other than services provided by clerical and administrative staff to SR&ED employees (see section 4.1))
• finance (other than the financing of funds used to perform SR&ED)
• purchasing (other than direct purchasing of material / SR&ED equipment)
• taxation
• legal services
• sales, marketing, and advertising
• shipping and distribution (other than shipping and distribution costs of experimental products for internal or customer testing)
• production (other than materials or equipment used in SR&ED)
• employee relations
• development of a benefits program for SR&ED personnel
• corporate secretary and reporting to shareholders.

Expenditures incurred for the following activities or tasks are not directly related to the prosecution of SR&ED. They are ordinary business expenses of the claimant. These include:

• bidding
• initiation and closing of licensing agreements
• feasibility studies (non-technological) leading to potential SR&ED collaborations and assessing the commercial feasibility of a given technology
• commercialization of existing intellectual property
• review and approval of SR&ED budgets and cost control
• patent application (including legal work)
• preparation of user manuals
• administrative training
• professional society membership fees
• putting products into saleable state
• preparation of claims for ISO 9000 registration
• fees paid to Health Canada for regulatory reviews of pharmaceutical drug submissions (these fees are not for SR&ED work and are not directly related to the prosecution of SR&ED; they are directly related to a company's decision to market a drug in Canada)
• ramp-down period that represents the transition period required to move the process from the experimental phase back to standard processing conditions – this may be part of an experimental development (ED) project depending on the facts of the case; however, if the ramp-down period is not part of the ED project, the costs do not qualify as SR&ED overhead and other expenditures. For more information on running production trials, refer to the SR&ED During Production Runs Policy.

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

3.2 Meaning of the term “incremental expenditure”

To be directly attributable to the prosecution of SR&ED, an expenditure, or a portion of the expenditure, must also be an expenditure that would not have been incurred if the prosecution of SR&ED had not occurred, that is, it must be an incremental expenditure.

For an expenditure to be considered incremental, the claimant must show that the expenditure would not have been incurred if the SR&ED work had not been carried out. An expense that increased because of the SR&ED work, or that would have been less if the SR&ED were not performed, will generally meet the incremental test. The onus is on the claimant to demonstrate that the incremental test is met for each particular expense. If an expense does not meet the incremental test, it is not an SR&ED overhead and other expenditures even if the expense is directly related to the prosecution of SR&ED.

For a particular expense to be allowed as SR&ED overhead and other expenditures, it has to be specifically identified and allocated to SR&ED. The method used by the claimant to allocate overhead and other expenditures to SR&ED must be reasonable. The claimant must be able to explain how the amount was determined and provide support for the allocation.

3.2.1 Determining whether a particular expense meets the incremental test

The following comments and examples may assist in determining whether a particular expense meets the incremental test:

a) A portion of an expenditure may be incremental.

The incremental test applies to each particular expenditure, or portion of the expenditure.

For example, the claimant incurs an expenditure of $10,000 to purchase 100 boxes of supplies. Of this total, 25 boxes were used by SR&ED staff in the prosecution of SR&ED. In this case, it is the portion of the expenditure ($2,500) that should meet the “directly related” and “incremental” tests. If it is reasonable to consider that the supplies were used in the prosecution of SR&ED and that the expense would have been $2,500 less if the SR&ED had not been performed, then this amount would be an allowable SR&ED overhead and other expenditures.

b) A percentage of an expenditure may or may not be incremental.

For the purpose of applying the incremental test, the CRA does not necessarily consider a percentage of an expenditure to be incremental. Each particular expense has to meet the incremental test on its own merit.

For example, corporation A incurs travel costs of $40,000 in its 2021 tax year. SR&ED employees represent 25% of the total personnel of the corporation. Corporation A cannot claim $10,000 as an incremental expenditure for the prosecution of SR&ED. It must show that the expenditure is directly related and incremental to the prosecution of SR&ED. For this purpose, corporation A will have to identify each trip, have evidence that each trip is directly related and incremental to SR&ED, and allocate the appropriate costs to SR&ED.

In certain cases, a cost may vary in relation to the level of production or use. For example, the cost of electricity, gas, and water may vary based on the usage of equipment. In such a case, a percentage of an expenditure may be incremental.

For example, a claimant incurs an expenditure of $100,000 for the electricity used to operate equipment. The cost varies in direct relation to the usage. The equipment was used 10% of the time for SR&ED. When it is reasonable to conclude that the expense was directly related to the prosecution of SR&ED and that the expense would have been less if the SR&ED had not been performed, $10,000 of the expenditure on electricity would be allowable as an SR&ED overhead and other expenditure.

Note

Expenditures of a capital nature, such as equipment purchases, do not qualify for SR&ED tax incentives. However, the costs to operate the equipment, including repair and maintenance costs, could still qualify as SR&ED overhead and other expenditures.

c) When a cost is fixed, the incremental test is not met.

A fixed cost is a cost that does not vary with increases or decreases in actual production or usage. When it is clear that a cost is fixed, generally the incremental test cannot be met.

For example, a claimant has a maintenance contract for equipment for a fixed cost of $100,000 per year. The equipment is used for both production activities and the prosecution of SR&ED. In 2021, the equipment was used 40% of its operating time for the prosecution of SR&ED in the tax year. The maintenance cost to the claimant remains the same irrespective of the use of the equipment. In such a case, 40% of the cost cannot be considered an incremental expenditure for SR&ED. Incremental costs will only be allowed if the claimant can support and provide evidence that a different maintenance contract would have been used at a lower cost if the SR&ED had not been performed. This determination, however, is a question of fact.

d) Application of the incremental test to certain salary or wages.

There may be cases where employees, on an individual basis, spend a relatively small portion of their time performing tasks directly related to the prosecution of SR&ED. However, the total percentage of their time that is directly related to the prosecution of SR&ED would be significant if taken together as a single expenditure. How should the incremental test be applied in such a case?

For example, a claimant has five clerks providing a service to SR&ED employees and each of them spends 20% of their time performing tasks directly related to the prosecution of SR&ED (for example, payroll for SR&ED staff, accounting, etc.). If that work was done entirely by one individual, the percentage of the expenditure used in SR&ED would be 100% of that individual's salary or wages. Can it be said that 20% of the expenditure of each clerical staff's salary or wages is incremental to the prosecution of SR&ED?

For each employee, the claimant has to show that the expenditure meets the incremental test. Specifically, the claimant has to demonstrate that each employee would have been employed only 80% of the time, or there would have been four clerical employees instead of five, if the SR&ED had not been performed. However, in this specific situation, the CRA will allow the salary or wages of one clerk to be treated as incremental (the CRA believes that it is reasonable to conclude that the claimant would have needed one less clerical staff if it were not for the prosecution of SR&ED). In other situations, however, each expenditure for salary or wages will have to qualify on its own merit.

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.0 Applying the “directly related” and “incremental” tests

This section contains a non-exhaustive list of the application of the “directly related” to the prosecution of SR&ED and “incremental” tests to various situations. These illustrations are meant to assist in the determination of the expenditures directly attributable to the prosecution of SR&ED in Canada.

4.1 Salary or wages of clerical and administrative staff providing a service to SR&ED employees

The portion of an expenditure for the salary or wages of clerical and administrative staff providing a service to SR&ED staff may be an allowable SR&ED overhead and other expenditure under the traditional method if the functions performed are non‑technological and aid the ongoing SR&ED work claimed in the year (for example, services rendered by staff in human resources, accounting, and purchasing). To be allowable SR&ED overhead and other expenditures, the portion of the expenditure for their salary or wages must be directly related (see section 3.1) and incremental (see section 3.2) to the prosecution of SR&ED in Canada.

Under the proxy method, an expenditure for the salary or wages of clerical and administrative staff providing a service to SR&ED employees cannot be claimed for SR&ED purposes, since it has been accounted for by the prescribed proxy amount (PPA).

In general, when all or substantially all (ASA) of an employee's time is spent directly undertaking, supervising, or supporting the prosecution of SR&ED, the entire salary or wages of that person will be allowed for SR&ED purposes. However, it should be noted that this rule does not apply to the salary or wages of an employee that is considered to be directly related and incremental to the prosecution of SR&ED. For example, if the facts show that the work performed by such an employee represents 93% of the employee's time, the expenditure will be allowed based on the actual percentage. For more information on the ASA rule for salary or wages, refer to section 8.3.3 of the SR&ED Salary or Wages Policy.

Legislative Reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.2 Contract costs – Other than an SR&ED contract

Contract costs that are not for SR&ED performed on behalf of the claimant may be allowable SR&ED overhead and other expenditures if the “directly related” and “incremental” tests are met. The contract costs for other work (for example, work performed by electricians, welders, and mechanics) that is not support work may qualify as SR&ED overhead and other expenditures under the traditional method.

Under the proxy method, these types of contracts cannot be claimed for SR&ED purposes, but an investment tax credit (ITC) is earned on the PPA. However, under both the traditional and proxy methods, such work performed by employees of the claimant can be allowable SR&ED salary or wages.

In certain cases, these types of contract costs can be included in the cost of materials. This would be the case when the cost may reasonably be considered to be the laid‑down cost of a material used in the prosecution of SR&ED. In particular, this means that the cost has been incurred to bring a particular material to its condition and location to be used in the prosecution of SR&ED. However, whether a contract can be treated as a laid-down cost of material, and therefore be part of the cost of materials, has to be determined on a case-by-case basis. For more information on the cost of materials, refer to section 3.0 of the Materials for SR&ED Policy.

The claimant should be able to identify the work performed and be able to show that the expenditures are directly related and incremental to the prosecution of SR&ED. This is one area where it might be appropriate to keep specific documentation on this matter, since it can be difficult to prove with documentation kept for other purposes. The claimant should review job costing records to confirm that costs claimed for non-SR&ED contracts are directly related and incremental to the prosecution of SR&ED.

Legislative Reference Income Tax Act
Subsection 248(1) Definition of “SR&ED”

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.3 Employer's share of related benefits

A claimant may be able to deduct related benefits as an SR&ED overhead and other expenditures under the traditional method if the expenditure, or a portion of the expenditure, is directly related and incremental to the prosecution of SR&ED. When the proxy method is chosen, the amount of these benefits is not a deductible expenditure for SR&ED purposes since it has been accounted for by the PPA.

Related benefits include the employer's share of payments to the Canada Pension Plan (CPP) or the Quebec Pension Plan (QPP), Employment Insurance (EI), various provincial workers compensation boards (for example, Workplace Safety and Insurance Board), or the Commission des normes, de l'équité, de la santé et de la sécurité du travail (CNESST) in Quebec, an approved employee pension plan, employee medical, dental, optical insurance plans, and premiums to a superannuation plan.

The following expenditures can also be considered related benefits provided they do not constitute a taxable benefit, since taxable benefits are elements of an employee's salary or wages:

• supplementary sick benefits; and
• an employer's contributions in relation to an employee savings plan where, for instance, for every $3 that an employee uses to purchase shares in the parent company the employer undertakes to pay $1, up to a given maximum.

The employer's contributions to the Quebec and Ontario health insurance plans are not related benefits since it is not necessary to be an employee to benefit from these plans. However, such contributions can be allowed as an SR&ED expenditure when the expenditure is directly related and incremental to the prosecution of SR&ED in Canada.

4.3.1 Related benefits for clerical and administrative staff providing a service to SR&ED employees

Related benefits can only be attributable to the prosecution of SR&ED when they relate to employees who directly undertake, supervise, or support the prosecution of SR&ED, as described in paragraph 2900(2)(b) of the Regulations.

On the other hand, since the administrative tasks will be evaluated under the “directly attributable” tests that apply to overhead and other expenditures as described in paragraph 2900(2)(c) of the Regulations (see section 4.1), the related benefits in respect of those salaries will never be directly related to the prosecution of SR&ED. The CRA does not consider that there is a direct link between the expenditure and the specific SR&ED work, staff, or machinery / equipment. The CRA considers that this is an overhead on overhead expenditure. Thus, the salary can be directly linked to the prosecution of SR&ED but the link between the prosecution of SR&ED and the related benefits is indirect because there is an intermediate step between the expenditure and the prosecution of SR&ED.

Legislative Reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative References Income Tax Regulations
Paragraph 2900(2)(b) Employee remuneration – Traditional method
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.4 Retiring allowance

A retiring allowance is an amount paid on or after the retirement of an employee in recognition of long service or in respect of the loss of an office or employment. A claimant can describe any amounts paid to an individual as a result of the loss of an office or employment as termination or severance pay. However, it is a question of fact as to whether a payment described as termination or severance pay meets the definition of a retiring allowance.

In certain situations, a retiring allowance can qualify as an expenditure directly attributable to the prosecution of SR&ED in Canada, under the traditional method. When the proxy method is chosen, such an amount is not a deductible expenditure because it has been accounted for by the PPA.

A retiring allowance includes an amount received in respect of a loss of an office or employment. In this context, the phrase "in respect of" has been held by the courts to imply a connection between the loss of employment and the subsequent receipt, where the primary purpose of the receipt was to compensate for the loss of employment. The following two questions were set out by the courts to determine whether a connection exists for purposes of a retiring allowance:

1. If it were not for the loss of employment, would the amount have been received?
2. Was the purpose of the payment to compensate for a loss of employment?

Only if the answer to the first question is no and the answer to the second question is yes will the amount received be considered to be a retiring allowance (that is, the amount would not have been received if there was no loss of employment and the payment was made to compensate for the loss of that employment).

A retiring allowance does not include certain non-eligible receipts such as an amount that qualifies as salary or wages or accrued vacation pay.

Depending on the circumstances, it may be difficult to determine whether a payment to an employee is a retiring allowance or salary or wages. Income Tax Folio S2-F1-C2, Retiring Allowances, and Income Tax Folio S2-F3-C1, Payments from Employer to Employee, can help make such a determination. Also refer to sections 5.4 and 5.4.1 of the SR&ED Salary or Wages Policy.

Generally, any amount payable under a written or oral agreement, which has the nature and quality of salary or wages, commissions, or accrued vacation pay will be considered salary or wages. However, an amount received upon or after retirement in respect of unused sick leave credits will qualify as a retiring allowance, but only if it is paid in recognition of the employee's long service or in respect of a loss of employment.

4.4.1 Application of the "directly attributable" tests to retiring allowances

A) Directly related test

A retiring allowance will only be directly related to the prosecution of SR&ED if:

• it is part of the written employment contract of the employee and the employee becomes a member of the retiring allowance plan. Furthermore, it results from the terms of an employment contract negotiated when the employee was hired. An amount paid as a retiring allowance that was negotiated after the employee began employment will normally not be “directly related” because the retiring allowance was not negotiated to induce the employee to perform SR&ED work (that is, not directly related to the prosecution of SR&ED);
• it is paid to an employee directly undertaking, supervising, or supporting the prosecution of SR&ED in Canada at the time of retirement or the loss of an office or employment (hands-on work). Refer to section 8.0 of the SR&ED Salary or Wages Policy. A retiring allowance paid to an employee carrying out clerical or administrative work (providing a service to SR&ED employees) will not qualify because the employee is not performing hands-on work.

The CRA considers that an amount paid on account of or in lieu of general damages (for example, damages for the loss of self-respect, humiliation, mental anguish or hurt feelings, or under an order or judgment of a competent tribunal) for something other than in recognition of services (that is, the prosecution of SR&ED) will not be considered to be directly related or incremental to the prosecution of SR&ED.

A retiring allowance negotiated to entice an employee to retire is also not considered to be an SR&ED expenditure since it relates to a corporate decision that has nothing to do with the prosecution of SR&ED.

B) Incremental test

The retiring allowance must also meet the incremental test. Did the expenditure increase because of the SR&ED work or would it have been less if the SR&ED were not performed? The expenditure is incremental only if the answer is yes.

The claimant must allocate all or a portion of the retiring allowance to SR&ED. This allocation should reflect the time spent by the employee in SR&ED versus the overall time the employee was employed by the claimant.

Furthermore, the claimant must provide the CRA with supporting information and the rationale used to allocate the retiring allowance to SR&ED. The CRA will accept the allocation method chosen by the claimant unless it does not result in a reasonable estimate of the SR&ED portion of the expenditure. Employee-specific information to support such an allocation may include:

• the total of salary or wages for the duration of employment;
• the total of salary or wages, or a portion thereof, allowed as SR&ED for the duration of employment;
• the number of years employed; and
• any other relevant and reasonable factors.

In all situations, the claimant has to show that the amount paid to an employee meets both the definition of retiring allowance and the requirements described above. Furthermore, the onus is on the claimant to establish the direct relationship between the prosecution of SR&ED and the expenditures for retiring allowances.

4.4.2 Examples

Example 1

A Canadian corporation hired a computer software engineer, Mr. A, in 2005. When he left the company in 2020, he received a retiring allowance of $90,000. During the entire period, Mr. A worked exclusively in the prosecution of SR&ED in Canada (hands-on work). The corporation used the traditional method to file its SR&ED claim. Is the corporation entitled to claim the $90,000 paid to Mr. A as a directly attributable SR&ED expenditure?

In this situation, the payment is made to an employee who only performed hands-on work. However, it should be determined if the retiring allowance was part of Mr. A's employment contract. If so, the $90,000 paid to Mr. A would be directly attributable to the prosecution of SR&ED. If not, the $90,000 is an ordinary business expense for the corporation.

Example 2

Ms. Z is an engineer who started working for B Limited on January 1, 2010. As part of her employment package, she negotiated a retiring allowance of $20,000 per year of service. On June 30, 2020, Ms. Z was laid off as part of the realignment of the corporation. B chose the traditional method to file its SR&ED claim. B determined that, over the years, Ms. Z devoted 60% of her time to SR&ED projects while the remaining of her time was related to the general administration of the corporation. Based on the facts of the case, it was determined that Ms. Z would not have been employed by B, if she was not performing the SR&ED. The CRA reviewed this claim and concluded that the 60% rate determined by B was reasonable. What portion, if any, of the $210,000 (10.5 years X $20,000) retiring allowance paid to Ms. Z in July 2020 is directly attributable to the prosecution of SR&ED?

In this situation, 60% of the $210,000 retiring allowance, or $126,000, will be considered to be directly attributable to the prosecution of SR&ED.

Example 3

This is similar to example 2, except that Ms. Z only devoted 25% of her time to SR&ED projects during her employment with B Limited. That portion of the retiring allowance is directly related to the prosecution of SR&ED. However, based on the facts of this case, it was determined that Ms. Z would have been employed full time by B whether she was involved in SR&ED or not. What portion, if any, of the retiring allowance paid to Ms. Z is directly attributable to the prosecution of SR&ED?

The retiring allowance does not meet the incremental test and, accordingly, no portion of the retiring allowance will be considered to be a directly attributable expenditure to the prosecution of SR&ED.

Legislative References Income Tax Act
Subsection 248(1) Definition of “salary or wages”
Subsection 248(1) Definition of “retiring allowance”

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.5 Expenses related to the selection and hiring of SR&ED personnel

Expenditures incurred for the salary or wages of human resources personnel for activities related to evaluating, recruiting, and hiring SR&ED personnel will be considered expenditures directly related to the prosecution of SR&ED and will be allowable SR&ED overhead and other expenditures if they are also incremental to the prosecution of SR&ED.

The treatment for SR&ED purposes of other expenses related to the selection and hiring of SR&ED personnel is summarized in the table below.

* A specialized professional recruiter paid to search for specialized personnel in a well‑defined technological niche.

The expenditures referred to in points 1 to 4 above are not directly related and incremental to the prosecution of SR&ED and are not allowable SR&ED expenditures. These expenditures relate to activities before the person became an employee of the claimant. They are not allowable SR&ED expenditures but are ordinary business expenses of the claimant.

The expenditure referred to in point 5 above is directly related to the prosecution of SR&ED. It may be allowed as overhead and other expenditures under the traditional method if it is also incremental to the prosecution of SR&ED. In the case of the moving expenses for the SR&ED personnel hired to do hands-on work, these expenditures will be directly related and incremental to the prosecution of SR&ED. Such expenses are not considered to be general administration or management of the business because they relate directly to SR&ED employees of a claimant. These expenses are also qualified SR&ED expenditures that will earn an ITC. Amounts deductible as SR&ED overhead and other expenditures are those expenses mentioned in the definition of “moving expenses” in the Income Tax Act. For more details on moving expenses, refer to Income Tax Folio S1-F3-C4, Moving Expenses.

The expenditures referred to in point 6 above may be allowed as SR&ED overhead and other expenditures under the traditional method of determining SR&ED expenditures. These expenditures are directly related and incremental to the prosecution of SR&ED.

Legislative References Income Tax Act
Subsections 6(19) and 6(20) Benefits re housing loss
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – Current expenditures
Subsection 62(3) Definition of “moving expenses”

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.6 Lease costs of equipment used less than 90% of the time for SR&ED

No portion of the lease costs of equipment used in SR&ED can be claimed as SR&ED overhead and other expenditures. Since 2014, expenditures of a capital nature or expenditures for the right to use capital property, such as lease costs can no longer form part of the SR&ED expenditures or qualified SR&ED expenditures.

4.7 Other expenditures that may qualify as SR&ED overhead and other expenditures

The determination of whether a particular expenditure is directly related and incremental to the prosecution of SR&ED is made on a case-by-case basis. Also, some expenditures that are directly related and incremental to the prosecution of SR&ED can be prescribed expenditures (see section 4.8). Note that the list below is not exhaustive. Examples of other expenditures that may be directly related and incremental to the prosecution of SR&ED include:

4.7.1 Cost of telephone, cellular telephone, and Internet

A payment made for the use of a telephone, a cellular phone, or the Internet will generally be considered to be an ordinary business expense and, therefore, will not be an expenditure directly related to the prosecution of SR&ED. Further, a portion of the cost of using a telephone, a cellular phone, or the Internet is a fixed monthly cost and, accordingly, it will not be an incremental cost incurred for the prosecution of SR&ED. Such costs would have been incurred by the company regardless of whether the SR&ED had been performed.

Therefore, irrespective of the percentage of time an employee spends in SR&ED activities, the fixed payment for the use of a telephone, a cellular telephone, or the Internet will generally not be an allowable SR&ED expenditure. However, in certain cases, an expenditure that is identifiable and directly related and incremental to the prosecution of SR&ED, such as long‑distance telephone charges, may be an allowable SR&ED overhead and other expenditures.

In certain cases, a claimant incurs an expenditure for using a dedicated telecommunications line. In that case, the expenditure is considered to be an expenditure for the lease of equipment which no longer qualifies as an SR&ED expenditure as it is an expenditure for the right to use capital property.

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

Other Reference
98 DTC 1877 Data Kinetics Ltd. v. The Queen

4.7.2 Expenses for travel to and lodging in Canada to do testing at a customer location

Expenditures reimbursed to the employee who incurs certain expenditures for travel, meals, and lodging when conducting experimental trials at a supplier's premises in Canada may constitute expenditures directly related and incremental to the prosecution of SR&ED. If an employee is directly performing, supervising, or supporting the prosecution of SR&ED in Canada, these expenditures will be directly related and incremental to the SR&ED activities. However, if the employee did not perform SR&ED work, the costs can no longer be directly related to the prosecution of SR&ED and the expense will not be allowable for SR&ED purposes.

4.7.3 Cost of training in Canada

Only the cost of technological training for ongoing SR&ED projects claimed in the year can be directly related and incremental to the prosecution of SR&ED. This only includes training provided to qualified SR&ED personnel and that is required for the prosecution of the SR&ED project claimed in the year. Refer to section 6.2 when the training is outside Canada. The cost incurred for other training such as training or on‑the‑job learning based on available know-how and administrative training is not directly related to the prosecution of SR&ED.

4.7.4 Cost of utilities

An expenditure for water (utility used throughout the plant and the boiler feed water, which is used to generate steam on site) and energy sources (for example, fuel, electricity, and oil) can be directly related and incremental to the prosecution of SR&ED under the traditional method. However, there are circumstances where water (process water stream) and energy sources used in performing SR&ED can be considered materials consumed. For more information on materials, refer to the Materials for SR&ED Policy.

4.7.5 Cost of periodical subscriptions

Only the cost of periodical subscriptions that specifically relate to the technology or scientific area of the SR&ED project can be directly related and incremental to the prosecution of SR&ED under the traditional method.

4.7.6 Cost of waste disposal

The SR&ED may result in producing waste output that requires disposal. The disposal charges for waste are generally not SR&ED overhead and other expenditures, as they are not considered to be directly related and incremental to the prosecution of SR&ED. The SR&ED activity that produced the scrap has finished. For instance, the disposal of waste output may be required by a regulatory body, or to provide room for storage or space to perform other work.

The SR&ED can result in output that is not disposed of, but reused. Costs related to reuse or recycle the scrap material can be allowed for SR&ED purposes when the scrap material is used in a new SR&ED project or when the scrap material is recycled in the prosecution of SR&ED. These costs are not overhead and other expenditures, but may form part of the cost of recycled material.

4.7.7 Fees paid to volunteers to participate in clinical studies and other related costs

In the context of clinical studies, fees may be paid to volunteers for their participation in studies. The fees may include an amount for their travel costs and the cost of food for the period of the clinical studies. Advertising costs may also be incurred by the claimant to recruit the volunteers.

The volunteers recruited for the clinical trials are not performing support work as described in the definition of SR&ED in the Act. However, because the volunteers are required for the prosecution of SR&ED, the fees paid to the volunteers will usually be directly related and incremental to the prosecution of SR&ED. The CRA will review the invoice as a whole and will not deduct the portion related to travel and food. Accordingly, the travel expenditures and food costs included in the fees paid to the volunteers will also be SR&ED overhead and other expenditures.

However, the cost of advertising to solicit volunteers for the clinical studies is not an expenditure that is directly related to the prosecution of SR&ED. There is no direct linkage between the cost of advertising to recruit volunteers and the prosecution of SR&ED. This is an ordinary business expense, and not an SR&ED expenditure. Because of the fact that the volunteers are directly related to the SR&ED work, the advertising expenditure is indirectly linked to it. Therefore, the expenditure is not deductible because the directly related test has not been met.

The portion of salary or wages for employees responsible for recruiting the volunteers may also be directly related and incremental to the prosecution of SR&ED.

Finally, the expenditures for liability insurance for clinical studies may also be directly related and incremental to the prosecution of SR&ED.

Legislative Reference Income Tax Act
Subsection 248(1) Definition of “SR&ED”

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

4.7.8 Expenses related to health and safety

Expenses incurred for the following activities will generally be considered directly related and incremental to the prosecution of SR&ED if these activities are specific to an SR&ED project carried out in the year:

• hazard and operability (HAZOP) reviews;
• health and safety compliance reviews for new processes (commensurate with the needs of the SR&ED project);
• employee health testing.

4.8 Expenditures directly related and incremental but that are also prescribed expenditures

Some SR&ED overhead and other expenditures that may be included in the pool of deductible SR&ED expenditures (if directly related and incremental), but are prescribed expenditures and cannot be included as qualified SR&ED expenditures for ITC purposes. Prescribed expenditures include expenditures of a current nature incurred by a claimant for the general administration or management of a business. For more information on prescribed expenditures, refer to section 10.0 of the Total Qualified SR&ED Expenditures for Investment Tax Credit Purposes Policy.

Expenditures directly related and incremental but that are also prescribed expenditures are explained in the following sections.

4.8.1 Fees for preparing SR&ED claims

Fees for preparing the SR&ED claim include work with respect to analyzing and evaluating the technical work, compiling technical information, drafting technical reports, evaluating the amount of expenditures that may qualify for SR&ED ITCs, compiling the costs of SR&ED, and meeting with the CRA. The costs are not all accounting fees but are costs necessary to submit an SR&ED claim to the CRA, both the financial portion of the claim and the technical portion of the claim.

Regarding the technical portion of the SR&ED claim, the CRA does not consider the preparation of technical descriptions for SR&ED claims to be support work.

Fees for preparing the SR&ED claim, including the accounting and technical portions of the claim, may be directly related and incremental to the prosecution of SR&ED. However, the cost of preparing technical descriptions determined as a percentage of the ITC received often relates to carrying on business in general and not specifically to the prosecution of SR&ED. The onus is on the claimant to establish the direct relationship between the prosecution of SR&ED and such costs.

When the amount to be paid as a fee is an allowable SR&ED overhead or other expenditures, the fee will be considered to be a prescribed expenditure under the Regulations as a fee incurred for the general administration or management of the business. This treatment applies to fees that relate to the accounting portion of preparing the SR&ED claim (in that case, the fee is specifically described in the Regulations as being prescribed) and to fees that relate to the technical portion of preparing the SR&ED claim. Consequently, no ITC can be earned in respect of fees paid for preparing SR&ED claims.

Note that salary or wages paid to employees of the claimant for preparing SR&ED claims is not a prescribed expenditure under the Regulations when the salary or wages is directly related and incremental.

Legislative References Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method
Subparagraph 2902(a)(i) Prescribed expenditure – General administration or management of a business
Clause 2902(a)(i)(A) Prescribed expenditure – Exception for salary or wages
Clause 2902(a)(i)(B) Prescribed expenditure – Legal or accounting fee

Other References
2007 DTC 879 Armada Equipment Corporation v. The Queen
97 DTC 551 Val-Harmon Enterprises v. The Queen

4.8.2 Cost to attend conventions or conferences

Only the expenditures for technical conventions or conferences specific to the SR&ED project or its technology can be directly related and incremental to the prosecution of SR&ED. Although a portion of the expenditure may be directly related and incremental to the prosecution of SR&ED, the expenditures are prescribed expenditures under the Regulations.

Legislative References Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method
Clause 2902(a)(i)(F) Prescribed expenditure – Convention and conference

4.8.3 Interest expenses

Interest expenses incurred on money borrowed for the prosecution of SR&ED are deductible as an SR&ED expenditure only to the extent that the borrowed money is used to pay SR&ED expenditures that are otherwise allowable SR&ED expenditures.

However, interest costs are prescribed expenditures under the Regulations because they are considered to be an expenditure incurred for the general administration or management of a business.

Legislative References Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method
Clause 2902(a)(i)(C) Prescribed expenditure – Interest

5.0 Expenditures directly attributable to the provision of premises, facilities or equipment

As per subsection 2900(3) of the Regulations, the following expenditures are directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada:

• the cost of the maintenance and upkeep of such premises, facilities or equipment (see section 5.1); and
• other expenditures, or those portions of other expenditures, that are directly related to that provision and that would not have been incurred if those premises or facilities or that equipment had not existed (incremental) (see section 5.2).

5.1 The cost of the maintenance and upkeep of premises, facilities or equipment

Because the cost of the maintenance and upkeep of premises, facilities or equipment used for the prosecution of SR&ED in Canada is specifically allowed under the Regulations, there are no “directly related” and “incremental” tests to be met for this type of expenditure. Also, the Income Tax Act does not refer to a portion of an expenditure since the determination of the cost already reflects the portion of the expenditure that is used for SR&ED purposes.

Determination of the cost

For example, a claimant awards a contract of $10,000 to a supplier for providing the maintenance service for both the equipment used for SR&ED and the equipment used for production. The maintenance hours spent on the equipment used for SR&ED represented 25% of the total maintenance hours. Since the total expenditure is $10,000, the portion of the expenditure for the equipment used for SR&ED purposes is $2,500. If the equipment is used solely for SR&ED purposes, the cost of maintenance allowed as an SR&ED overhead and other expenditures will be $2,500. However, if the equipment is used 40% of the operating time for the prosecution of SR&ED, the cost of the maintenance allowable as SR&ED overhead and other expenditures will be $1,000 (that is, 40% of $2,500).

Maintenance / upkeep

The terms “maintenance” and “upkeep” are not defined in the Act. Therefore the ordinary meaning of these terms applies. The dictionary definitions of “maintenance”, “maintain”, and “upkeep” are:

a) Maintenance

• the care and work put into property to keep it operating and productive; general repair and upkeep
• preservation, upholding, protection, continuation, safeguarding
• the act of maintaining; the state of being maintained
• the upkeep of property or equipment

b) Maintain

• to keep in an existing state (as of repair, efficiency, or validity); to preserve from failure or decline (~ machinery)
• to keep in a good state

c) Upkeep

• maintenance, repairs, keep, conservation, preservation
• the act of maintaining in good condition; the state of being maintained in good condition; the cost of maintaining in good condition.

Accordingly, to be considered allowable SR&ED overhead and other expenditures, the cost of maintenance and upkeep of premises, facilities or equipment must be incurred to keep them operating and productive, keep them in an existing state, or preserve them from failure or decline.

For example, the following expenditures are considered to be costs incurred for the maintenance and upkeep of premises, facilities, or equipment used for SR&ED:

• the cost of cleaning;
• the cost of painting;
• the cost of servicing equipment;
• the cost of repairs.

The following expenditures, however, are not considered to be costs incurred for the maintenance and upkeep of premises, facilities, or equipment used for SR&ED:

• lawn and garden care around the building;
• snow removal from the parking lot and steps;
• standard building maintenance such as vacuuming, emptying the garbage, and recycling;
• watering and maintaining the plants;
• exterior window cleaning.

Legislative Reference Income Tax Regulations
Paragraph 2900(3)(a) Cost of maintenance and upkeep of premises, facilities or equipment

5.1.1 Common areas

The cost of the maintenance and upkeep of the common areas in a premises or facility (for example, hallways, corridors, and stairwells) is not an expenditure directly related to the provision of premises or facilities for the prosecution of SR&ED in Canada.

Other Reference
92 DTC 6487 Imapro Corporation v. The Queen

5.2 Other expenditures directly related to the provision of premises, facilities or equipment and that are incremental

Some expenditures or the portions of these expenditures (other than the cost of the maintenance or upkeep discussed in section 5.1) can be directly attributable to the provision of premises, facilities, or equipment for the prosecution of SR&ED in Canada.

Directly attributable tests

In order to meet the requirements of the Regulations, an expenditure, or a portion of the expenditure, must satisfy two tests.

1. The expenditure must be directly related to the provision of premises, facilities, or equipment used for the prosecution of SR&ED in Canada (see section 3.1).
2. The expenditure would not have been incurred if those premises, facilities, or equipment had not existed (incremental) (see section 3.2).

Directly related test

The Regulations refer to the term “directly related,” which means that any indirect portion must be excluded. However, the terms “portion” and “directly related” used in the Regulations indicate that some portion of expenditures might meet the “directly attributable tests”, and that this determination will be based on a finding of fact.

An expenditure must connect with the SR&ED (that is, relate to), and there must be no intervening step or intermediary between the expenditure (that is, directly) and the provision of premises, facilities, or equipment used for the prosecution of SR&ED. The claimant must use a rational method for linking the expenses to the prosecution of SR&ED, and must be able to show that the method is reasonable.

Examples of expenditures that may meet the directly related test in the case of a building or equipment owned by the claimant:

• municipal taxes for a building owned by the claimant;
• insurance for a building owned by the claimant;
• insurance for equipment owned by the claimant;
• expenses for safety and security.

Example of an expenditure that does not meet the directly related test:

• capital cost allowance (CCA).

The CCA is allowed as a deduction in calculating the income of a claimant and is based on the prescribed rate determined by the Regulations. This type of expenditure does not meet the directly related test.

Incremental test

An expenditure directly related to the provision of premises, facilities, or equipment for the prosecution of SR&ED, or a portion of the expenditure, must also meet the incremental test (would not have been incurred) to be deductible for SR&ED purposes. The onus is on the claimant to show that the expenditure is incremental.

For the purpose of applying the incremental test for this type of overhead and other expenditures, the CRA considers a reasonable percentage of the expenditure to be incremental. For example, if a building owned by the claimant is used for the prosecution of SR&ED, a reasonable portion of the municipal taxes and the cost of insurance for the building or the equipment is considered to meet the incremental test.

The method used to determine the portion of the municipal taxes that is directly related to SR&ED and is incremental must also be reasonable and may, for example, be based on the square footage of the building used for SR&ED over the total square footage of the building. Other methods can be used to determine the portion of an expenditure that is directly related to the provision of premises, facilities, or equipment for the prosecution of SR&ED, provided they are reasonable in the circumstances. Regardless of the method used, the claimant must be able to show that it is reasonable.

Legislative Reference Income Tax Act
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable

Legislative Reference Income Tax Regulations
Paragraph 2900(3)(b) Expenditures directly related and incremental to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method

Other Reference
98 DTC 1710 Ergorecherche et Conseils Inc. v. The Queen, Tax Court of Canada. This case was cited by the judge in 2000.
DTC 2177 Quantetics Corporation v. The Queen.

6.0 SR&ED overhead and other expenditures incurred for work performed outside Canada

The treatment of the SR&ED overhead and other expenditures will be different when the expenditure is for support work performed outside Canada (see section 6.1) or is for work carried on outside Canada that does not constitute SR&ED (see section 6.2). SR&ED overhead and other expenditures may also relate to salary or wages for SR&ED outside Canada and that is deemed to be an expenditure incurred for SR&ED performed in Canada (see section 6.3).

6.1 SR&ED overhead and other expenditures related to support work performed outside Canada

When a claimant performs support work outside Canada, even if the work is in support of a particular Canadian SR&ED project of the claimant, the expenditures related to such work that is directly undertaken by, or on behalf of, the claimant and is related to a business of the claimant may only be deductible as an expenditure for SR&ED carried on outside Canada. Such expenditures do not form part of the pool of deductible SR&ED expenditures nor the qualified SR&ED expenditures for the purposes of calculating the ITC. However, some salary or wages for work performed outside Canada may be deemed to be expenditures incurred for SR&ED carried on in Canada. For more information on permissible salary or wages of employees carrying on SR&ED outside Canada, refer to section 10.0 of the SR&ED Salary or Wages Policy.

The location where the SR&ED activities are carried on is the only criterion for determining which expenditures can be claimed for SR&ED performed in Canada or outside Canada. Accordingly, SR&ED overhead and other expenditures, including foreign travel expenditures, and any other expenditure for SR&ED carried on outside Canada will only qualify for a deduction related to SR&ED carried on outside Canada. These types of costs are considered to be directly related to the prosecution of SR&ED outside Canada. The location where the cost is incurred or paid (that is, the location where the contract is entered into or the location of the bank account used for payment) is not relevant. Even if a particular expenditure for SR&ED carried on outside Canada is incurred in Canada or is made through a Canadian subcontractor, or if it represents a minor portion of the project, it will not qualify for a deduction for SR&ED performed in Canada, but it will be treated as a deduction for SR&ED performed outside Canada. Expenditures deductible for SR&ED carried on outside Canada do not qualify for SR&ED investment tax credits (ITCs).

6.1.1 Example: Transportation costs

A claimant is developing a prototype and the work constitutes SR&ED. All the work is carried on in Canada, with the exception of the testing of the prototype, which is carried on outside Canada. The claimant incurs costs for transporting the prototype for testing outside Canada. The SR&ED claim is prepared using the traditional method.

The cost of transporting the prototype for testing outside Canada, in a situation where the testing constitutes SR&ED that is directly in support of SR&ED carried on in Canada, is considered to be an expenditure in respect of SR&ED carried on outside Canada. The transportation cost is directly related and incremental to the prosecution of SR&ED outside Canada (that is, testing) and would not have been incurred if such prosecution had not occurred. Therefore, the transportation cost may be deducted only under subsection 37(2) of the Income Tax Act as an expenditure for SR&ED carried on outside Canada. As this is an expenditure deductible for SR&ED carried on outside Canada it does not qualify for an SR&ED ITC.

Legislative References Income Tax Act
Subsection 37(2) Research outside Canada
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable
Paragraph 248(1) Definition of “SR&ED”

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

Other References
2000 DTC 6108 LGL Ltd. v. The Queen (FCA)
2000 DTC 6112 Tigney Technology Incorporated v. The Queen (FCA)

6.2 SR&ED overhead and other expenditures for work outside Canada that does not constitute SR&ED

In situations where expenditures are incurred for work outside Canada that does not constitute SR&ED, only expenditures, including foreign travel expenditures, that are incurred for the following purposes may be deductible as expenditures for SR&ED carried on in Canada, resulting in the earning of ITC, provided the expenditures are directly related and incremental to the prosecution of SR&ED in Canada:

• for the acquisition of equipment to be used in SR&ED in Canada,
• for the acquisition of materials used in SR&ED in Canada,
• for training hands-on employees with respect to SR&ED carried on in Canada, or
• for visits to foreign customers with respect to SR&ED carried on in Canada to update the customer on the SR&ED project's status.

However, in certain cases, contract costs related to work performed outside Canada that is work other than SR&ED may be included in the cost of materials consumed or transformed for the prosecution of SR&ED in Canada. For more information on materials consumed or transformed, refer to the Materials for SR&ED Policy.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Subclause 37(8)(a)(ii)(A)(II) SR&ED expenditures in Canada under the traditional method – Directly attributable
Paragraph 248(1) Definition of “SR&ED”

Legislative References Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method
Paragraph 2900(3)(b) Expenditures directly related and incremental to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method

6.3 SR&ED overhead and other expenditures that relate to permissible salary or wages for SR&ED work performed outside Canada

In certain cases, claimants can earn SR&ED ITCs on permissible salary or wages for SR&ED work performed outside Canada. For more information on permissible salary or wages of employees carrying on SR&ED outside Canada, refer to section 10.0 of the SR&ED Salary or Wages Policy.

When a claimant uses the traditional method, it is the CRA's position that no SR&ED overhead and other expenditures can be allowed under subsection 37(1) of the Act when they relate to an expenditure for salary or wages for SR&ED performed outside Canada and the expenditure is deemed to be incurred for SR&ED carried on in Canada. For example, travel, hotel, and meal costs related to salary or wages for work performed outside Canada are not deductible SR&ED expenditures under subsection 37(1) of the Act even if they relate to an expenditure for salary or wages that is deemed to be incurred for SR&ED carried on in Canada.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Subsection 37(1.4) Salary or wages for SR&ED outside Canada

Legislative Reference Income Tax Regulations
Subsection 2900(4) Calculation of the prescribed proxy amount

Appendix A – References

A.1 Legislative references

A.2 Jurisprudence

Appendix B – Revisions

B.1 Explanation of changes

This document cancels and replaces the SR&ED Overhead and Other Expenditures Policy (December 18, 2014).

The following is the explanation of changes to the SR&ED Overhead and Other Expenditures Policy as part of the revision of October 14, 2022.

Section 3.2.1 b) a note has been added at the end of the examples as a reminder that expenditures of a capital nature, such as equipment purchases, do not qualify for SR&ED tax incentives, but the cost to operate the equipment, including repair and maintenance costs could still qualify as SR&ED overhead and other expenditures.

Section 3.2.1 c) has been revised to illustrate that a fixed cost maintenance contract cannot meet the incremental test for SR&ED overhead and other expenditures. Previously, the example referred to the leasing of equipment which is an expenditure for the right to use capital property that, after 2013, cannot be claimed for SR&ED tax incentives.

Section 4.4.2 has been revised to update the years referenced in Example 1 and Example 2. An additional fact was added in Example 2, “Ms. Z would not have been employed by B Limited, if she was not performing the SR&ED,” to provide support why in this situation 60% of the retiring allowance is considered directly attributable to the prosecution of SR&ED. Example 3, was revised to include a question, and the answer was included as a separate paragraph.

Section 4.6 has been revised to indicate that expenditures of a capital nature or expenditures for the right to use capital property, such as lease costs can no longer form part of the SR&ED expenditures or qualified SR&ED expenditures.

Section 4.7.6 has been reformatted into two paragraphs to better illustrate that generally, the cost of waste disposal is not considered to be directly related and incremental to the prosecution of SR&ED when the SR&ED activity that produced the scrap has finished. When scrap is recycled and used in SR&ED, any disposal costs for the scrap are not overhead and other expenditures, but may form part of the (recycled) material cost for SR&ED.

Section 6.1 has been revised to explain that expenditures for SR&ED carried on outside Canada do not form part of the pool of deductible SR&ED expenditures nor the qualified SR&ED expenditures for the purposes of calculating the ITC.

Other minor formatting and editing corrections were made throughout the document.