As more and more construction companies innovate in their operations, they are discovering a tax incentive to fund those innovations and reduce costs.
That incentive, the scientific research and experimental development (SR&ED) credit, helps companies recoup investments in innovation. It is one of the most generous incentives in the world—so much so that two companies may want to claim expenses for the same development work. This can happen when a construction company pays a specialized third party to do its development work.
But only one company can claim the expenses. How does the Canada Revenue Agency (CRA) decide between competing SR&ED claims in construction? This article explains the CRA's four criteria.
Why construction companies can claim SR&ED
Much of the innovation in the construction industry today qualifies for support under the SR&ED program. This is not a bug in the program; it's a feature. SR&ED was designed to support innovation in the business community.
Real estate and construction companies are not typically perceived as being in the “science and technology” business, but they are often paying for and taking the financial risks in respect to engineering development work.
Types of work eligible for SR&ED
Eligible work ranges from design and development of equipment and structures to building materials and new energy sources. To accomplish these goals, companies may use old-school methods or the latest technologies, from analytics to building information modeling to virtual reality. They may also develop new methods to utilize the latest technologies.
Potential work to explore includes:
- equipment, tools, and structures such as windows and doors to address non-standard construction scenarios
- methods to use new or improved construction and building materials, such as metals and alloys, glass, plastics, ceramics, concrete and cement, and insulation
- new or improved construction techniques to improve finish quality, durability and efficiency, and soil remediation, and to achieve environmental certification under programs such as Leadership in Energy and Environmental Design (LEED)
- methods and processes to reduce overall cycle time and construction time.
Opportunities to claim construction expenses under SR&ED stand to increase. Environmental regulation has pushed companies to develop environmentally friendly structures, materials, equipment, and processes. Companies are looking to increase efficiency and make their operations more profitable. Companies have gradually embraced construction technologies, known as contech. And customers are demanding more—both in the construction process and the final product.
SR&ED: From overlooked to in demand
Because construction companies often subcontract their most innovative work to a third party, they may not realize that they can claim their costs as SR&ED.
For example, engineering firms hired by construction firms often undertake SR&ED eligible projects yet don't qualify to claim the costs. In reality, the construction firm may claim the SR&ED.
But more and more companies are scanning their operations for SR&ED opportunities. And with good reason: Depending on the project, province, and type of company, owner-operated construction businesses can reduce their taxes by well over half of their qualified expenses. This reflects combined federal and provincial investment tax credit and corporate income tax rates.
Who claims the SR&ED—construction company or third party?
Contract payment rules in the SR&ED regime are designed to prevent two Canadian companies from claiming the same costs for the same project. These rules are among the most complex in the program. The Canada Revenue Agency (CRA) examines four criteria to decide who can claim the costs for SR&ED eligible work.
These four criteria all aim to clarify one point: whether the work performed by the third party was done on behalf of the construction company under the terms of the contract.
1. What work does the contract require?
If the contract requires the third party to perform specific research and development activities for the company, or follow certain specifications when doing the work—that may show the work was done for the company under contract.
Contract language is sometimes open to interpretation, but the CRA provides one example: “The contractor shall design, integrate, test, and verify performance.” The wording indicates that the contractor, or third party, had to perform SR&ED work on behalf of the company, meaning that the amount paid is a contract payment and therefore claimable by the construction company–often the general contractor. This is also often overlooked by real estate developers.
2. Who assumes the financial risk?
The financial terms of the contract can also say a lot about who owns the SR&ED work—particularly whether the third party carries financial risk.
If the contract specifies a flat fee or ceiling price, that minimizes the financial risk taken by the third party. And even if the contract specified a ceiling, would the third party have been paid for cost overruns if the work did not initially meet the specifications set out under the contract? If so, the financial risks seem to be taken on by the company–again, typically the general contractor, and as such they are entitled to the claim.
In both cases, the financial risk sits with the company and indicates the work is done on their behalf.
3. Who owns the intellectual property?
If the rights to the intellectual property of the SR&ED work belong to the construction company, this may indicate that the third party was required to perform SR&ED on their behalf. However, if the company has only a conditional right to use the SR&ED results, it's more likely the work was not done on their behalf. The third party would claim the SR&ED, not the company.
4. Is the contract for service or for the sale of goods?
When the other criteria don't clarify who gets the SR&ED claim, the CRA may look at whether the contract is for service or for goods.
A contract for service may indicate that the SR&ED work was being performed on behalf of the company. On the other hand, if it is a contract for goods, it is more likely that the company owns just the goods—and not the SR&ED done to create those goods.
The SR&ED credit helps construction companies improve their business in two critical areas: technology and profitability. For a deeper look at the current issues facing construction companies and how to solve them, see our report on construction in Canada.