One of the eligible expenses when claiming R&D Tax Credits, is contract expenditure. Arm’s Length contractors and Non-Arm’s Length contractors have basic difference in Scientific Research and Experimental Development (SR&ED) projects. It is important to know the difference between both types of contractors to eliminate any confusion.
SR&ED Arm’s Length Contractors
Arm’s Length contractors are those contractors who are independent and do not have any personal or blood relationship with you or your company’s shareholders. You or any of your company’s shareholders must not have control over contractors’ company. Tax Act defines control as “having enough shares which are enough to claim majority of votes in the election of the board of director”.
SR&ED Non-Arm’s Length Contractors
If you or any of your company’s shareholders have personal or blood relationship with contractor or have control over contractor’s company, that contractor will be termed as Non-Arm’s Length contractor. Non-Arm’s Length contractors can be beneficial if evaluated consciously. Although they don’t qualify for ITC and reduce potential R&D Tax Credits, but adding your contractor to company’s payroll as an employee is feasible. This will not only make that eligible for ITC, but also they qualify for additional 60% overhead allowance (PPA).
There are rules and steps to assure your company is eligible to claim contractors’ expenditures:
- Arm’s length contractors can qualify for investment tax credits (ITC), whereas Non-Arm’s Length Contractors don’t.
- Your company should own the risk incurred from SR&ED activities or intellectual property (IP) earned from research.
- As per Tax Act only Canadian Contractors’ expenditures would qualify for Tax Credits.
- The qualified contractors should provide any of the following support services to the company: Engineering; Design; Operations research; Mathematical analysis; Computer programming; Data collection; Testing; Psychological research.
- If a contractor assists to apply additional work on a prototype or machine this can be assumed and claimed as part of material expenses (e.g. heat treating a part).
It is necessary to ask for professional advice from your SR&ED Consultant about contract and agreement terms to determine eligibility of the expenditures. To find out how much will be your tax credits or tax rebate for eligible contractors’ expenditures check out Kelid’s SR&ED Calculator.