SR&ED tax incentives: What’s changed and what to know

The Canadian federal tax system provides two incentives for scientific research and experimental development (“SR&ED”).

1. Deduction of SR&ED expenditures: Eligible taxpayers can deduct qualifying expenses in the year in which these expenses are incurred, or to add them to a pool that can be used on a discretionary basis in future years.

2. Investment tax credit (ITC): Earned on qualifying SR&ED expenditures, with enhanced refundable ITCs available to Canadian-controlled private corporations (CCPCs) that meet certain income and taxable capital criteria.

The Fall Economic Statement 2024 (“FES 2024”), released on December 16, 2024, provided significant updates to the SR&ED regime. This article outlines the key changes.

Enhancing SR&ED ITC

The rate and level of refundability of the SR&ED ITC vary depending on certain characteristics of the taxpayer, including its ownership structure and size. The current SR&ED ITC regime can be summarized as follows:

Entity type	ITC rate	Refundable portion of ITC	Expenditure limit
Non-CCPC private corporation	15%	Nil	N/A
Unincorporated businesses / individuals / certain trusts	15%	40%	N/A
CCPC	35%	100%	$3 million of qualifying SR&ED expenditures*
	15%	40%**	Qualifying SR&ED expenditures over $3 million or the reduced limit*

*The $3-million expenditure limit for a taxation year is gradually reduced where the prior-year taxable capital employed in Canada (on an associated group basis) is between $10 million and $50 million.

**Depends on whether the CCPC’s income for the previous taxation year exceeds its qualifying income limit.

The FES 2024 proposes to:

1. increase the expenditure limit on which the enhanced 35 per cent rate can be earned from $3 million to $4.5 million. As a result, qualifying CCPCs would be able to claim up to $1.575 million per year of enhanced, fully refundable ITC, which is $525,000 more than can be refunded under the current regime.
2. increase the taxable capital phase-out thresholds for determining the expenditure limit from $10 million and $50 million to $15 million and $75 million, respectively.

3. extend eligibility for the enhanced refundable ITC to eligible Canadian public corporations, being either:

• a corporation that, throughout the taxation year, (1) is resident in Canada; (2) has a class of shares listed on a designated stock exchange (a list is available on the Department of Finance website) or, if not, has elected, or been designated by the Minister of National Revenue, to be a public corporation; and (3) is not controlled directly or indirectly in any manner whatsoever by one or more non-resident persons; or
• a Canadian-resident corporation where all or substantially all of the shares of the capital stock are owned by one or more eligible Canadian public corporations.

4. allow CCPCs to elect to have their expenditure limit for the enhanced SR&ED ITC determined based on the same gross revenue phase-out structure proposed for Canadian public corporations, rather than taxable capital (see below).

The proposed SR&ED ITC regime would be as follows, which would apply for taxation years that begin on or after December 16, 2024:

Entity type	ITC rate	Refundable portion of ITC	Expenditure limit
Non-CCPC private corporation	15%	Nil	N/A
Unincorporated businesses / individuals / certain trusts	15%	40%	N/A
CCPC	35%	100%****	$4.5 million of qualifying SR&ED expenditures*
	15%	40%**	Qualifying SR&ED expenditures over $4.5 million or the reduced limit*
Canadian public corporation	35%	100%	$4.5 million of qualifying SR&ED expenditures***
	15%	Nil	Qualifying SR&ED expenditures over $4.5 million or the reduced limit***

*The $4.5 million-expenditure limit for a taxation year is gradually reduced where the prior-year taxable capital employed in Canada (on an associated group basis) (or if elected by the CCPC, the average gross revenue over the three preceding years) is between $15 million and $75 million.

**Depends on whether the CCPC’s income for the previous taxation year exceeds its qualifying income limit.

***The $4.5 million expenditure limit for a taxation year is gradually reduced where the average gross revenue over the three preceding years is between $15 million and $75 million.

****ITCs earned on capital expenditures would only be eligible for partial refundability at a rate of up to 40% (see discussions below).

Restoring eligibility of capital expenditures

The current types of expenditures that may qualify as SR&ED deductions and qualify for SR&ED ITC are generally salary and wages, cost of materials, contract payments, third-party payments and overhead expenditures. Capital expenditures were removed from eligibility under the SR&ED program for property acquired after 2013.

The FES 2024 proposes to restore the eligibility of capital expenditures for both the deduction against income and ITC components of the SR&ED program. The rules would be generally the same as those that existed prior to 2014.

The proposed change would apply to property acquired on or after December 16, 2024, and in the case of lease costs, to amounts that first become payable on or after December 16, 2024.

1. Deducting capital expenditures against income

The FES 2024 further announced that eligible capital expenditures could be fully deducted for the purpose of determining taxable income in the year the eligible property becomes available for use or carried forward to the extent it is not deducted in the tax year (i.e., as part of the SR&ED pool).

Eligible capital expenditures refer to expenditures incurred to acquire new or used depreciable property that the claimant intends to either:

• use all or substantially all of the operating time in its expected useful life in the performance of SR&ED in Canada, or
• consume all or substantially all of its value in the performance of SR&ED in Canada.


2. Earning SR&ED ITC on capital expenditures

The FES 2024 also announced that qualifying capital expenditures would generally be eligible for the SR&ED ITC, with some differences from those eligible for full deduction noted above, including:

• The acquisition of property that had been used or acquired for use or lease before it was acquired by the claimant would not be eligible for the SR&ED ITC;
• A SR&ED-related capital expenditure ineligible for a full deduction against income because it does not meet one of the all-or-substantially-all tests noted above could still be partially eligible for the SR&ED ITC.


3. Refundability of SR&ED ITC on capital expenditures

As noted in the table above, for qualifying CCPCs with access to the enhanced 35 per cent rate, ITCs earned on eligible capital expenditures would only be partially refundable at a rate of up to 40 per cent, even though ITCs earned on current expenditures will continue to be fully refundable up to a CCPC’s expenditure limit.

Assuming a taxpayer qualifies for the enhanced 35 per cent rate, the following examples are illustrative:

• Example 1 (SR&ED capital expenditure): The taxpayer acquires a piece of machinery for $1 million in 2025. The taxpayer could deduct the full $1 million from its income for the year. In addition, the taxpayer would earn $350,000 SR&ED ITC on the cost of the machinery, $140,000 of which would be refundable.
• Example 2 (SR&ED current expenditure): In 2025, the taxpayer pays $1 million of wages to employees engaged in R&D. The taxpayer could deduct the full $1 million from its income for the year. It would also earn $350,000 SR&ED ITC, which would be fully refundable.


4. Recapture

If a taxpayer sells or converts the use of capital property recapture rules will apply in respect of the capital cost allowance claimed, as well as the SR&ED ITC earned in respect of said property.

What this means moving forward

Since Parliament was dissolved before the announcements in the FES 2024 could be enacted, they were not passed into law. It is common for a new government to reintroduce proposed amendments in the next legislative session, but there is always a chance they may take a different approach. At this time, there is no indication that the government plans to change course.

If you have questions about the above changes or any other tax issues, please contact one of the authors or a member of our Tax Group.