How to Assess Third Party Software Development Costs for SR&ED

To assess third party software development costs for Scientific Research and Experimental Development (SR&ED), Canadian businesses will need to assess if what they have done is eligible and what the associated costs are. This process will help Canadian companies ensure that they are claiming the correct eligible costs, and keeping proper records.

Assess Whether the Activities are Eligible

The first thing to look at is whether the actual software development activity is eligible. You will generally require systematic investigation or searching to be carried out via experimentation/analytical methods to get eligible SR&ED activities. Simple programming or software development, maintenance and development using standard techniques will not be eligible.

Look at why you engaged in this work and what experimentation was carried out to address the technical uncertainty. For example, developing a standard application using standard frameworks will not be eligible but if you are looking at a new processing architecture to solve past performance issues then this could be eligible. You can use contracts, technical specs, project plans and development documentation to understand the nature and purpose of the work. Understanding the SRED eligibility requirements can also help businesses determine whether their software development activities qualify.

Break Down Costs to Understand what is Eligible

Often you will have mixed costs coming back from third parties. Your vendor may have charged you for experimentation, standard development, project management, testing, deployment and maintenance activities. Ask for detailed invoices or a breakdown so you understand which costs relate to eligible SR&ED activities.

Just because you are doing something to support your overall research project doesn’t mean it is eligible. Often standard development, deployment and release activities may not be eligible. To ensure you are allocating costs correctly you want to use a reasonable and justifiable method. This could be based on what activities were carried out, how much time was spent developing, project milestones, etc. This will give a more accurate claim and will be easy to explain to the CRA.

Review the Agreement

The type of relationship you have had with your vendor can impact how you treat the costs. Look at what was included in your agreement. Was there a service provided? Were deliverables defined? What was the IP ownership? Who made the technical decisions and carried out what experimentation? You can use the payment terms, ownership and contract to understand what was going on.

There are different types of costs for SR&ED in Canada. This will depend on what the costs are and what type of relationship you had. You should also ensure that the costs were incurred and paid in the correct period. If you received any reimbursements, assistance or other adjustments this may affect your claim. Getting professional tax advice from G6 Consulting can help you understand what class of costs they are.

Ensure You Have Good Records and Allocated Costs Correctly

Having good records to show what costs were incurred and why will help you. Try to keep a copy of your contract, invoices, payment details, project plans, timesheets, technical meetings, test results, source control and experimentation reports. These should explain what the development team were trying to do, what issues arose and what different options were looked at.

Ensure you are allocating your costs in a consistent way. If your vendor has helped with multiple projects or there were ineligible activities then don’t assume the whole invoice relates to SR&ED. Ensure that you can justify what you are claiming by matching up your claim with your accounts. You should also ensure that your supporting documentation matches. Having clear records will help show that the work was done in the correct fiscal period.

Estimate the Benefit

As a final check you should look at what costs you may be able to claim and how much benefit you will receive from the tax incentive. Just because you have eligible costs doesn’t mean you will get the same amount of credit back. This will depend on what type of costs they are, your company situation, what rules apply and whether you are eligible for increased refundable credits. There may also be different incentives at federal and provincial level.

Create a draft cost plan to identify what activities were eligible, what costs were incurred, what evidence you have and what questions you have around eligibility. Reviewing this with an SR&ED specialist or qualified tax professional can help you identify any errors with how you have classified your costs and identify areas to improve your documentation. Taking your time to carefully review your costs will ensure you have a stronger claim and will help you make informed decisions around future third party research and development projects.

Conclusion

When considering third party software development costs for SR&ED you need to review the technical activities, agreement, cost types and documentation. Don’t assume all your software development is eligible – focus on showing that you have eligible experimentation. By separating out the standard development, using reasonable methods to allocate your costs and having good records you will have a more accurate claim and better manage your opportunities for tax incentives.