While the SR&ED claiming guidelines can sometimes seem nebulous, there are some clear truths we can draw from it. One is that there are options that work better based on the size of your company. Some options work better for bigger companies, and others for smaller companies. A great example of this is the decision you will have to make when claiming overhead. Do you go for the traditional method, or the proxy method?
Companies that use the proxy method take advantage of PPA, which is the Prescribed Proxy Amount. This is a percentage of the claimed salary base at which SR&ED overhead and other expenditures are accounted for under the proxy method. Currently, it is 55%.
It’s important to know the answer, because you don’t just get the same amount either way. The “wrong choice” here is the one that doesn’t maximize the amount of your SR&ED claim. It’s true that companies show up in all different sizes, along a spectrum, so here’s how we can phrase our simple rule:
With a few exceptions, it makes sense to use the proxy method rather than the traditional method. If anybody could benefit from using the traditional method, it would be larger companies. With larger companies, the overhead could be bigger and easier to track.
What is the Traditional Method?
The traditional method is where you must track overhead and SR&ED expenditures in a highly detailed way, with a date stamped record keeping system. You will need to show that every expenditure claimed is directly related to the SR&ED project being claimed. Your records will have to show how the amounts are determined and provide supporting evidence for the determination.
It requires more effort over time, but in rare cases, it can pay off for larger companies. Your amount of overhead and expenditures could actually be greater than the prescribed proxy amount, you won’t need to calculate the salary base and determine this PPA, because the PPA is for people using the proxy method. You just have to keep excellent records, and your SR&ED consultants can explain to you what the CRA might consider to be excellent records.
If yours is a large company making a large claim, you might want to calculate what this method would get you before turning to the proxy method.
What is the Proxy Method?
The short answer is that the proxy method allows you to make a capped calculation of overhead expenses so that you don’t need to track such expenditures directly. What you need to do is calculate the amount of salary that is eligible for SR&ED, and the proxy method estimates overhead expenses based on that. The only work that you would need to do that you wouldn’t have to do with the traditional method is to calculate your salary base in order to make that PPA calculation. A lot of time is saved on detailed expenditure and overhead tracking that won’t be as necessary, though excellent records are still your best asset in case of an audit. In most cases, this will maximize your SR&ED claim.
The only down side is if this PPA is less than the actual overhead and expenditures. For most claimants, that will not be the case. If you want to make absolutely sure, you’ll have to calculate what you would expect to get from the same claim using each method. But if you know you don’t have a large company and you’re not making a large claim, you may as well skip straight to the proxy method and not worry about the traditional method’s calculations and strict expenditure record keeping.
The following example is directly from the SR&ED Guide. It helps to illustrate how you would weigh traditional-method overhead claims against the proxy method, and where exactly the proxy calculation comes into play.
Let’s suppose Acme Ltd. is a Canadian controlled private corporation, eligible for an Investment Tax Credit (ITC) of 35%, and these are their numbers:
Salaries of employees directly engaged in SR&ED : $100,000
Materials for SR&ED: $15,000
Overhead expenditures: $50,000
Using the traditional method, the total additions to the pool of deductible SR&ED expenditures would be $165,000. Compare this with the proxy method, where you wouldn’t include the overhead expenditures, and would claim $115,000.
But the proxy method calculation comes into play when the ITC is used to calculate the PPA. You don’t claim the PPA with the traditional method, because traditionally there is no PPA. So the PPA on the amount of $100,000 SR&ED claimable salaries is like adding 55% of the salary amount, and nets you $55,000. $115,000 + $55,000 = $170,000 claimable by proxy method.
Therefore, at its SR&ED claim size, Acme Ltd. would be better off to pursue the proxy method.
If you have additional questions about traditional versus proxy method and which is better for your company’s claim, the consultants at SR&ED Unlimited would be happy to discuss this with you.