The traditional and proxy methods are two ways to file an SR&ED claim. The traditional method is the default method to file SR&ED claims for businesses who qualify for the SR&ED program. An organization can choose the proxy method to file a claim, on their T661 form on Line 160, if they do not want to use the traditional method. Whatever method an organization chooses, it will become the default method for filing an SR&ED claim for that organization for the entire year.
In the next year, the organization can change the method of filing an SR&ED claim. But any claims filed in a certain method will be processed under the same guidelines even if the year has changed. Similarly, the SR&ED claim will be compensated in the chosen method even if that results in the organization getting a lower compensation. Here we try to provide an interpretation of the benefits and different factors to consider before selecting any method to file a claim.
The Traditional Method of Filing a Claim
SR&ED Canada selects the traditional method of filing a claim if your organization does not choose the proxy method. An organization must have exceptionally organized records of taxes, each online business transaction, and a combination of paper and electronic receipts of business transactions to successfully benefit from choosing the traditional method. Records of all business transactions and all business expenses including the office furnishings, appliances, and fittings may be required and more.
Always remember to include operating expenses in the T661 form if you select the traditional method of filing a claim. Organizations often select the traditional method but fail to include overhead expenses and lose out big time on their compensations. People who are not directly involved in achieving SR&ED goals can also be included if they are there to support the individuals working on the SR&ED program.
According to the traditional method you can claim for plant and equipment expenses if they are 90% or more used to achieve SRED Canada goals and objectives. With the traditional method, you can claim overhead expenses on line 360 as the employer’s share of related benefits. You can also claim other expenses of salary or wages of employees who directly complete, support, or supervise SR&ED functions that are pertinent for the current tax year. With the traditional method, you do not need to calculate a base salary or find out the prescribed proxy amount (PPA). You also do not need to calculate the overall cap.
Some of the disadvantages of the traditional method are that you must be able to prove that the overhead expenses and the other expenses are directly related and valuable for the activities of the SR&ED. The traditional method can also be difficult to implement if you have both SR&ED work and non-SR&ED work in the same physical office. Another disadvantage is that the organization must be specific to identify and calculate which overhead and other expenses are being used for the promotion of the SR&ED goals. A disadvantage for organizations is that you need to provide justifications for the specific amount of the expenses you have claimed. Finally, the PPA can be more than the actual overhead and other expenses sustained by a business.
The Proxy Method of Filing a Claim
Organizations that have projects that require a lot of manual labor will find it easier to file a claim with the proxy method. The proxy method uses a prescribed proxy amount (PPA) equation to calculate the amount a claimant can receive. The PPA is a representation of SR&ED expenses and overhead expenses such as office supplies, heat, water, electricity, telephones, salary, and wages of support staff.
With the proxy method, there is no need to specifically distinguish, track, and designate overhead or other expenses for SR&ED purposes. An advantage is that SR&ED investment tax credit is earned on the PPA. The investment tax credit that is earned is 55% of the salary base calculated with the salary of the employees directly engaged in the SR&ED activities. A benefit for businesses is that it becomes easy to determine the PPA after the base salary is established.
All of the actual and overhead expenses incurred by a business may be less than the PPA. Although a disadvantage is that the PPA or any other expenses represented by the PPA cannot be included in the SR&ED expenses pool of deductible expenditures. Another drawback is that the salary base needs to be calculated including the overall cap on the PPA. Another downside is that the PPA may be less than the actual overhead and other expenses incurred by the organization.
Explanation & Calculation of Prescribed Proxy Amount
Entitled SR&ED expenses are referred to as the PPA which can be included as an alternative to SR&ED operating and other expenses. A percentage of the salary base is referred to as the PPA. The salary base is the sum of all salaries and wages of the workers who are directly committed to promoting and pursuing SR&ED activities and goals. The salaries that are included must be incurred and dispersed within the end of the180 days of the tax year.
But the salaries cannot include any earnings on profits, taxable benefits, incentives, or the previous year’s unpaid salary. The salaries and wages have more restrictions for a person who may be a shareholder of the organization. The PPA is a representation of the SR&ED costs and expenses. The PPA is only used to specify an organization’s qualified SR&ED expenses for computing the investment tax credit. The PPA can be identified as the costs and expenses incurred by a business in a year.
The formula for calculating the PPA is
PPA = [W × 65%] – [W × 5% × X/Z] – [W × 10% × Y/Z]
W = Salary base
X = 2013 number of calendar days in the tax year
Y = Number of days after 2013 in the tax year
Z = Number of days in the tax year
Ideally, the traditional method will be better adapted for larger businesses that have all of their records and business transactions clearly transcribed. It will be more profitable for small businesses to use the proxy method to file a claim because they will not be able to justify so many overhead costs and expenses in comparison to larger organizations.
*Please note that this information is only accurate as of February 15th, 2021*
