By Engineva Research Team
SR&ED, Contractor Costs, Government Funding, CRA Compliance
Why Contractor Costs Matter in SR&ED
For many Canadian companies, third-party contractors and consultants represent a major portion of R&D spending. Whether you hire specialized developers, engineers, or scientists, these costs can be eligible under the Scientific Research and Experimental Development (SR&ED) program—but only if the structure, documentation, and jurisdiction are correct.
The CRA carefully reviews contractor relationships because this is where many claims are incorrectly filed or overstated. Understanding how to plan and document these arrangements can protect your refund and prevent costly denials.
1. The 80% Rule
Under SR&ED rules, you can claim only 80 percent of the amount paid to arm’s-length contractors who perform eligible work.
| Scenario | Contract Value | Eligible SR&ED Amount |
|---|---|---|
| Contractor performs SR&ED work directly | $100,000 | $80,000 |
| Contractor performs a mix of eligible + non-eligible tasks | $100,000 | Prorate only SR&ED portion (e.g., $60,000 if 75% of work qualifies) |
The 20% reduction reflects CRA’s assumption that some costs relate to overhead or administration rather than pure R&D.
Tip: When estimating your claim, always factor this reduction upfront to avoid overstating expenditures.
2. The Geographic Test: Where the Work Happens
For contractor costs to qualify, the SR&ED work must be physically performed in Canada.
Even if you engage a Canadian company, you must confirm that their subcontractors also perform the work within Canada. If any portion of the work is outsourced abroad, that portion becomes ineligible—even if your main contract is domestic.
Tip: During a review, CRA may request proof of work location (such as employee addresses or timesheets). Your claim must trace actual work performed, not just billing entities.
3. The Taxable Supplier Requirement
In addition to work location, the contractor must be a taxable supplier in Canada—meaning they file Canadian income tax and GST/HST returns.
| Eligible | Ineligible |
|---|---|
| Canadian corporation performing SR&ED services in Canada | Foreign corporation with no Canadian tax presence |
| Individual contractor resident in Canada | Non-resident individual working remotely from another country |
Even a U.S. citizen temporarily working in Canada may not qualify if they are not considered a Canadian tax resident.
4. Arm’s-Length vs. Non-Arm’s-Length Contractors
CRA distinguishes between arm’s-length and non-arm’s-length relationships:
- Arm’s-length: The contractor and claimant operate independently, with no shared control or ownership.
- Non-arm’s-length: The parties are related (e.g., common shareholders, directors, or family ownership).
Key difference:
- Arm’s-length contracts qualify for the 80 percent rule described earlier.
- Non-arm’s-length contracts require a different claiming approach, where only the contractor’s actual SR&ED expenditures can be transferred—not the full contract amount.
Example:
If Company A hires a related Company B to perform SR&ED work for $100,000, Company A cannot claim 80% of that amount. Instead, Company B may claim its own eligible costs, or Company A may claim transferred expenditures under specific CRA provisions.
5. Who Can Claim: Payer vs. Performer
In many collaborative R&D arrangements, both the company paying for the work and the company performing the work may believe they are entitled to claim SR&ED.
The CRA allows only one claimant—based on ownership of results and assumption of risk.
| Factor | Determines Who Can Claim |
|---|---|
| IP Ownership | The party that retains ownership of the resulting knowledge or intellectual property. |
| Financial Risk | The party that bears the risk if the project fails or exceeds budget. |
| Direction of Work | The party that defines objectives and evaluates technical progress. |
Example:
Company A hires Company B to develop a prototype.
- Company A owns the IP and bears the cost of failure → Company A claims SR&ED.
- Company B provides technical services only → Company B cannot claim unless its actual costs exceed what it was paid.
Tip: Clear contracts specifying ownership, deliverables, and risk allocation make it easy to defend your claim if reviewed.
6. The “On Behalf Of” Clause
To qualify, contractors must perform SR&ED on behalf of the claimant—meaning the work directly supports the claimant’s experimental development or research.
Eligible Examples
- Algorithm development to overcome a computational limitation
- Prototype fabrication for testing experimental materials
- Statistical model design to test a new predictive hypothesis
Non-Eligible Examples
- General quality assurance testing
- Software installation or maintenance
- Market or user testing for feedback
7. Special Case: Foreign Client Exception
Here’s an often-overlooked opportunity:
If your Canadian company performs SR&ED work for a foreign client, you can still claim SR&ED credits—even if the client pays you and owns the IP.
Because the foreign company cannot file a Canadian SR&ED claim, your payment is considered contract revenue, not government assistance.
The eligible work performed in Canada still qualifies under normal SR&ED rules.
Example:
A Montreal-based AI firm develops an experimental model for a U.S. partner.
The work is carried out by Canadian engineers in Montreal.
Result: The Canadian firm can claim SR&ED on the wages and costs related to that experimental work.
8. Documentation Requirements
The CRA pays close attention to evidence when reviewing contractor claims. Strong documentation should include:
- Detailed contract scope describing the experimental development or research performed
- Invoices and payment proof tied to specific milestones
- Time tracking records showing SR&ED-eligible effort
- Technical documentation (reports, code commits, lab results) connecting contractor work to R&D
Note: Generic consulting agreements that say “professional services” are not sufficient. Every eligible activity must be clearly tied to SR&ED objectives.
9. Strategic Best Practices
- Draft clear contracts outlining IP ownership and technical objectives.
- Confirm all contractors are Canadian tax residents.
- Collect invoices, timesheets, and progress reports as work happens.
- Separate eligible vs. non-eligible tasks at the billing level.
- Coordinate financial reporting to ensure only the net eligible portion is claimed.
Working with experienced SR&ED advisors during the contracting stage often prevents issues that cannot be fixed at year-end.
Final Thoughts
Contractor and subcontractor expenses can be one of the most powerful components of your SR&ED claim—but also one of the most complex.
With the right structure, documentation, and awareness of CRA’s definitions, your company can recover a substantial portion of outsourced R&D costs safely and confidently.
At Engineva, we help companies design SR&ED-compliant contracts, track eligible subcontractor costs, and build airtight documentation that stands up to CRA review.
📞 Book a consultation to review your contractor arrangements and discover how to maximize your SR&ED recovery.
Engineva helps you claim smart, stay compliant, and grow confidently.
Disclaimer
This article provides general information and does not constitute professional tax or legal advice.
Consult a qualified SR&ED specialist to assess your company’s specific situation.