Software Development Sub-contractors: Who can make a SR&ED claim?

The development of new software products often requires hiring contractors to leverage skill sets not always available within a company. Software development companies have a choice to perform the research in-house, sub-contract out the Scientific Research and Experimental Development (SR&ED) aspect of the work, or pay a university or not-for-profit organization to perform specific tasks for them.

However, if contracts are not clear about who owns the intellectual property, and what work they were hired to do, it can lead to confusion. Who has the right to the claim tax credits available for science and technological development through the Canada Revenue Agency (CRA)? Is it the sub-contractors or the company that hired them to assist in their technological advancements?

Not surprisingly, Canadian businesses of all sizes are attracted to the lucrative tax credit offered by the SRED programme, whether they are the company developing the software or they were hired to assist in the process. Here we explore the implications of the SR&ED tax credit and who has the right to make a claim for software development projects.

SR&ED for Software Development

In general terms, it is always better to do your own software development R&D. When you do everything in house, you can claim 100% of the eligible research. However, if you decide to outsource SR&ED for software development, you are still entitled to 80% of the expenditures.

Many companies go the sub-contractor route when developing new software, for various aspects of the R&D, especially during the early stages of the project. However, only one entity involved in R&D can be the eligible SR&ED claimant. Therefore it’s important for companies and subcontractors such as dev shops to understand when they have the right to claim SR&ED.

Making SR&ED Claims For Outsourced Software Development

So, when can a company claim the SR&ED tax credit?

If the subcontractor performs the work on behalf of the claimant and the software development company is Canadian, it is the software company hiring the subcontractor who has the right to claim the SR&ED tax credit. To avoid confusion over the claim, software development companies should use the following best practices to ensure they cover the four basic criteria of the CRA in their contracts:

1. The contract specifies the Research and Development (R&D) work

The contract between both parties must be clear that it is the corporation controlling the work and not the R&D sub-contractor. As project lead, the development company contract should include the subcontractor as a member of its team responsible for specific tasks and deliverables to help your corporation complete its goals.

2. The contract indicates who assumes the risk

The contract must show that your corporation assumes all risks associated with the project, financial and otherwise.

3. The contract indicates who owns the Intellectual Property

Your corporation must make it clear you are the sole owners of the intellectual property. You must also pass litmus tests for certain projects, such as those with a university or the federal government.

4. The contract should be for a service, not for a product

Always indicate it is services provided by the subcontractor that you are paying for, instead of an end product to ensure it’s clear you can claim related SR&ED subcontractor expenditures, because you are paying for every incremental task that the sub-contractor will do.

If you cover these four bases, you won’t encounter any challenges either presented by the sub-contractor wanting to claim the SR&ED deduction as their own, or the CRA questioning the validity of your claim.

Can Subcontractors Claim SR&ED For Their Work?

If you are a subcontractor on the other hand, you might be wondering if you can claim SR&ED for your work. The answer is yes, but ONLY IF the company that hired you does not claim the outsourced SR&ED for software expenditures. In this case, you have to meet the same criteria as the corporation that hired you. That means you would have to prove that:

• The contract is not specific to R&D work
• The contract has a price ceiling which means as the subcontractor, you had to assume some associated risks with the project
• You actually maintain ownership of the intellectual property or technological know-how that is created
• The contract with the corporation is for the sale of an actual product, not time-and-materials

If you compare these details to those provided above for development corporation best practices, you will see the onus for IP and the product provided would disqualify them as an eligible claimant for the SR&ED tax credit.

Can Subcontractors Claim SR&ED For Their Work?

Software development companies should consider doing their own software development R&D whenever possible. This is the only way they can claim the full 100% as opposed to just 80%. If you do determine outsourcing is your best course of action, always choose a Canadian company.

As well, ensuring you specify the research to be done clearly in the contract will ensure you meet the CRA’s criteria to qualify for the tax credit. To ensure you don’t encounter a dispute over who claims the tax credit, get clarity up-front and clearly outline who owns the IP in the contract.