Subcontractors and SR&ED ‘Loopholes’

Subcontractors who are Canadian (i.e. companies operating in Canada), or individuals in Canada hired on a subcontract basis and are performing SR&ED eligible work, can be claimed under the program. The difference between subcontractors and employees is simply the refund rate. Through the program, a higher return rate is applied to salaried employees versus subcontractors.

There is another scenario involving subcontractors that people mistakenly think is a loophole to be exploited. In some cases, a company will hire a Canadian subcontractor (typically a company) to perform some SR&ED eligible development on their behalf. The Canadian subcontractor then outsources this work offshore. Some outsourcing companies present this as a way to win business as they can lower their costs to the client, while still allowing the client to claim SR&ED on their work. In fact, this is not a loophole, and is something that the CRA accounted for long ago. Through a directive, that can be found here, the CRA basically states that the work performed by a Canadian subcontractor who in turn outsources the work outside of the country, SR&ED cannot be claimed on that portion of work. There are a few other nuances, we’ve tackled the gist of it. This rule has been in place for many years now, but few people take the time to read the directives that refine the rules of SR&ED.

Knowing the above, some companies will still try to file SR&ED on the entire subcontracted amount, with the attitude that they “didn’t know”, or “played the odds of getting caught”. This is tantamount to tax fraud, as amounts claimed are being misrepresented. In the eyes of the CRA, claiming ineligible amounts is the same as underreporting income, or claiming credits on things for which you are not eligible. Similarly, it is not sufficient to rely on the representations of your subcontractors who say you can claim on their outsourced work. At the end of day, you are the one filing your SR&ED claim, and if such a misrepresentation gets noted, the best case is your claim gets reduced, and in the worst case, you can have your entire claim rejected, and get fined.

If you have any questions about SR&ED and subcontract arrangements, feel free to contact us.