Financial Claim Review Manual – Review Procedures for Financial Reviewers

Chapter 4.0 Planning the review

Table of contents


 

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4.1 Summary of chapter

This chapter discusses how to plan for the review, and some special situations that might affect the review. This chapter covers the following activities:

4.2 Requirements of the chapter

4.3 Documentation

4.4 SR&ED claim review process

4.5 Service standards and delay codes

4.6 Risk management

4.7 Receiving the file from the control function

4.8 Preliminary review

4.9 Analyzing the information gathered

4.10 Financial reviewer observations

4.11 Identifying review issues and / or concerns

4.12 Preparing the SR&ED financial review plan

4.13 Additional considerations for large files

4.2 Requirements of the chapter

The basic requirements for financial reviewers (FRs) are the following:

  1. Formulate a plan for the review and coordinate that plan with the research and technology advisor (RTA).
  2. Make a written review plan with the following key elements:
    1. identification and rationale for issues to be reviewed;
    2. scope of the review, based on the risk scoring (risk grid) and other factors; and
    3. proposed review strategy.
  3. Consult the financial review manager (FRM) or financial technical advisor (FTA), if needed, before finalizing the plan.
  4. Document all relevant communications with respect to the review planning and revisions made to the review plan.
  5. Follow general Canada Revenue Agency (CRA) requirements for communications and information security, including the safe-guarding of claimants' information.

4.3 Documentation

It is important to stress the benefits of a well-documented file from the perspective of both reviewers. Documenting the review occurs at all stages of the review process: during the planning, the conducting and the finalizing of the review. Some of the advantages of a well-documented file include:

  • increased defensibility of the decision that is made as a result of:
    • documenting due process that was provided to the claimant; and
    • working papers providing the support for decisions made;
  • improved risk management for subsequent year claims; and
  • facilitate an efficient file review by various internal and external stakeholders such as managers (FRM or RTM), Appeals officers, quality review personnel, lawyers from the Department of Justice, and judges from the Tax Court of Canada.

Note: Well-documented does not mean obtaining all invoices or employee T4s. The FR must particularly explain what was done, why, how, by whom, as well as any thoughts, references and conclusions. Supporting documents refer to relevant documents only.

4.4 SR&ED claim review process

The rationale for performing any review is to gain reasonable assurance that the claimant is complying with the relevant legislation. Where it is determined that compliance is an issue, the FR and the RTA will work to clarify specific misunderstandings of the claimant in order to improve future compliance.

The review process itself comprises many steps and procedures. It may be anything from a relatively short process where the only issue examined is quickly resolved, to a long and protracted process where the file has multiple and complex issues requiring research and referrals to Headquarters (HQ). However, the basic process for the FR is generally to perform and document the following steps while coordinating their review process with the RTA, if one has been assigned. Some of these steps may require repetition and modification during the review process.

  1. Gather relevant information.
  2. Identify the material issues and non-compliance to be addressed.
  3. Formulate a review plan that addresses the issues and non-compliance.
  4. Contact the claimant to address the issues and non compliance and to gather additional evidence to resolve them. This may require a site visit.
  5. Provide the findings to the claimant and allow time for rebuttal of those findings.
  6. Finalize the Financial Review Report (FRR) based on final determinations and inform the claimant of the final results.
  7. Finalize the file, insert all of the relevant documentation in the file, and forward the results to the tax centre (TC).

4.5 Service standards and delay codes

The CRA's service standards and its policy on the use of delay codes in respect of claim reviews are discussed in Chapter 2.12. Upon receiving the file, the FR will note the service standard for the file in order to establish the relative degree of priority associated with the particular type of claim filed. As the service standards were implemented for the claimant's benefit, most delays would be a result of the claimant's actions or inability to meet their obligations to the CRA in a timely manner.

To meet the requirements of the service standards, the FR will need to monitor and prioritize their workload regularly. If for any reason the FR believes that the review cannot be completed within the applicable service standard, the FR should advise the responsible FRM.

4.6 Risk management

Risk management is an important aspect in all of the CRA's operations. In the Scientific Research and Experimental Development (SR&ED) Program, using risk assessment techniques is crucial to selecting claims for review and to determining the scope of review. Properly conducted risk assessment identifies files with the greatest potential of non-compliance and thus allows for efficient utilization of resources. It helps prevent doing unnecessary reviews of compliant claimants, thereby increasing the overall efficiency and effectiveness of the SR&ED Program.

The risk management policy, Directive SR&ED 2003-01R SR&ED Claim Processing Risk Management Policy, states:

"The risk management policy of the SR&ED Program is that all complete claims are reviewed, but that the reviews are to be conducted only to the extent necessary to obtain a reasonable level of confidence that there is a minimal risk of material error in the claim. Reviews can range from preliminary reviews of specific issues to detailed on-site reviews of the work and expenditures being claimed. Once identified issues have been resolved, the focus should then be on documenting the conclusions, via the appropriate technical and financial review reports."

Although this directive was last revised in 2004, prior to the inception of process realignment, the essence of the risk management policy has not changed. Only the initial screening and risk assessment procedures have been reallocated between the TC and the coordinating tax services office (CTSO).

Using risk management to select files and issues to review, in conjunction with claimant-centered services, provides a balance between fiscal integrity and delivering timely incentives to claimants. It also minimizes the cost of compliance to the claimant and the cost of administration to the SR&ED Program. The process of risk management for claims begins as soon as the TC receives a claim and it continues throughout the entire review process. The FR thus takes part in the risk assessment during the review. Prior to the FR receiving the file, both the TC and the control function have done a preliminary review of the claim to identify possible areas of concern.

4.6.1 Risk assessment

Risk assessment is the continuous process of evaluating information received over the course of the review and considering its possible negative impact to the CRA. For SR&ED purposes, risk assessment is synonymous with identifying and eliminating issues on a continuous basis as new information comes to light. It involves examining relevant information at the disposal of the FR concerning the claim and the claimant (including the evaluations of risk from the TC and the control function) in order to make a judgement whether the claim requires a detailed review in line with the SR&ED Risk Management Policy. Risk assessment is a component of risk management.

The Risk Management Tool utilized at the TC establishes an initial risk scoring for each claim that either recommends a downscreen at the TC or a referral of the claim to the CTSO for review. All claims referred to the CTSO pass through the control function where the risk grid generated by the TC is reviewed and the claim is evaluated to determine the potential for any further technical and / or financial review. Where the claim is recommended for review, the risk grid should be forwarded to the FR with the comments from the control function. These two sources of information provide a starting point for the determination of the scope and depth of the review.

The preliminary review stage should provide the FR with sufficient information to make an informed assessment of the level of perceived risk for the review. This assessment is updated as the review progresses and additional information is gathered. After identifying the issues, the nature and extent of audit tests to address these issues must be determined and documented in the file. The determination of which issues to review is based on the perceived level of risk associated with each issue. The nature of the tests depends on the nature of the potential issue and the claimant's accounting system, or lack thereof. If after performing the preliminary review, the FR has determined that potential material issues or serious non-compliance exists, the FR would proceed with a detailed review. The focus now becomes the development of a review plan for each of the issues identified.

4.6.1.1 Concept of materiality vs. risk

Materiality relates to but does not equate to risk. Materiality is essentially a judgement of how overstated or understated a claim may be before the CRA would prefer a reassessment of the claim over accepting the claim as filed. To carry out a review in a cost effective manner, the FR needs to consider the concept of materiality which should be established at the preliminary review stage.

Risk in the context of planning a review relates primarily to the risk of non-compliance in the claim. The dollar amount at risk related to the non-compliance may or may not be material in the present claim. However, over time the issue may become material if the claimant continues to claim such ineligible amounts or if the tax intermediary claims similar expenditures on behalf of multiple claimants.

4.6.1.2 Determining materiality

Materiality means that in a given situation some transactions are more significant than others and therefore demand greater scrutiny. The concept of determining materiality is not precise; rather it is a matter of professional judgement and may need to be discussed with the FRM / FTA. Normally, reassessments are not raised for immaterial amounts. However, where exceptions to this policy are deemed to be appropriate, they should be explained in the file.

The following are factors for consideration when determining materiality:

Claim size – An amount that is considered material for one claimant may not be considered material for another. For example, a $20,000 expenditure, representing 20% of a $100,000 claim, may be material whereas the same amount is not considered material when the claim is $10,000,000 (.2% of the claim). Materiality is thus often determined by relating the amount to the size of the claim. When all other factors are equal, this approach results in higher materiality thresholds for larger claims.

Cost vs. benefits – Regardless of the size of a claim, it may not be economical to review issues/ expenditures where the amounts are small due to the costs involved in carrying out any review procedure. However, if a systematic error is discovered, these small amounts may become material if the error recurs many times and a large number of projects are affected.

Consistency – Materiality guidelines should be defined by CTSO management based on the availability of resources and other factors. The guidelines should be applied consistently by FRs for all claimants.

As an example, an FR may decide that, for an expenditure claim of $60,000, $6,000 of expenditure is a material amount. The FR would therefore look at the primary portions of the claim where there could be a material error. Once satisfied that all of the potential adjustments, when added together, amount to less than $6,000, the FR could accept the claim as filed.

4.6.1.3 Evaluating the risk of non-compliance

The risk of non-compliance may stem from a claimant's lack of knowledge or understanding of the policies and law underpinning the SR&ED Program, or from wilful non-compliance. Once the file is assigned to the FR it then becomes the FR's responsibility to review the claim in order to assess the associated risk of non-compliance and determine a course of action appropriate to the circumstances. As the review progresses and the FR learns more about a specific claim, they will be in a better position to assess the risk of non-compliance. While the FR may look at many of the same factors as the control function and the TC, the FR looks at them with greater depth or with the perspective of their specialized knowledge.

Two cases where risk may outweigh materiality follow:

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it may be difficult to determine whether the expenditures and investment tax credits are reasonable. As well, the claimants may be unfamiliar with the legislative requirements of the Income Tax Act. Special care should be exercised when reviewing these claimants. An on-site visit may be warranted in order to provide information concerning the SR&ED Program and obtain knowledge of the claimant and its business.

Wilful non-compliance: Where wilful non-compliance is suspected, materiality becomes less important than risk. That is, the risk to the CRA requires further examination even if the amount of investment tax credit (ITC) in question is not material. FRs should consult with the FRM in such cases.

On occasion, the FR will come across an issue where the potential adjustment is not material. However, the amounts may become material in future years for the particular claimant or, where tax intermediaries are involved, similar amounts may be included in many other claims. The FR must decide whether the issue should be examined in spite of the fact that the present ITC at risk is not material. If unclear about how to proceed, the FR should consult with the FRM to help with the decision. If the final decision is not to propose the adjustment, the FR will advise the claimant in the final letter that the amount is not eligible and why, and that, although the CRA is not making the adjustment in the year, the claimant should not include similar amounts in future claims. Otherwise, the issue will be reviewed normally and the adjustment will be proposed.

4.6.2 Impact of risk and materiality on the scope of review

Once the FR has determined materiality and the risk that the claim may have material errors, the next step is to determine how to address the issues. This involves deciding upon which specific items will be scrutinized to either establish that the claim is materially over (under) stated or that it is substantially in compliance with the legislation and established policies. This process is also known as "scoping the review". An important consideration relevant to determining the scope of the review involves coordinating the review with the RTA such that the FR includes procedures that assist the RTA on joint issues included in the RTA's review plan.

Keeping in mind that the financial portion of the review should be concluded once the FR has established that the potential of an undiscovered material error is minimal, the FR should limit the review process to that required to achieve the above goal. The scope of the review and the review plan will change as new information is received throughout the review process. The scope may be curtailed or expanded depending on what the FR or RTA discover during the review.

4.6.3 Indicators of risk

Indicators of risk include collectively any information filed or derived that appears inconsistent with other known information or norms. It also includes any information that is filed that presents the FR with a question as to whether or not the claimant is complying with the Act and the CRA's associated policies.

Derived information results from the manipulation of primary information, past and present, and takes the form of various ratios, comparisons, trends or even reasonableness tests.

4.6.3.1 Ratio analysis and review of the financial statements

Ratios may be used to determine the reasonableness of the expenditures claimed and may indicate areas that require further verification. Specific ratios such as SR&ED expenses to total expenses or SR&ED salaries to total salaries can be tested against information in the claimant’s income tax return as well as used to determine the reasonableness of SR&ED expenses as reported on the Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim. Ratios can be compared from one year to another and also with the ratios of other claimants in the same industry. Remember however, that a ratio is only a guide and any variance can have many different explanations. Further verification may be necessary when the current year’s ratio indicates a material variance from the expected norm (for example, prior years’ ratios).

4.6.3.2 Comparative analysis and reasonableness tests of SR&ED expenditures

Comparison of current and past filings may provide the FR with indicators of issues that need to be addressed during the review. For example, a significant percentage increase to SR&ED expenditures, year over year, might be unusual. Similarly, in the context of commercial operations, it may not be reasonable to find that a claimant spends a large percentage of their total operating expenses in their SR&ED projects.

4.6.3.3 Trend analysis

Comparing current and prior years’ SR&ED expenditures will identify items that may seem out of the ordinary, unreasonable or questionable. For example:

Have the SR&ED salaries increased materially?

Do the ratios vary greatly from year to year?

Where significant items are identified, they are noted in the review plan and discussed with the RTA and possibly with the FRM or FTA.

4.6.3.4 Tax centre verifications

The FR needs to understand that the TC ensures the accuracy and, in some cases, the reasonableness of amounts on various T2 Corporation Income Tax Return (T2) schedules. As a result, the FR would not normally duplicate these verifications and reasonableness checks. The system validations in CORTAX include:

  • all carryforward balances (losses, investment tax credits (ITCs), SR&ED expenditure pool, and undepreciated capital cost (UCC));
  • addbacks on T2SCH1, Net Income (Loss) for Income Tax Purposes, (amortization, provision for income taxes, charitable donations, and prior year reserves deducted);
  • deductions on T2SCH1 (SR&ED expenses, capital cost allowance (CCA), and any other deduction that is claimed on another T2 schedule); and
  • deduction of the prior year's ITC applied and / or refunded on Form T661.

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During the preliminary review, the FR should not duplicate the reasonableness tests performed by the TC. However, where a detailed review is undertaken, the FR should obtain the true reconciliations from the claimant and verify them.

4.6.3.5 Changes in reporting SR&ED expenditures

FRs should be wary of changes in accounting policies that are made in the year. For a meaningful comparison of figures from year to year, it is necessary that the figures be compiled on a consistent basis. For example, SR&ED expenditures might have been capitalized in the prior year and expensed in current year.

The FR should ensure that the year-to-year comparison is in the same currency. The claimant may have elected to report in a currency other than the Canadian dollar or may have revoked a previous election. The functional currency status code for the particular year can be found in Part 1 of the Func screen in CORTAX. If there is no Func screen, the claimant has never opted into the functional currency reporting regime and all amounts are in Canadian dollars. Refer to appendix 4 for more information on functional currency reporting.

4.7 Receiving the file from the control function

4.7.1 TC risk grid and risk score

All T2 returns are subjected to the initial validation and completeness check by a T2 Assessing Officer at the TC. If an SR&ED claim has been filed, the process is followed up with risk scoring using the SR&ED Risk Management Tool, an automated tool that analyzes a variety of factors based on Form T661 and T2SCH31, Investment Tax Credit – Corporations, information to determine a risk score. The risk grid, which shows the details of the risk score and a list of overriding factors, is used to decide whether a claim is sent to the CTSO for review or whether it can be downscreened.

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 The risk grid is accessed online by the control function at the CTSO where a preliminary screening of the Form T661, T2SCH31 and other financial and technical information is completed. This preliminary screening is performed to determine whether the claim has sufficient potential issues or risks to warrant a more detailed review.

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the control function will either close the file or assign it for a technical and/or financial review.

4.7.2 Comments from the control function

If the FR receives the file, it is because the control function has determined that there are issues that require a more detailed review before the claim can be processed. The comments from the control function are provided (on a form to be determined by the CTSO) and should be accompanied by the SR&ED Financial Checklist / Questionnaire [tool currently in development at SR&ED Headquarters (HQ)] and the risk grid. The risk grid and the risk score created by the TC may provide insights and indicators as to why the file was sent to the CTSO to be reviewed and where the perceived risk lies. The comments from the control function also provide guidance for the minimum review process required to close the file and thus determine the minimum scope and depth of the review.

This preliminary information may provide the FR (in conjunction with the RTA) with a starting point on which to build a review plan. All comments from the control function must be addressed in the review. Further, a rationale must be provided in the file for any issues that will not be examined.

4.8 Preliminary review

The preliminary review commences after a file is received from the control function and involves all of the procedures and interactions required to arrive at the decision point as to whether the claim requires a detailed review or can be accepted as filed. It may also include a decision as to whether the review can be accomplished with or without a site visit. Clearly, the preliminary review includes several activities which are required to arrive at this decision point including:

  • gathering information relevant to the decision;
  • coordinating with the RTA to understand the technical issues and decisions;
  • determining the potential risk areas and evaluating the materiality of each risk;
  • formulating a review plan based on what additional information will be needed to address any material issues; and
  • documenting all of these activities for the file.

The following section will examine the review procedures for the FR when conducting a coordinated preliminary review at the office. Conducting a detailed review, with or without a site visit and finalizing the review are discussed in subsequent chapters.

4.8.1 Gathering information for the preliminary review

At the preliminary review stage, the FR needs to gather and review sufficient relevant information in order to have a sound understanding of the claim. This will help the FR to identify relevant issues and to create a review plan. Also needed is a good understanding of relevant CRA policies, procedures and systems (refer to the discussion in Chapter 1 for a non-exhaustive list) and what sources of information are available both within and outside of the CRA.

If a review was performed in a prior year, the FR should discuss that review with the RTA to gain knowledge of the claimant’s business and projects before preparing the review plan. The FR should also read the financial review report of that prior year.

4.8.2 Internal and public sources of information

The FR should bear in mind that access to claimant information is on a need-to-know basis. The following provides a comprehensive list of sources for the information gathering stage of the review. For our purposes, public information is any information that is readily available on the Internet or in publications; these may be created by private entities or government bodies. Internal sources of information are CRA documents or other sources of information within the CRA that are not meant for distribution to the general public. Even though severed versions of some of these documents may be accessible to the public in CRA "reading rooms" or through an Access to Information and Privacy Act request, we still consider these documents as internal and protected. For our discussion, a claimant’s submissions and filings to the CRA are internal documents since they are confidential, and therefore protected information.

The SR&ED Reference Material page on InfoZone has links to both internal and external sources of information.

Internal information:

  • screener’s comments from the control function
  • risk grid with the risk scoring from the TC
  • current and prior years’ Form T661, T2SCH31 and any other T2 schedules filed (including financial statements) on CORTAX
  • prior years’ review information on databases and common drives, such as prior years’ reports (technical and financial), pre-claim project reviews (PCPRs), account executive (AE) services provided, etc.
  • other accounts (for example, payroll returns)
  • TF98 folder
  • consultation with FTA, RTA and other colleagues who have reviewed similar businesses
  • historical information (log of action) available from various mainframe databases, such as the CSCOR
  • SR&ED Directorate (HQ shared drive):
    • Technical Guidance Division opinions
    • SR&ED HQ 1196-000 course
  • permanent document file, which may include agreements, reports, elections, etc.
  • specialist sections such as Electronic Commerce Audit Specialists, Large Case, International Tax, and Employer Compliance Audit

Intranet sources:

  • Rulings decisions
  • Directives
  • Training material
  • Audit Manual
  • Various internal policies and procedures
  • Claim Review Manual (financial and technical)
  • Technical Guidance Division – Issues and Initiatives

Public information (not an exhaustive list):

  • All documents posted on the CRA Internet Site
  • Press releases and budget announcements
  • Legislation and other related publications
    • Income Tax Act
    • CCH and Carswell publications
    • Income Tax cases
    • Professional periodicals (CICA / CMA / CGA, Law Firm Letters)
  • World wide web
    • Claimants’ Web sites: information related to shareholders, directors, products, investors, funding, customers, suppliers, and competitors, etc.
    • Industry Canada
    • Statistics Canada
    • Industry organizations and publications
    • Provincial government websites

4.8.3 Relevance of selected internal sources of information

CORTAX is by far the most used system by the FR. It captures and stores all of the income tax information filed by corporations and provides revisions to that information based on taxpayer (claimant) requested adjustments and audit or appeals actions. In addition, it is linked to the Business Number (BN) system in RAPID.

Other systems such as RAPID, Audit Information Management System (AIMS), and T2 Assessing Case Management (CSCOR) may also provide useful information related to the file. RAPID holds all of the Income Tax and Benefit Return (T1) information of claimants including the T1 charge-out menu, as well as payroll summaries and Statement of Remuneration Paid (T4 slips) for all employers. AIMS stores information on the results of all prior audit and review actions. It also tracks the status of the current review file. CSCOR is primarily used by the TC to track its log of action and status of current inventory. Some of the additional information available to the FR is discussed below.

4.8.3.1 Form T661, Scientific Research and Experimental (SR&ED) Expenditures Claim

Form T661 and schedule T2SCH31 (or T2038 (IND), Investment Tax Credit (Individuals)) are the primary filing documents to claim SR&ED expenditures and ITCs. When completed fully by the claimant, they provide key information on which to formulate questions and a review plan, and also provide direction as to where to obtain information which could confirm whether a financial issue exists or not. A thorough review of the Form T661 filed is therefore a prerequisite to a better understanding of the comments from the control function, the TC’s risk grid, and to determine what other potential financial issues require further examination.

Generally, in order to identify additional issues with respect to expenditures claimed, the FR would need to compare an expenditure amount on Form T661 with other known or available information. Any inconsistency or resulting question may need to be investigated.

4.8.3.2 T2SCH31, Investment Tax Credit – Corporations, or T2038 (IND) – Individuals

A review of the T2SCH31 or T2038 (IND) provides the FR with important information regarding the quantum and rate of ITC claimed, and the amount of ITCs the claimant is carrying forward from prior years. It also indicates how the claimant is applying any available ITCs to settle their current or prior years’ Part I tax liability, claim a refund, and the amount that is carried forward to future years. The FR should also verify that any capital expenditures qualified for SR&ED ITC are not also claimed as qualified property in Parts 4 to 7 of the T2SCH31.

Limited information from form T2038 (IND) can be accessed in RAPID. Therefore, the FR is advised to charge out the relevant T1 return to see form T2038 (IND) or request a copy from the claimant.

4.8.3.3 T2SCH1, Net Income (loss) for Income Tax Purposes (reconciliation)

The T2SCH1, Net Income (Loss) for Income Tax Purposes, is used to reconcile the net income / loss per financial statements to the net income / loss for income tax purposes. Several lines of the T2SCH1 apply to SR&ED claims. The most common lines used for SR&ED claims are:

  • line 118 – SR&ED expenditures expensed in the accounts;
  • line 231 – recapture of SR&ED expenditures (negative subsection 37(1) pool balance);
  • lines 290-294 – other additions such as the provincial tax credit earned on the prescribed proxy amount (in the current or the prior year);
  • line 411 – amount of SR&ED expenditures deducted in the year, as claimed on line 460 of form T661; and
  • line 499 – sum of other deductions including ITC and government and other assistance recorded in the income statement of the claimant and / or other amounts not related to the SR&ED claim.

Where line 118 does not agree with the amount of current expenditures claimed on Form T661, the FR should attempt to reconcile the amount filed or request and review the claimant’s reconciliation. Similarly, when the amount of ITC and assistance deducted on T2SCH1 cannot be readily matched to the amount reported in the income statement of the claimant, a reconciliation of the deduction should also be requested from the claimant.

4.8.3.4 T2SCH8, Capital Cost Allowance (CCA)

The FR should ensure that SR&ED, all or substantially all (ASA), capital expenditures claimed in the year on Form T661 are not included as additions on the T2SCH8, Capital Cost Allowance (CCA). If there are no ASA capital expenditures claimed on Form T661, the FR would not normally examine the T2SCH8. One exception being that, if there was a claim for shared used equipment (SUE) in the prior year, the FR should ensure that any ITC applied in the prior year related to that SUE is adjusted on the T2SCH8.

4.8.3.5 T2SCH50, Shareholder Information

The T2SCH50, Shareholder Information, is primarily important in verifying the Canadian-Controlled Private Corporations (CCPCs) status of a claimant and the claimant’s entitlement to the enhanced ITC rate of 35%. This process may require the FR to look into the T2SCH50 of the parent companies or additional layers of ownership until the individual controlling interests are determined.

4.8.3.6 T2SCH9, Related and Associated Corporations

The T2SCH9, Related and Associated Corporations , should indicate all of the corporations related to the claimant and it indirectly provides information for other related parties, for example, controlling shareholders of the related corporations. The importance of this information in the context of an SR&ED claim exists where any of these related parties are providing contract services or goods that are claimed as SR&ED expenditures and are not identified as non-arms’ length transactions.

The analysis of this schedule could also indicate that a review is in progress on one of the related or associated corporations. A discussion with the other FR will help to determine if the two corporations should be reviewed by the same FR.

4.8.3.7 T2SCH23, Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Business Limit

The T2SCH23, Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Business Limit, provides the FR with the associated group’s allocation of the business limit for CCPCs for the calendar year. The allocation made to the claimant would be used to determine the Part I tax amount. The FR would also use the business numbers indicated on this schedule to determine the prior year’s taxable income of the associated group, which is one factor in the determination of a qualifying corporation.

4.8.3.8 T2SCH49, Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Expenditure Limit

CCPC claimant is required to file a T2SCH49, Agreement Among Associated Canadian-Controlled Private Corporations to Allocate the Expenditure Limit , when it is part of an associated group and is eligible for the enhanced ITC rate on some or all of its qualifying expenditures. Although the TC does a reasonableness check on the expenditure limit calculation, there are limitations on the accuracy of their verification. Therefore, the FR may need to examine the form and ensure that the total expenditure limit calculated is accurate. Refer to Module C, Lesson 6 of HQ-1196-000 for examples of expenditure limit calculations.

4.8.3.9 T2SCH100, Balance Sheet Information and T2SCH125, Income Statement Information

CORTAX schedules T2SCH100, Balance Sheet Information , and the T2SCH125, Income Statement Information, may be useful when the financial statements are temporarily unavailable. The FR could use these schedules to identify or eliminate several potential issues, such as shortfalls in the addback at line 118 on T2SCH1, excess capital additions on T2SCH8, or an overall proxy cap issue.

4.8.3.10 T2SCH24, Wind-ups and Amalgamations

The FR may need to examine the T2SCH24, First Time Filer after Incorporation, Amalgamation or Winding-up of a Subsidiary into a Parent , in order to verify the expenditure limit claimed for the year. Newly amalgamated (or wound up) corporations that were associated in the prior year would not appear as associated in the current year’s T2 return filing.

4.8.3.11 Carryforward balances, part I tax calculation, investment tax credit applied

When processing adjustments, the FR is required to determine the correct Part I tax payable prior to the application of any available ITCs. At times, the claimant may be reporting different carryforward amounts than those recorded on CORTAX. By comparing the "RPT" entries to the "IAS" entries on CORTAX, the FR may find these discrepancies. Should discrepancies exist, the FR should investigate the sources of these errors for possible correction or for confirmation of the amounts to the claimant.

4.8.3.12 Prior years’ income tax filings

The T2 return and related schedules, including the Form T661, T2SCH31, T2SCH100 and T2SCH125 are available online on the CORTAX system. The T1, Income Tax and Benefit Return (T1), including the T2038 (IND), is available on the RAPID mainframe.

This prior year information could be used to examine trends in SR&ED expenditures or changes in ratios over time.

Note: Some of these trends and ratios may have been identified by the control function and forwarded to the FR for consideration.

4.8.3.13 Permanent document file

Permanent document (PD) files were created to retain documents that may impact more than one tax year and to separate these documents from the tax returns.

The PD may contain information useful to the planning of current reviews, such as prior FRRs, elections, waivers, penalty reports, agreements, directors’ resolutions, correspondence (including rulings), and information regarding concerns that were noted during other contacts with the claimant / representative that require follow up. This information may also be in the T2 file.

4.8.3.14 The business number system

The BN system provides a wealth of information related to the claimant. Some of the information needed for the review includes:

  • location of the books and records;
  • current mailing address;
  • contact information and authorized representatives;
  • owner information;
  • incorporation information; and
  • other accounts open such as GST / HST, Importer and Payroll.

The BN system 

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4.8.3.15 RC59, Business consent for access by telephone and mail

The RC59, Business consent for access by telephone and mail is normally filed by a corporate claimant when they wish to be represented by a third party in dealing with the review process. If the BN system does not indicate that a party is an authorized representative, the FR should not divulge any of the claimant’s confidential information to that party until such time as they have written authorization from the claimant authorizing the CRA to discuss the claim.

If an RC59 is filed indicating that the representative is only authorized for purposes of the claim, that RC59 will not be entered in the BN system. The FR should check the TF98 file before asking the claimant for another RC59. When receiving this restricted RC59, the FR would place it in the TF98 file. If the RC59 has no restrictions, it should be sent to the TC in care of the BN Unit for input.

The equivalent form for use by individual claimants is the T1013, Authorizing or Cancelling a Representative.

4.8.3.16 Notes to the financial statements

The notes to the financial statements may provide sufficient information to determine the treatment of the SR&ED expenditures and receipts. Using these notes, the FR may be able to update and reconcile continuity schedules for deferred costs and capital assets without contacting the claimant.

The notes may also identify related-party transactions, changes to share capital during the year, government loans and assistance received, and additions to capital assets.

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If the T2 return has been filed electronically, the Notes to the Financial Statements may be found at the end of T2SCH100 in CORTAX.

4.8.3.17 Payroll information

The payroll summaries of employers are filed on a calendar year basis and stored on RAPID Option DD.1.

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or to examine the trend of gross salaries and compare the increase or decrease to the trend in SR&ED salaries. A high percent of SR&ED salaries or high percentage increases in SR&ED salaries when compared to the increases in gross salaries may indicate an issue requiring further examination.

T4 slips for the calendar year can usually be found on RAPID Option DD.2. The FR may compare them to the salary information provided by the claimant to determine if the claimant's salary schedule appears reasonable. However, the T4 slips themselves have inherent limitations, especially when the proxy method has been elected by the claimant. The taxable income amount shown on the T4 slip may include bonus payments and taxable benefits for both the current and an adjoining tax year, depending on the year end date of the employer in question. As well, the T4 slips may not as yet be available on the system when the review is in progress; they are not due until the end of February of the following year and, when received, must be input by CRA staff. Also, the T4s are filed for the calendar year whereas the claimant may have a tax year that does not end on December 31.

The claimant's payroll register is a more detailed tool that allows for the verification of several issues such as the date of employment, bonuses, and employee benefits.

 4.8.3.18 Current assignment and delays

AIMS can be accessed to view information on the current assignment of the file, including any delays and the reasons for the delays. The system will also identify other open cases for this claimant for the tax year under review or any other tax year. The FR should be aware of other audits (small and medium enterprises (SME) or large files) in progress because they could affect the assessing information that the FR will be working with to close the file.

 4.8.3.19 Provincial research and development tax credits

The CRA administers the corporate income taxes for all provinces and territories (agreeing provinces) except for Quebec and Alberta (non-agreeing provinces). The details of the provincial tax calculation and credits can be found in Part 2 of T2SCH5, Tax Calculation Supplementary - Corporations. Many provinces offer R&D tax credits in addition to the federal ITC. These credits are generally based on the federal qualified expenditures incurred by the claimant for SR&ED carried on in the province. Provincial claims for expenditures in excess of Form T661 amounts or in jurisdictions where the claimant does not have a permanent establishment may require further review. The provincial claims can be found in CORTAX. Refer to Chapter 6.4.2.1 for a list of the schedules for provincial claims.

Quebec and Alberta also offer R&D tax credits but the claims are not available in CORTAX.

 4.8.3.20 TF98 Folder – Technical Project Information

In most cases, the technical project information will be available in CORTAX for corporations. However, on occasion, it may not be possible for the TC to capture that information in CORTAX. In such a case, that information will be placed in the TF98 folder. The information included in the TF98 folder is highly confidential (Protected B) and should be kept in a secure location such as a bond room or secure locked cabinet. When reviewing the TF98 in the office, the FR should never leave the folder on their desk unattended. It is also strongly recommended that the FR never remove the TF98 from the office. Each TSO should implement tracking procedures and ensure that they are in place and followed when the FR, or anyone else, borrows the TF98.

 4.8.3.21 Assistance from ECAS and using IDEA

If a claimant is tracking the SR&ED expenditures in the accounts, the FR may consider obtaining support from the Electronic Commerce Audit Specialists (ECAS) for the SR&ED review of the large claim. On occasion, the data files needed by the FR may have been already retrieved by ECAS for another program, such as the Large File Program. However, normally SR&ED would review a claim long before other programs. Therefore, given the lead times required by ECAS to obtain and manipulate the data files to meet the needs of the FR, the request for assistance should be made early in the planning phase of the review. Obtaining the data files as early in the process as possible may assist the FR in refining the scope of the review, and in identifying unusual transactions and very large amounts in the SR&ED expenditures. It is expected that using the Interactive Data Extraction and Analysis (IDEA) software should increase the efficiency and effectiveness of the review.

For FRs unfamiliar with IDEAECAS may also provide rudimentary training on this software program that the CRA is using to query data files and extract entries in the accounts of a claimant for the purpose of creating working papers. This on-the-job training does not replace the need to become familiar with all of the capabilities of IDEA through a formal course.

The decision to request assistance from ECAS requires an evaluation of the following elements to determine whether the use of IDEA would improve the efficiency and effectiveness of the review process:

  • the scope of the review with respect to the issues identified;
  • the volume and quality of the claimant's information available in electronic format; and
  • the relative ease of downloading and accessing the required data.

4.8.4 Prior years' review information

If there has been a previous technical and / or financial review, the FR should examine the applicable reports for those years to ensure that any outstanding items are addressed in the current review plan.

4.8.4.1 Prior years' financial review reports

The prior years' FRRs may be useful to the FR to gain knowledge of the claimant's business and the claimant's representatives. The reports may also highlight significant issues for follow-up which the FR needs to address, such as potential ITC recapture, letter issued for better books and records, filing errors and inconsistencies that the claimant was to correct (for example, provincial tax incentives may not have been netted against the qualified expenditures in the prior year). The reports may also provide useful reconciliations of carryforward balances such as the SR&ED deferred costs. A prior year's FRR may provide the following useful information:

  • adjustments and reasons for the adjustments;
  • referrals made;
  • whether a “better books and records letter” was issued;
  • any disputes or other issues with the claimant / representative;
  • reconciliations of any deferred expenditures and the SR&ED expenditure added back on T2SCH1; and
  • nature of books and records maintained by the corporation.

4.8.4.2 Prior years' RTA's SR&ED review reports

The prior years' SR&ED Review Reports of the RTAs may be useful to the FR to gain an understanding of the projects spanning several years. The claimant may also have highlighted key information in the project information such as external assistance to be received or the anticipated end date for the project.

If the FR has not been involved in the prior year reviews, then they may gain substantial knowledge of the claimant and the business of the claimant by perusing these recent reports.

4.8.4.3 Account executive services provided

If Account Executives (AE) services were provided, the FR should examine the interim findings of the RTA and possibly the FR to determine which issues were examined, and whether the claimant made the appropriate adjustments to the filing as a result of this preliminary review. As with the review of prior years' RTA's SR&ED Review Reports and FR's FRRs, the AE file may provide background information on the claimant's business, on-going projects, and the internal controls of the claimant's accounting system.

4.8.4.4 Pre-claim Project Review Service

The FR may wish to review the Form T2020 related to a Pre-claim Project Review (PCPR) to gain background information or refresh their memory of the event. Often during a PCPR, the claimant is provided guidance related to expenditures that may or may not be eligible.

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4.9 Analyzing the information gathered

Sufficient knowledge of the claimant's business is required to prepare a review plan, to formulate questions for the initial interview, and to understand the claimant's responses to the questions. Information gathered during the preliminary review will help to resolve the issues as effectively and efficiently as possible.

Following the gathering of pertinent information, the FR needs to analyze this information in order to identify the potential issues and determine the scope and depth of the review based on risk and the associated materiality. Eventually, this analysis will form the basis of the review plan.

As a starting point, analyzing Form T661 and the financial statements may help identify specific issues and concerns, which should be noted for discussion with the RTA, if warranted. The significant issues identified should be on the review plan and addressed during the interview with the claimant. To this end, a number of tools are available to help the FR identify potential issues. Some of these are:

  • The SR&ED Review Issue Sheet [tool currently in development at SR&ED HQ]lists potential issues and concerns that may be relevant in the review and also provides the specific references to the Act.
  • The SR&ED course, HQ 1196-000, SR&ED – lists issues and suggests steps to resolve them.
  • The Line Number Income Tax Act Reference Sheet [tool currently in development at SR&ED HQ] – a reference tool that matches the Form T661 line numbers with the relevant sections of the Income Tax Act. It provides a quick reference to the Act that helps the FR present references accurately and in a consistent manner.
  • The Notes and Adjustments Sheet – useful to keep track of unusual or important information. The FR can initiate several Notes and Adjustments Sheets and list the specific questions / concerns that need to be addressed. These tools serve as a reminder of the items requiring clarification or verification and are probably the most used working papers in the file.

4.10 Financial reviewer observations

Generally, when gathering information, the FR will attribute importance or irrelevance to any specific information encountered. The observations related to important information would normally either open new questions and information needs or may serve as the explanation to close a previous question. All of these observations relate, directly or indirectly, to risk and materiality. The FR notes these observations and questions in the file so that they are not lost. Ultimately these observations will form the basis for all of the review process undertaken and lead to the conclusions reached by the FR. Once documented, they establish that there was a logical progression to the review and that the conclusions reached are supported by these observations and the review process undertaken.

4.11 Identifying review issues and / or concerns

Having gathered and analyzed the information, the FR may have identified areas of risk that need to be examined in a detailed review. If these review concerns exist, they need to be included in the review plan. In addition, the FR needs to determine whether or not the issues will require input from an RTA to resolve them. If an RTA is assigned to the file, the reviewers should meet to determine how their respective issues will be addressed and to what extent there are joint issues. If an RTA is not assigned to the file, the FR should request RTA assistance as per local office procedures.

The sharing of the perceived risks in the file will allow for the review plans to become both effective and more efficient. As the FR and RTA share their review plans and highlight any need for assistance from the other reviewer, efficiencies will become apparent. For example, duplication of work will be eliminated where it is determined that one reviewer can obtain the information needed by both reviewers. Or possibly, the FR has suspicions that the bulk of the expenditures for one project are ineligible for ITC purposes (for example, performed outside of Canada or by a person who is not a taxable supplier). The sharing of this information could encourage the RTA to refocus the RTA's review plan on other aspects of the claim.

4.11.1 Requesting assistance from the RTA

Throughout the review process, the FR may require assistance or an opinion from the RTA. Once the issues have been identified, communication with the RTA is necessary if the issues depend on a technical decision. For example; equipment claimed for SR&ED may require the RTA to make a determination as to whether this equipment is used ASA in SR&ED. The RTA may already know of the existence of this equipment and may be able to quickly resolve the issue.

Communication with the RTA can be accomplished verbally in person or by telephone. Email communication is appropriate between the FR and the RTA if the relevant communication policy is followed (refer to the CRA's Communications Security Policy). All relevant communications with the RTA should be documented in the file.

Typically, communications related to joint issues include the following:

  1. Claimed SR&ED was performed outside Canada. Is the work in accordance with the definition of SR&ED in subsection 248(1) of the Act?
  2. Shared-use equipment is claimed. Is the percentage claimed reasonable?
  3. Capital expenditures are claimed as ASA for SR&ED. Are the assets used ASA?
  4. Assets were produced as a result of the claimed SR&ED. Was it a prototype, custom product, or commercial asset?
  5. There were physical outputs of a process or production line used in the claimed SR&ED. If there is SR&ED, is the context of the work experimental production (EP) or commercial production with experimental development (CP+ED)?
  6. Materials were claimed. Does the amount claimed relate to the materials consumed or transformed in the prosecution of SR&ED? Are the quantities reasonable and proportional to the needs of the trials?
  7. It is not clear what all the people claimed were actually doing concerning the claimed SR&ED.
  8. The work or output of the work was part of a contract, and it is not clear what was actually being done under the terms of the contract, including the ownership of any Intellectual Property.
  9. Contract payments were claimed and it is not clear if the contract was for SR&ED.
  10. Third-party payments were claimed, and it is not clear who performed the work and what the payments were for.
  11. It is not clear at what point (in time or in a process) the SR&ED ended, or if the work was completed.
  12. Overhead was claimed under the traditional method. Is all overhead claimed directly attributable (directly related and incremental) to the prosecution of SR&ED?

4.11.2 Lending assistance to the RTA

A similar request for assistance may come from the RTA to the FR. For example, the RTA may ask the FR to review the calculation and breakdown of salaries or materials claimed for a particular project as the amounts appear high based on the work that was done during the year. The RTA may also ask the FR to determine if certain capital assets have been claimed, or to what extent a specified employee's salary has been included.

4.12 Preparing the SR&ED financial review plan

When the FR has completed the initial information gathering and analysis stage and has determined risk and materiality, the next step is preparing a review plan. The review plan consists of a list of the items that the FR intends to review. The review plan should identify potential issues and may even indicate the audit procedures that will address these issues. As noted earlier, a written review plan is mandatory for each review. However, the review plan is subject to change; the latest plan is always based on the information currently at hand and will change when significant new information is obtained. A written review plan is essential if the FR is to control their review. It enables the FR to focus on the key issues while managing their time.

4.12.1 Review scope

Once the FR has identified the issues, coordinated with the RTA and discussed the issues with the FRM and / or the FTA (if necessary), the FR and RTA will determine how to resolve the issues by each preparing a review plan and determining whether an on-site visit is needed. In preparing the review plan, the FR will determine the audit procedures needed to both resolve the financial issues and support resolution of the technical issues.

By its very nature, an SR&ED review is a limited scope audit. However, in the context of the review plan, the scope of the review relates to the issues that the FR is planning to examine. Scoping the review involves narrowing the review to a relatively few matters of significance to the SR&ED Program, for example, expenditures for materials associated with one project are reviewed to ensure they are eligible SR&ED expenditures. The scope of the review will also depend upon risk assessment, materiality, the complexity of the file, and history of the claimant.

The review scope may be restricted to certain transactions or operations, or expanded to include other issues. FRs use their professional judgement in determining the scope of the review. When in doubt, the FR should consult with the FRM or the FTA before changing the scope of the review.

In determining whether or not an on-site visit is needed for the detailed review, the FR would consider the following factors:

  • The FR determines that it would be efficient to visit the claimant due to the number of issues to be addressed in the review plan.
  • The volume of information needed to resolve the issues requires an on-site visit.
  • The FR needs to determine the SR&ED context of the expenditures claimed and gain knowledge of the business of the claimant.
  • The claimant has never been visited and / or a first-time filer service would benefit the claimant to better understand the SR&ED Program.
  • The RTA requests assistance from the FR for their on-site visit.
  • The claimant requests an on-site visit.

Even where the FR initially believes that the issues can be resolved without an on-site visit, they will not be precluded from expanding the review to include an on-site visit when circumstances change. Additional examples to the items listed above that could require an on-site visit include the following:

  • The information received from the claimant does not resolve the issues.
  • Due process requires an on-site visit to ensure that the claimant is given every reasonable opportunity to provide information in favour of the claim when the FR considers denying a significant portion of the claim.

4.12.2 Elements of the SR&ED financial review plan

A good review plan includes the scope of the review and states whether an on-site visit is contemplated. The plan should be consistent with the complexity of the file (size of claim and size of claimant). It may include, but is not limited to, such items as:

  • issues identified by the control function and still outstanding after the preliminary review;
  • issues identified during the preliminary review;
  • additional issues identified during the detailed review;
  • scope of the review, that is, for each review issue, identify the reason why and to what extent it needs to be addressed;
  • audit procedures to resolve the issue (with a reference to the appropriate working paper or a listing of expected audit procedures to be conducted with a brief reasoning);
  • discussion of the joint issues requiring assistance from the RTA and delineation of the responsibilities of each party;
  • a managerial approval section, if required by local policy;
  • reference to discussions, if any, with the FRM or FTA with respect to the review plan;
  • reference to the assessment of risk and materiality;
  • follow up of outstanding issues from prior years, if any (for example, recapture of ITC on sale of SR&ED capital);
  • recurring issues that need to be addressed: for example, work in a prior year was performed outside of Canada, or follow-up on whether the claimant has improved the books and records as per CRA's request;
  • the review planning schedule, or a timeline of the procedures to be conducted;
  • procedures to assess the quality of the claimant's internal controls, if needed;
  • discussion of the claimant's books and records;
  • other items that may need to be reviewed:
    • minute book (corporate structure)
    • revenue reconciliation (to determine if there is assistance or the sale of a prototype missing on Form T661)
    • accounts payable review (to determine whether SR&ED expenditures are paid within 180 days)
    • reconciliation of SR&ED expenditures to the financial statements, T2SCH1 and T2SCH8
    • reconciliation of any provincial ITC
    • cost allocations and cutoff of expenditures
    • proxy calculation (overall proxy cap)
    • related / associated claimants or contractors

and

  • assistance, consultation and referrals (that is, SR&ED Directorate in HQ, ECAS; International, Enforcement, Aggressive Tax Planning, Large Case, Small and Medium Enterprise sections, etc.).

The FRM or FTA should be actively involved in the preliminary review stage especially where the reviewer is inexperienced or unfamiliar with the type of business and / or typical issues in the business sector.

Significant changes to the review plan should be discussed with the FRM or FTA unless local policy states otherwise.

4.12.3 Approval of the SR&ED financial review plan

The FR should respect local policy in effect for the approval of review plans. However, if approvals are not required, the FR can still consult with the FRM or FTA regarding any aspect of the review plan before commencing the review (or at any other point in the review). Discussion with the FRM can include the expected hours needed to complete the review, issues identified in a prior year that may impact the working relationship with the claimant, any needed referrals, or even challenges with scheduling the review itself.

4.13 Additional considerations for large files

Although every SR&ED claim is subjected to a risk assessment at the TC, all claims with expenditures in excess of

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are referred to the CTSO, regardless of the risk score. The preliminary screening that is usually performed by the control function may then be deferred to the FR and the RTA, particularly if they have reviewed past claims. The FR and RTA are most aware of what should be in the claim, often having seen the work in progress during a previous review. They may undertake a limited review to determine if a detailed review is warranted, or go directly to planning the detailed review.

Coordination of the review is of the utmost importance in the case of a large file. The issues tend to be more complex than smaller claims and often require more interaction with the claimant as well as more information and documentation. As discussed briefly in Chapter 3, the FR and the RTA are encouraged to undertake a joint review in the case of a large file.

With a large file, communication and coordination are not only required between the FR and the RTA, but also between SR&ED and the Large File Case Manager (LFCM). The LFCM manages the relationship between the CRA and the large corporation. If an audit protocol establishing guidelines for the audit process has been signed between the CRA (represented by the LFCM) and the large corporation, SR&ED reviewers must respect these guidelines and consult the LFCM when planning, conducting and finalizing their reviews. In some cases, the protocol may dictate that the SR&ED review must occur concurrently with the general audit.

Large corporations are accustomed to seeing the same reviewers from year to year. If an FR is assigned a large file for the first time, the FRM or the LFCM should introduce the new reviewer to the claimant.

The LFCM may not be actively involved in the SR&ED review of a large file whether or not there is a protocol, but they may ask to be made aware of significant events such as site visits, and proposing and processing adjustments. The extent of the LFCM's involvement in a case may depend on the particular claimant. Some claimants may ask that all dealings go through the LFCM while others may prefer to deal directly with the SR&ED reviewers.

The address of a claimant's headquarters normally determines which CTSO has jurisdiction over the claim. Large claims are more likely than smaller ones to comprise of SR&ED activities performed in more than one location, sometimes even in multiple jurisdictions. The review may require extensive travelling or assistance from one or more CTSOs. Such considerations are the responsibility of the local management.

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