Traditional and Proxy Methods Policy

Date: March 30, 2022

Table of contents

• 1.0 Purpose
• 2.0 Overview
• 3.0 Choice of method
• 4.0 Traditional method
  • 4.1 Legislation
• 5.0 Proxy method
  • 5.1 Legislation
• 6.0 Traditional method vs. proxy method
  • 6.1 Comparison of the treatment of expenditures
  • 6.2 Salaries or wages
  • 6.3 Retirement allowances
  • 6.4 Personnel expenses
  • 6.5 Cost of training
  • 6.6 Cost of materials consumed or transformed
  • 6.7 Contract expenditures for SR&ED performed on behalf of the claimant
  • 6.8 Provincial and territorial research and development tax credits
  • 6.9 Comparison of the traditional and proxy methods
  • 6.10 Example – Additions to the expenditure pool and calculating the investment tax credit for the traditional and proxy methods
• Appendix A – References
  • A.1 Legislative references
• Appendix B – Revisions
  • B.1 Explanation of changes

1.0 Purpose

The purpose of this document is to clarify the position of the Canada Revenue Agency (CRA) regarding the traditional and proxy methods when administering the scientific research and experimental development (SR&ED) legislation under the federal Income Tax Act and the Income Tax Regulations.

2.0 Overview

The Income Tax Act provides two methods for calculating expenditure additions to a pool of deductible SR&ED expenditures — the traditional method (see section 4.0) and the proxy method (see section 5.0). The amount that can be included in a pool of deductible SR&ED expenditures will depend on whether the claimant elects to use the proxy method or chooses to use the traditional method for a tax year. The choice of method is made on a year-by-year basis and it is irrevocable for the year. After a claim has been filed, the method of determining the SR&ED expenditures cannot be changed.

The main difference is that the traditional method allows specifically for the inclusion of SR&ED overhead and other expenditures incurred in the pool of deductible SR&ED expenditures. The overhead and other expenditures are also included in the qualified SR&ED expenditures used to calculate the investment tax credit (ITC). Under the proxy method, the prescribed proxy amount (PPA) is calculated, representing a notional amount replacing incurred SR&ED overhead and other expenditures. The PPA can only be included in the qualified SR&ED expenditures used to calculate the ITC. 

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method
Subsection 37(10) Time for election

Legislative Reference Income Tax Regulations
Subsection 2900(4) Calculation of the prescribed proxy amount

3.0 Choice of method

For each tax year, a claimant has to select one method to claim SR&ED expenditures. It is important to note that the selection cannot be changed for the tax year once the Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim is filed.

If the traditional method (see section 4.0) is used, each amount for SR&ED overhead and other expenditures claimed must be identified and its inclusion in the pool of deductible SR&ED expenditures justified by the claimant. For claimants who choose to use the traditional method, well-maintained books and records cannot be over emphasized. For more information on keeping records, refer to the Keeping records webpage.

Alternatively, the claimant must elect to use the proxy method (see section 5.0) each year on the form T661 when the first claim for the year is filed, otherwise the traditional method will apply automatically.

Legislative References Income Tax Act
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method
Subsection 37(10) Time for election

4.0 Traditional method

4.1 Legislation

Expenditures of a current nature

Under the traditional method, expenditures of a current nature on or in respect of SR&ED, include:

• An expenditure that is all or substantially all (ASA) attributable to the prosecution, or to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada;
• An expenditure that is directly attributable to the prosecution of SR&ED, or directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED in Canada.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method

Legislative References Income Tax Regulations
Subsection 2900(2) Expenditures directly attributable to the prosecution of SR&ED – Traditional method
Subsection 2900(3) Expenditures directly attributable to the provision of premises, facilities or equipment for the prosecution of SR&ED – Traditional method

5.0 Proxy method

5.1 Legislation

Expenditures of a current nature

Under the proxy method, expenditures of a current nature on or in respect of SR&ED include only:

• an expenditure in respect of the prosecution of SR&ED in Canada directly undertaken on behalf of the claimant. Refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy;
• the portion of an expenditure for salary or wages incurred in the year for an employee who is directly engaged in SR&ED in Canada that can reasonably be considered to be for such work, with regard to the time the employee spent performing the work. For this purpose where that portion is all or substantially all (ASA) of the expenditure, that portion shall be deemed to be the amount of the expenditures. Refer to the SR&ED Salary or Wages Policy; and
• the cost of materials consumed or materials transformed in the prosecution of SR&ED in Canada. Refer to the Materials for SR&ED Policy.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

6.0 Traditional method vs. proxy method

6.1 Comparison of the treatment of expenditures

Table 1 illustrates the treatment of expenditures under the traditional and proxy methods.

The PPA approximates overhead and other expenditures such as:

• office supplies
• heat, water, electricity, and telephones
• salaries or wages of clerical and administrative staff providing a service to SR&ED employees
• other salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED and relating to work not considered to be directly engaged in SR&ED (for example, long-term planning for future SR&ED projects and contract administration that directly relate to the SR&ED work)
• contract costs for work that is not SR&ED (for example, the work of electricians, welders, and mechanics), which is directly related and incremental to the performance of SR&ED
• employer's share of related benefits
• travel and training
• property taxes
• maintenance and upkeep of SR&ED premises, facilities, or equipment
• any other eligible expenditure directly related to the performance of SR&ED that the claimant would not have incurred if the SR&ED had not been carried out

6.2 Salaries or wages

Under the traditional method (see section 4.0), salaries or wages for SR&ED related to work that is not directly engaged may be claimed as overhead and other expenditures if the expenditures are directly attributable to the prosecution of SR&ED. The portion of other salary or wages of employees who directly undertake, supervise, or support the performance of SR&ED but who are not directly engaged in SR&ED can be claimed as SR&ED overhead and other expenditures on line 360 of Form T661, Scientific Research and Experimental Development (SR&ED) Expenditures Claim. Refer to Table 5 in the T4088, Guide to Form T661 Scientific Research and Experimental Development (SR&ED) Expenditures Claim, for example of such tasks.

Additionally, expenditures that are directly related and incremental to the prosecution of SR&ED are directly attributable to SR&ED. Salary or wages incurred for clerical and administrative personnel providing a service to SR&ED employees could be considered to be directly related and incremental to SR&ED depending on the facts of the case. Claimants should be prepared to identify the work performed, and be able to show that the expenditures are directly related to the prosecution of SR&ED  and that the expenditures would not have been incurred if the SR&ED had not been conducted (incremental).

If a claimant has elected to use the proxy method (see section 5.0), only salaries or wages for directly engaged SR&ED work can be claimed. Salaries or wages related to work that is not directly engaged cannot be claimed, since these amounts are captured by the PPA.

For more information on SR&ED salaries or wages, refer to the SR&ED Salary or Wages Policy.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

6.3 Retirement allowances

Under the traditional method, a retiring allowance may be allowed as an overhead or other expenditure that is either  ASA attributable or directly attributable to the prosecution of SR&ED in Canada. For more information on retirement allowances, please refer to the SR&ED Overhead and Other Expenditures Policy.

A retiring allowance cannot be claimed under the proxy method since this type of allowance is considered to be part of the PPA.

Legislative References Income Tax Act
Subsection 37(1) Pool of deductible SR&ED expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

6.4 Personnel expenses

Under the traditional method (see section 4.0), the following personnel expenses may be allowable:

• moving expenses relating to selected candidate(s) and to relocate SR&ED employees to another facility, and
• taxable benefits to employees related to selecting and hiring SR&ED personnel.

For more information in respect of personnel expenses, refer to the SR&ED Overhead and Other Expenditures Policy.

Under the proxy method (see section 5.0), only the taxable benefits that are included in the salary or wages of an employee who is directly engaged in SR&ED may be deductible.

Legislative References Income Tax Act
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – Current expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Clause 37(8)(a)(ii)(B) SR&ED expenditures in Canada under the proxy method

Legislative Reference Income Tax Regulations
Section 2902 Prescribed expenditures

6.5 Cost of training

The cost of training can only be claimed under the traditional method. If a claimant uses the proxy method, training costs cannot be claimed since they are covered by the PPA.

For more information in respect of the cost of training, refer to the SR&ED Overhead and Other Expenditures Policy.

Legislative References Income Tax Regulations
Paragraph 2900(2)(c) Other expenditures directly related and incremental to the prosecution of SR&ED – Traditional method

6.6 Cost of materials consumed or transformed

The cost of materials consumed or materials transformed in the prosecution of SR&ED may be claimed when using either the traditional method or the proxy method. For more information on materials, refer to the Materials for SR&ED Policy.

Legislative References Income Tax Act
Paragraph 37(1)(a) Pool of deductible SR&ED expenditures – Current expenditures
Clause 37(8)(a)(ii)(A) SR&ED expenditures in Canada under the traditional method
Subclause 37(8)(a)(ii)(B)(V) SR&ED expenditures in Canada under the proxy method – Cost of materials consumed or transformed

Legislative Reference Income Tax Regulations
Paragraph 2900(2)(a) Expenditures directly attributable to the prosecution of SR&ED – Traditional method – Cost of materials consumed or transformed

6.7 Contract expenditures for SR&ED performed on behalf of the claimant

To claim the SR&ED contract costs, under the traditional method (see section 4.0) or proxy method (see section 5.0), a claimant must have contracted to have SR&ED performed in Canada on its behalf. The contractor must have performed SR&ED work as defined in subsection 248(1) of the Income Tax Act.

If the work performed by the contractor is support work, it must be commensurate with the needs and be directly in support of the SR&ED performed by the payer. Given that these requirements have been met, a payer may claim support work done by a performer regardless of the method chosen by the payer—the traditional or proxy method.

Costs for work that is not SR&ED or support work cannot be claimed as contract expenditures for SR&ED, but may be allowed under the traditional method as overhead and other expenditures.

For more information on claiming SR&ED contract costs, refer to the Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy.

Legislative References Income Tax Act
Subparagraph 37(1)(a)(i.01) Pool of deductible SR&ED expenditures – Current expenditures, on behalf
Subsection 248(1) Definition of “SR&ED”, paragraph (d)

6.8 Provincial and territorial research and development tax credits

The treatment of provincial and territorial research and development (R&D) tax credits is the same under both the proxy and the traditional methods in determining the amount of qualified SR&ED expenditures for the year.

Under the proxy method, the portion of the provincial or territorial R&D tax credit that relates to the PPA reduces the qualified SR&ED expenditures, because it is assistance in respect of SR&ED regardless of whether the credit is refundable or non-refundable. The amount of provincial or territorial tax credit that relates to the PPA is not included in determining the amount of assistance to be applied against the pool of deductible SR&ED expenditures. This amount should be included in net income for income tax purposes (T2SCH1) in the tax year it is received. For an example of the treatment of provincial government assistance under the traditional and proxy methods, refer to section 6.0 of the Assistance and Contract Payments Policy.

For example, the Quebec R&D salaries tax credit program includes in its calculation the salaries and the portion of a subcontract that is attributable to salaries, for work that assists the R&D. If the claimant has elected to use the proxy method, such expenditures do not qualify as allowable SR&ED expenditures under the federal SR&ED program because they are overhead and other expenditures. Therefore, this portion of the Quebec R&D salaries tax credit is not assistance for the purposes of calculating the pool of deductible SR&ED expenditures. For more information on this subject, refer to section 4.5.3 of the Assistance and Contract Payments Policy.

Legislative References Income Tax Act
Paragraph 12(1)(x) Inducement, reimbursement, etc.
Paragraph 37(1)(d) Pool of deductible SR&ED expenditures – Government or non-government assistance
Subsection 127(18) Reduction of qualified expenditures

6.9 Comparison of the traditional and proxy methods

Table 2 illustrates the advantages and disadvantages under the traditional and proxy methods.

6.10 Example – Additions to the expenditure pool and calculating the investment tax credit for the traditional and proxy methods

The example below illustrates the differences in the additions to the pool of deductible SR&ED expenditures when calculating an  ITC  using the traditional method (see section 4.0) and proxy method (see section 5.0). It does not include the impact of any potential assistance from provincial or territorial research and development tax credits.

Acme Ltd. is a Canadian-controlled private corporation and is entitled to ITC at a rate of 35%. Acme Ltd. has incurred the following SR&ED expenditures in the tax year that just ended.

Salaries of employees directly engaged in SR&ED : $100,000
Materials for SR&ED: $15,000
Overhead expenditures: $50,000

* $100,000 x 55% = $55,000.

Appendix A – References

A.1 Legislative references

Appendix B – Revisions

B.1 Explanation of changes

The following are the explanation of changes to the Traditional and Proxy Methods Policy as part of the revision of March 30, 2022:

Section 2.0 has been revised to include a new paragraph, which provides a brief description of the main difference between the traditional and proxy methods.

Sections 4.1, 5.1, and 6.1 have been revised to remove any discussion related to expenditures of a capital nature as such expenditures do not qualify for SR&ED tax incentives after 2013.

Former sections 6.8, Lease costs and 6.9, Capital expenditures, were removed as expenditures of a capital nature are excluded from SR&ED expenditures.

Former section 6.10 Provincial and territorial research and development tax credits, was renumbered as section 6.8. Some clarifying wording was added.

Former section 6.11 Comparison of the traditional and proxy methods, was renumbered as section 6.9.

Former section 6.12 Example – Additions to the expenditure pool and calculating the investment tax credit for the traditional and proxy methods, was renumbered as section 6.10.

Other minor formatting and editing corrections were made throughout the document.