What is a Research and Development Tax Credit?

Carol Francois

A research and development tax credit is available to businesses and organizations that conduct these activities on a regular basis. The purpose of this type of tax credit is to encourage companies to invest in research and development. Almost every country in the world with a taxation system provides some type of research and development tax credit.

Businesswoman talking on a mobile phone
Businesswoman talking on a mobile phone

There are three aspects to every research and development tax credit program: eligibility criteria, suitable expenses and program management. This type of tax credit is not available for personal income tax returns, only for business or corporate returns. Inventors who wish to claim this credit must register a business through the appropriate channels and must meet all of the reporting criteria for the expenses to be admissible.

The eligibility criteria for the research and development tax credit typically includes documented proof of a research project; receipts for equipment, supplies and related expenses; and some type of report on research progress. The total amount of the tax credit varies, depending on the local tax regulations. Some jurisdictions have a ceiling on the total amount of tax credit available.

Suitable expenses for the research and development tax credit usually are restricted to equipment, supplies and consumables that are used directly to conduct research. The tax guidelines will include a list of items that are specifically excluded from the tax credit. Common items that are excluded include computer equipment, office supplies, food and entertainment costs.

Program management evidence is necessary to properly track the expenses and project details in order to support the research and development tax credit. In many companies, the responsibility for tracking costs is part of a larger project management process. Most enterprise resource planning or accounting systems include the ability to flag specific expenses that are eligible for a tax credit.

The effective use of research and development tax credit programs provides a form of government funding for product development efforts in private industries. Although the company might eventually profit from the research efforts, the costs can be quite high and often form a barrier to small or medium-size enterprises investing in new technology or ideas. Tax credits for businesses can be carried forward and backward several years, allowing the company to offset expenses in future years.

In most companies, annual tax returns are filed upon completion of the fiscal year-end review process. The financial statements are used as the base document, from which the tax statement is prepared. Expenses must be reorganized to be included or excluded based on tax rules.

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