SR&ED Founder Salary or Dividends: What Counts for the Claim

Do dividends count for SR&ED?

No. An SR&ED claim counts the salary or wages of employees for the share of their time spent on the work (Income Tax Act s. 37(8); Regulation 2900(2)). The Act defines salary or wages as income from an office or employment (s. 248(1)). A dividend is a return on shares, not pay for work, so a founder paid only in dividends adds nothing to the claim for their own time.

What makes a founder's case less simple:

• Ownership. A founder who owns 10% or more of any class of shares is a specified employee, which brings exclusions and caps.
• Control. The refundable 35% credit is for Canadian-controlled private corporations. A corporation controlled by non-residents, such as one owned by a US parent, generally earns the 15% credit, and it is not refundable (CRA). That shrinks what salary buys.
• Associated corporations. A founder who is also a specified employee of a holding company or another associated corporation brings a shared cap and a filed agreement (see below).
• Quebec. Quebec employers deduct QPP, not CPP, and Quebec has its own research credits.

Gather the cap table, payroll records and T4 slips, the year-end date, and time records showing what each founder worked on. Salary or dividends as a general choice is covered in salary or dividends.

Who is a specified employee for SR&ED, and why are most founders one?

A specified employee is an employee who owns, directly or indirectly, 10% or more of the issued shares of any class of the corporation or a related corporation at any time in the year, or who does not deal at arm's length with the corporation (s. 248(1)). Founders usually hold far more than that, so most founders are specified employees.

The test reaches further than direct ownership:

• Shares owned by a person the founder does not deal at arm's length with, such as a spouse, count as the founder's.
• Shares held through a partnership or a fixed trust count in proportion to the founder's interest. A beneficiary of a discretionary trust, such as a typical family trust, is treated as owning all of the trust's shares.
• Ownership at any time in the year is enough, so a founder diluted below the line after a round may still be specified for that year.
• A family member who works in the business but owns no shares is still a specified employee if they do not deal at arm's length with the corporation.

The CRA salary or wages policy uses the same test and gives a startup example where every founder kept enough shares to be specified.

Does a year-end bonus to a founder count for SR&ED?

No, if the founder is a specified employee. The Act excludes remuneration based on profits or a bonus paid to a specified employee from SR&ED expenditures (s. 37(9); Guide T4088, line 305).

The CRA describes a bonus as an amount in addition to the employee's normal pay (salary or wages policy). A year-end amount declared to clear the corporation's income down to a target, the common owner-manager pattern, risks being treated as a bonus or as remuneration based on profits. Regular salary set and paid through payroll during the year is what the claim can include.

Bonuses and profit-based pay are also kept out of the proxy salary base for every employee, not only specified ones (Regulation 2900(9)). A bonus can still be deductible to the corporation; it just earns no SR&ED credit for a specified employee.

Is there a cap on founder salary in an SR&ED claim?

Yes, two. The SR&ED salary claimed for one specified employee cannot exceed $373,000, which is five times the year's maximum pensionable earnings ($74,600.00), prorated for the days in the tax year the person was a specified employee (s. 37(9.1)). Under the proxy method, a second, lower cap limits how much of that salary earns the overhead allowance (Regulation 2900(7)).

The proxy cap matters for a founder who spends nearly all their time on SR&ED. If a founder spends all or substantially all of their time on SR&ED, as the CRA's salary policy defines it, the full salary normally counts, but the proxy base for a specified employee still stops at 75% of total salary.

Associated corporations share the cap. If a founder is a specified employee of two or more associated corporations, none of the founder's salary counts in any of them unless they all file an agreement allocating one cap among them (s. 37(9.2) to (9.4)). The proxy salary base for a founder employed by associated corporations is also capped once across the group (Regulation 2900(8)). Check this whenever a founder holds shares through a holding company that also employs them.

How much SR&ED refund does a founder's salary bring back?

A Canadian-controlled private corporation within its $6 million expenditure limit earns a credit of 35% on qualified spending. For a corporation whose prior-year taxable income was no more than $500,000, and within the taxable capital limits, the credit on current spending is 100% refundable, paid in cash even with no tax owing (CRA).

Under the proxy method, which the corporation elects on Form T661 when it first files the claim for the year (s. 37(10)), qualified spending for a founder's salary is:

1. The SR&ED share of the salary, within the cap above.
2. Plus a prescribed proxy amount of 55% of that share, within the proxy cap, in place of claiming actual overhead (Regulation 2900(4)).
3. Times the credit rate.

The proxy cannot exceed the business's total deductible expenses less certain listed items (Regulation 2900(6)); the CRA says this rarely bites when other expenses are well above the proxy. Under the traditional method, actual overhead replaces the proxy. Who qualifies for a refund, provincial credits and refund timing are covered in claiming SR&ED on your corporate return. After a large round, taxable capital can reduce the expenditure limit; see SR&ED and small business limits after a large round.

What does a founder salary cost in CPP, remittances and personal tax?

Salary brings payroll and personal tax costs that a dividend does not. The corporation deducts the salary, but it must run payroll, and both the founder and the corporation pay CPP.

A dividend avoids CPP and payroll but earns no SR&ED credit. Salary also creates RRSP room and CPP pension credits; see salary for RRSP room and CPP. If the corporation has no taxable income, the salary deduction adds to its loss rather than cutting tax now, so the refundable credit is usually the main cash return. Payroll setup and remittance deadlines are in running payroll, and how much to pay overall is in how much to pay yourself.

Can unpaid founders claim their time for SR&ED?

No. SR&ED credits are earned on expenditures, and a founder who is paid nothing creates no salary expenditure, however many hours they put in (s. 37(8)). Dividends paid later do not fill the gap.

What can still count in a year with unpaid founders: salary of other employees, payments to contractors who do the work, and materials, subject to the rules in claiming SR&ED on your corporate return. Keeping time records from the start still matters if the founders begin drawing salary later in the year.

When must founder salary be paid to count for SR&ED?

Salary accrued at year-end must be paid within 180 days after the end of the tax year to count in that year. If it is still unpaid then, it is treated as incurred only when paid, both for the deduction and for the credit (s. 78(4); s. 127(26)).

A prior-year amount paid late can enter the SR&ED salary for the year it is paid, but it never enters the proxy salary base (Regulation 2900(9); prescribed proxy amount policy). The CRA says the best evidence of payment is that the related payroll withholdings were remitted on time (salary or wages policy). Founders who accrue salary they cannot yet pay may find the credit arrives a year later and smaller.

What records show how much of a founder's time was SR&ED?

The claim needs a reasonable, supported split of each founder's time between SR&ED and everything else. The CRA bases "directly engaged" on the tasks a person performs, not their title, and expects a claimant's records to capture that time (salary or wages policy).

Keep:

• Timesheets or another time record, made as the work happens, that separate SR&ED from fundraising, sales, hiring and management.
• Project notes that tie the time to the technical uncertainties being worked on.
• Payroll records and T4 slips showing what was paid and when, and proof of remittances.
• The cap table, with dates of every share issue or transfer, to show who was a specified employee and for how many days.
• For a founder claimed at all or substantially all of their time, evidence for that founder specifically; the CRA expects support for each employee.

Founders split their time more than most staff, which makes an estimate after the fact harder to defend. In the CRA's own startup example, the claimant set aside a founder's rough estimate and used a reasoned method based on meeting time instead.

Example

These examples are illustrative and use Canadian dollars. Each corporation is a Canadian-controlled private corporation eligible for the fully refundable credit, using the proxy method, with enough other expenses that the overhead cap on the proxy does not apply.

Two founders on salary

Two Calgary founders each own half the shares and each take a C$100,000 salary through payroll. Time records show 70% of each founder's time on eligible work.

• SR&ED salary per founder: C$70,000, under the cap.
• Proxy base: C$70,000, below the lesser of 75% of salary (C$75,000) and the 2.5-times cap.
• Proxy amount: 55% of C$70,000 = C$38,500.
• Credit per founder: 35% of C$108,500 = about C$37,975, refundable.

Against that, each founder's salary costs about C$4,650 of CPP and CPP2 from the corporation and the same from the founder, plus personal tax on employment income.

Dividend plus a year-end bonus

A founder who owns 50% takes a C$150,000 dividend and a C$50,000 year-end bonus. The dividend is not salary, and the bonus is excluded because the founder is a specified employee. The founder's work adds nothing to the claim, though the C$50,000 bonus is still a payroll cost.

No pay in the first year

Two founders take no pay in year one and hire an arm's-length contractor for part of the build. The founders' time adds nothing. The contractor's work may count under the contract rules. In year two the founders start salaries in January and keep timesheets, so their SR&ED share counts from then on.

Different for you?

• Choosing salary or dividends for reasons beyond SR&ED: see salary or dividends and how much to pay yourself.
• Setting a salary for RRSP room or CPP, or asking whether you pay EI: see salary for RRSP room and CPP.
• Starting payroll for the first time: see running payroll.
• Filing the claim, its deadline or a refund that has not arrived: see claiming SR&ED on your corporate return and get corporate tax help.
• A large round, a foreign investor or a US parent changed who controls the corporation: the credit rate and refund can change; see SR&ED and small business limits after a large round and get corporate tax help.
• A founder is employed by a holding company and the startup, or salary was accrued and paid late: the shared cap and 180-day rule can remove salary from the claim; get corporate tax help.
• Your company is a US C corporation: see founder salary in a venture-backed corporation.