Category Archives: Tax Planning

Budget 2019 Increases SR&ED Funding

The 2019 Federal Budget removed the prior year’s taxable income as one of 2 factors used to determine the SR&ED (“scientific research & experimental development”) expenditure limit. All Canadian-controlled private corporations (aka “CCPCs”) are entitled to 35% refundable tax credits on their “SR&ED expenditure limit”.

The SR&ED expenditure limit starts at $3 million and was reduced as taxable income in the preceding year rose above $500,000. For every dollar of taxable income above $500,000, the SR&ED expenditure limit was reduced by $10. This had the effect of eliminating the SR&ED expenditure limit when the taxable income of the preceding year increased to $800,000.

Once that happened the company was only entitled to a 15% non-refundable tax credit.

As a result, in the past practitioners worked to keep taxable income lower using a variety of techniques. This could have consequences that would work at cross-purposes to the public policy intention of the SR&ED program.

Budget 2019 proposes to repeal the use of taxable income as a factor in determining a CCPC’s annual expenditure limit for the purpose of the enhanced SR&ED tax credit. As a result, small CCPCs with taxable capital of up to $10 million will benefit from unreduced access to the enhanced refundable SR&ED credit regardless of their taxable income.

As a CCPC’s taxable capital begins to exceed $10 million, this access will gradually be reduced as shown in the highlighted column in Table 5.

This change will provide a more predictable phase-out of the enhanced SR&ED credit rate, which will more effectively support growing small and medium-sized
firms as they scale up.

This measure will apply to taxation years that end on or after Budget Day.

…from Investing in the Middle Class – Budget 2019

After these changes take effect, the expenditure limit will be reduced only by “taxable capital”. Note that taxable capital remains in the Income Tax Act after capital tax was eliminated. It is used as a proxy for a company’s size. While taxable capital can be complex to calculate, it can be approximated by looking at total assets.

If total assets are less than $10 million, there is no need to calculate taxable capital. The expenditure limit will be reduced in a straight line as taxable capital increases from $10 million. The expenditure limit will be entirely extinguished when taxable capital exceeds $50 million.

Tax Planning for SR&ED

As a former senior manager with one of the largest SR&ED practices in Canada, I remember that other tax practitioners referred to us disparagingly as part of the tax ‘compliance’ function. In the hierarchy of tax practitioners, tax compliance practitioners were considered somehow less ‘sexy’ than US & International Tax, Mergers & Acquisitions and some of the other specialties in the tax practice.

Of course while some of the M&A and International Tax work often involved much larger companies, SR&ED was far more important to  the bottom line of many SME clients.

Consider the case of a 6 year old company with $5.5 million in taxable income – who earned a tax refund of $175K. At standard rates they should have paid at least $1.35 million in tax – for a benefit of more than $1.5 million.

UNDERSTANDING THE SR&ED EXPENDITURE LIMIT

At my old firm we had National Top Tier clients and Local PCS clients (Private Company Services). The so-called Top Tier clients were often staffed by alumni of the Big 4 audit firms. As a result the tax planning was forward-looking and much of it done in-house.

By contrast, PCS clients were more of an afterthought and the PCS  practice resembled smaller, local CPA firms of the kind that typically service startups and early-stage SMEs – except that the rates were higher.

I remember frequently getting calls from local PCS partners with “quick questions” about SR&ED. “Quick question” was unwritten code for – “please don’t put any time on the W.I.P. (work in process). The questions were invariably ‘after-the-fact’ and tax planning involving SR&ED wasn’t possible, since the PCS partners typically wanted to perform the tax planning themselves and didn’t have the SR&ED expertise to understand the SR&ED ‘Expenditure Limit”.

There were some notable exceptions who did interesting work, but most PCS partners looked at SR&ED as an afterthought.

Managing the SR&ED Expenditure Limit is the key to maximizing SR&ED incentives

Simply put, small Canadian controlled private corporations (aka “CCPCs”) start with up to $3 million in available ‘expenditure limit’. These are the expenditures for which companies can earn up to 35% in refundable investment tax credits against. In other words they can receive as much as $1,050,000 in federal tax refunds. Add to that, up to $300,000 in refundable BC tax credits (or similar in most provinces other than PEI), and it’s plain to see that managing the expenditure limit can be important to these smaller CCPCs.

The trouble is that the expenditure limit is determined by the prior year’s taxable income. So managing the expenditure limit requires foresight in managing taxable income the year before companies claim the tax incentive. Given the importance of the SR&ED incentive to companies that use it, this means that good tax planning is essential.

Good Tax Planning is Essential for Companies Wishing to Maximize SR&ED

When taxable income in the prior year exceeds $500K, companies start to lose expenditure limit at the rate of $10 per dollar of taxable income in excess of $500K. So by the time that a company earns $800K, the subsequent year’s refundable tax credit will be zero.

SRED Exp Limit

Tax professionals also need to consider the taxable incomes of all associated corporations. Since the taxable incomes of all corporations in the associated group had to be aggregated. Note that in aggregating taxable incomes, we ignore losses of companies in the associated group.

Stranding Losses in Associated Corporations is Orders of Magnitude More Costly for SR&ED Incentives than it is for Maximizing the Small Business Deduction

Considering how much effort goes in to planning the maximization of the small business deduction, it should be surprising that more effort doesn’t go in to maximize the SR&ED expenditure limit. I can only guess that the people who generally prepare SR&ED claims work mostly after-the-fact and independently from those engaged in tax planning.