My name is Mark Goodfield. Welcome to The Blunt Bean Counter ™, a blog that shares my thoughts on income taxes, finance and the psychology of money. I am a Chartered Professional Accountant and a partner with a National Accounting Firm in Toronto. This blog is meant for everyone, but in particular for high net worth individuals and owners of private corporations. The views and opinions expressed in this blog are written solely in my personal capacity and cannot be attributed to the accounting firm with which I am affiliated. My posts are blunt, opinionated and even have a twist of humor/sarcasm. You've been warned.

Tuesday, May 31, 2011

The benefits of undertaking Scientific Research and Development in Canada

The Canadian government's Scientific Research & Experimental Development (“SR&ED”) program has been controversial at times, with some pundits calling for action to tighten the program and its eligibility requirements. However, the SR&ED program has been a lifesaver for a couple of my clients. These clients were cash starved in their formative years and were able to soldier on and to grow into substantial companies, thanks in part to the funding from the Federal and Ontario SR&ED programs. These companies now pay income tax and employ a significant number of people.

In this blog, I will not delve into the criteria required to make a SR&ED claim, nor all the machinations of the income tax calculations. However, I wish to draw attention to the substantive nature of the SR&ED claims available to those businesses with qualifying expenditures. These benefits are best illustrated through an example.

Assume Research in Lotions Inc. (“RIL”) a company trying to develop an anti-aging formula for men spends $10,000 in SR&ED wages and has various overhead expenses. Since the tracking and identification of overhead SR&ED costs was problematic for most companies, the government provided an alternative election known as the Prescribed Proxy amount. If a company elects to use the proxy, it does not need to track its SR&ED overhead costs, but can simply multiply the $10,000 in SR&ED wages by a predetermined ratio of 1.65. Thus, if a RIL incurs $10,000 in wage costs, it is actually allowed to claim $16,500 ($10,000*1.65) in qualifying expenditures for purposes of the Investment Tax Credit (“ITC”). The $16,500 is then reduced by approximately $2,320 in Ontario SR&ED incentives as discussed below, leaving a balance of eligible expenditures for the ITC of $14,180.

Generally, a Canadian-controlled private corporation ("CCPC") can earn an annual refundable ITC of 35 percent on its first $3 million of qualified expenditures for SR&ED carried on in Canada, and a 20 percent ITC on any excess amount ( 40% of the 20% ITC is refundable). The ITC would be refundable in cash to RIL, or would be applied against any income tax owing by RIL. Non-CCPC's can earn a non-refundable ITC of 20 percent of qualified expenditures for SR&ED carried out in Canada.

So continuing with our example, RIL would be eligible to claim an ITC of $4,963 ($14,180 x 35%). It should be noted that RIL would have to addback the $4,935 to income in the following year.

In Ontario, most companies are eligible for an additional 10% refundable Ontario Innovation Tax Credit. So again following our example, a further refundable credit of $1,650 would be earned ($16,500 x 10%). In Ontario there is also a research and development tax credit of 4.5% that can be applied against income tax, but is not refundable (this credit can be waived, which in certain circumstances makes sense).

For SR&ED incentives in other provinces see this link.

I have simplified the SR&ED tax credit process, as it is extremely complex. The key take away here is that if RIL incurs $10,000 in SRED cost, it would potentially be entitled to SR&ED refunds by the Federal and Ontario governments totaling $6,613 ($4,963 Federal and $1,650 Ontario), making the net cost to RIL of undertaking SR&ED only $3,387. In my opinion, this is a significant incentive for any company to undertake SR&ED, despite the complexities in filing and tracking expenses.

SR&ED Wages Incurred
$  10,000
Federal Investment Tax Credit
$ (4,963)
Ontario Innovation Tax Credit
$ (1,650)
Out of pocket SR&ED Cost
$    3,387


On Thursday I will have a guest post that clarifies several points of confusion in regard to the SR&ED program and provides examples of qualifying SR&ED in industries you would not expect to be eligible to make a SR&ED claim.

The blogs posted on The Blunt Bean Counter provide information of a general nature. These posts should not be considered specific advice; as each reader's personal financial situation is unique and fact specific. Please contact a professional advisor prior to implementing or acting upon any of the information contained in one of the blogs.

4 comments:

  1. Nice company name (RIL). :)

    However, your implicit argument that SRED helps businesses ("these companies now pay income tax and employ a significant number of people"), seems to depend upon the economic fallacy of omitting the unseen parties.

    In order to subsidize SRED business activities, the government raises corporate and personal taxes upon the rest of us (who by virtue of being taxable are already productive), reducing their aggregate ability to expand business.

    The tax base would be better increased by letting the market decide which research and development is worthwhile rather than a CRA bureaucrat.

    P.S. Here's an interesting article on the economics of tax policy:

    http://online.wsj.com/article/SB10001424052748703514904575602943209741952.html?KEYWORDS=hauser

    ReplyDelete
  2. I have a corporation and I am thinking about doing some R&D work. Assuming the corporation pays me $100,000 and I have no overhead as I will work out of my home office. Can I still claim the proxy of 65%? If not, I assume the corporation would only receive about 40% of the amounts paid to me as salary (from your article above). There would also be CPP, EI, personal income taxes, accounting fees, etc. It it possible it may make more sense to just complete the R&D work and not take a salary? Maybe R&D makes sense for bigger corporation's and not start-up corporations?

    ReplyDelete
  3. Skuj, the economic reality is that the Venture and start-up market does not have a huge appetite for start-up R&D companies. Take away the Canadian governments funding and our pathetically weak R&D situation may become non-existent. Your argument that the best potential R&D will be funded is probably correct, however, how many successful R&D companies survived due to funding from the SR&ED program? I know, you would argue the cost to provide for a few success stories is not worth it. :)

    ReplyDelete
  4. Anon, I was trying to stay away from the technical rules, but I will give you a brief answer. Your wages would fall into the specified employee category and be subject to a special calculation for the proxy calculation (75% maximum of wages paid and a pensionable earnings calculation that sets a ceiling). Assuming your $100k was all R&D, you would probably have $75k available for the proxy. However, the CRA also has a overall cap calculation that could impact the proxy claim if you essentially only have overhead of your own wages, that cap would need to be calculated. Hope that helps. I would suggest talking to your corporations accountant first to analyze all the facts.

    ReplyDelete