Big bucks for business innovations
By Sandy Hale, Partner
BDO Dunwoody
“Earn Big $ for Your Business Innovations!” may sound like a gimmicky ad, but the offer is the real deal. And it comes from reliable sources: the federal and provincial governments. They are offering bona fide rewards — nearly $2 billion dollars in incentives every year — to encourage innovation among Canada’s businesses.
Sound too good to be true? It almost is. Since launching the Scientific Research and Experimental Development (SR&ED) Tax Incentive program in the 1980s, the federal and provincial governments have steadily sweetened the pot in an effort to boost Canada’s competitiveness and economic performance in the global marketplace.
Today, the SR&ED program is one of the most generous research and development tax incentive programs in the world — and the benefits are potentially available to any business that strives to enhance productivity through new innovations.
Valuable benefits
In Canada’s high-wage economy, innovation is a key driver of productivity improvements. Unfortunately, according to the Canadian Advanced Technology Alliance, we only rank 14th in innovation among the 17 countries in the Organization for Economic Co-operation and Development. Recognizing that we still have a way to go, our governments are extending and enhancing the SR&ED program in an effort to ramp up innovation.
Qualifying businesses receive three valuable benefits. The first is a 100% tax deduction of eligible current and capital expenditures in the year these expenditures are incurred. Current expenditures include wages, materials, machinery, equipment and certain overhead used for research and development activities. Contracts with individuals or businesses that perform SR&ED on behalf of a company are also deductible. Capital expenditures generally include facilities and equipment used at least 90% for research and development activities.
Second, qualifying companies may claim all, some or no SR&ED deductions in the current taxation year, or in any future taxation year. This deferment option provides valuable tax planning flexibility.
Third, Canadian Controlled Private Corporations (CCPCs) are eligible for investment tax credits of 35% for current and capital expenses of up to $2 million. This $2 million limit is reduced as taxable income for the previous taxation year rises above $400,000 (for 2007) and as taxable capital in the preceding year exceeds $10 million. Above the $2 million threshold, CCPCs are eligible for tax credits of 20%. Other Canadian corporations, proprietorships, partnerships and trusts are also eligible for the 20% tax credit rate. All of these credits can be carried back up to three years or forward up to 20 years.
Refundable or non-refundable?
Investment tax credits may be either refundable or non-refundable, depending on the province or territory in which the R&D is conducted. Refundable tax credits are paid out to the company regardless of the level of taxes payable. Non-refundable credits reduce the company’s taxes payable.
Tax credits earned by non-CCPC corporations are non-refundable. Tax credits earned by proprietorships or certain trusts may be partially refunded after applying the credits against taxes payable.
In addition, if credits exceed a company’s income tax payable, the business may be eligible for cash refunds for 100% of the SR&ED tax credits on current expenses and 40% on capital expenses.
The following chart compares the after-tax cost of expenditures used to conduct research and development to show the savings a company can achieve by utilizing the federal government’s SR&ED tax incentive program.
For a CCPC that qualifies for a 35% investment tax credit rate, the after-tax cost of R&D is only about 53% of the actual expenditure. For companies that qualify for tax credits of 20%, the savings are even more significant because income tax levels are higher.
Provincial-territorial incentives
The provinces and territories make these SR&ED incentives more valuable; all offer income tax deductions and, with the exception of Alberta, Northwest Territories, Nunavut and PEI, offer additional tax incentives for research and development conducted within their borders. The chart on the previous page summarizes these offerings.
Note that (1) the 2007 BC budget extended the SR&ED tax credit for an extra five years, up to September 1, 2014, and is now available to partnerships for eligible R&D expenditures incurred after February 20, 2007.
In Ontario (2), CCPCs with less than $400,000 in taxable income receive a tax credit of 10% of R&D expenditures. The province also offers credits to non-CCPCs with taxable income of less than $500,000 and taxable capital of less than $50 million. The 2007 Ontario budget announced that the province’s SR&ED incentive will be replaced with a more generous 4.5% non-refundable tax credit when the Ontario and federal corporate tax bases are harmonized for taxation years ending after 2008.
And the Quebec budget (3) extended the Quebec SR&ED wage credit to include out-of-province businesses. Now, for taxation years after April 21, 2005, companies that conduct business anywhere in Canada and perform research and development in Quebec qualify for the Quebec credit. As well, the province increased the threshold from $25 million to $50 million of assets for CCPCs to be eligible for the refundable wage tax credit of 37.5% for SR&ED expenditures incurred for work performed after December 4, 2006.
Three key tests
It’s apparent that Canada wants more companies to participate in the SR&ED program. The CRA has introduced numerous initiatives to facilitate the application process.
Generous tax breaks and enhanced productivity are simply too valuable to ignore. But how do you know whether your activities may qualify? They simply must meet three tests.
- Advancement — Activities must be directed toward advancing know-ledge by creating something new or improving something. Examples would be developing a new or improved product, prototype, software, or process. It’s important to know that R&D doesn’t have to succeed to qualify for benefits. It is the attempt to achieve an advancement that determines eligibility. Failure also increases knowledge and is therefore considered valid R&D.
- Uncertainty — There must be an element of doubt in the research — uncertainty as to whether the goals can be achieved, or if the correct method is being used.
- Content — To meet this test, activities must be conducted in a scientific manner — systematically, and with thorough documentation, so that a knowledgeable person could “repeat” the research.
To qualify for benefits, applicants must file two forms. Form T661, Claim for Scientific Research and Experimental Development (SR&ED) in Canada, details a company’s SR&ED activities and the expenditures being claimed. Schedule T2SCH31, Investment Tax Credit — Corporations, is used to calculate investment tax credits.
These forms must be filed within one year after the filing due date for the taxation year in which the company incurred the R&D expenditures. For corporations, this is 18 months after year-end.
It’s always worthwhile investigating potential SR&ED tax credits. Not only are there opportunities for earning money, but by focusing on R&D, many companies also benefit from gains in productivity and enhanced competitiveness.
Sandy Hale, CA, is a partner in the Mississauga office of BDO Dunwoody. She helps clients secure federal and provincial tax refunds for their research and development expenditures. You can reach her at (905) 272 7805 or by email at shale@bdo.ca
