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Federal budget SR&ED change could impact your tax planning


If your Canadian-controlled private corporation (CCPC) is engaged in Scientific Research & Experimental Development (SR&ED), you are likely familiar with the various tax benefits available in Canada. One of the most generous incentives is the federal investment tax credit (ITC). The federal ITC can be as high as 35% of eligible expenditures and can be refundable for qualifying CCPCs, offering significant tax relief and potentially helping to provide the cash flow needed to sustain the SR&ED activities of the business. (For a general overview of the SR&ED program and tax incentives, read our article “The Tax Benefits of SR&ED”.)

The 2019 federal budget announced a beneficial change that makes access to the enhanced federal ITC less restrictive. To understand the full impact, we'll first take a look at the relevant federal ITC rules that existed prior to the budget change and how tax planning has been structured to maximize the benefit of the ITC for CCPCs. We will then explain the change and the implications for tax planning.

Federal ITC before the budget change

For federal tax purposes, a corporation can earn a non-refundable tax credit at a basic rate of 15% on qualified SR&ED expenditures. Since this ITC is non-refundable, it can only be applied to reduce income tax payable. However, a CCPC may be entitled to earn a refundable tax credit at an enhanced rate of 35% on qualified SR&ED expenditures, up to a maximum annual expenditure limit of $3 million. The annual expenditure limit is phased out based on two factors—taxable income and taxable capital employed in Canada in the previous tax year. Generally, these factors apply as follows:

Taxable income — The $3 million expenditure limit is reduced when taxable income in the previous tax year exceeds $500,000 and is eliminated when an income level of $800,000 is reached.

Taxable capital — The $3 million expenditure limit is also reduced if taxable capital employed in Canada in the previous tax year exceeds $10 million and is eliminated when it reaches $50 million.

Note that the expenditure limit must be shared by all CCPCs in an associated group, and the reduction factors above must be determined on an associated group basis.

For certain CCPCs, especially those in the scaling and growth stage of business, it has often made sense to plan ahead in order to reduce taxable income by paying a bonus to the owner-manager. This "bonusing down" strategy avoids having the annual expenditure limit reduced where the CCPC could benefit from it.

Federal budget change

In the 2019 federal budget, the government proposed to eliminate the use of prior year taxable income as a factor in determining the annual expenditure limit. This is welcome news especially for companies in the scaling and growth stage that can greatly benefit from the capital and cash flow associated with the refundable enhanced ITC. The change will apply to tax years that end on or after March 19, 2019. The expenditure limit restriction based on prior year taxable capital (as described above) will continue to apply.

As a result of the tightening of compliance requirements associated with SR&ED incentives in recent years, there have been companies—most notably in the manufacturing sector—that have dropped out of SR&ED programs altogether and may include companies that do not exceed the taxable capital employed in Canada threshold. With the prior year taxable income factor being removed from the annual expenditure limit calculation, now may be a good time to re-consider participation in SR&ED programs. Contact your BDO advisor for assistance with SR&ED incentives.

Impact on tax planning going-forward

This federal budget proposal eliminates the need to reduce taxable income with the payment of bonuses to owner-managers for purposes of benefiting from the refundable enhanced 35% ITC rate for CCPCs. Retaining income in the CCPC will allow for a deferral of the personal taxes that would have been payable by the owner-manager if a bonus had been paid. But keep in mind that most provinces and the Yukon also provide SR&ED tax credits, some of which are restricted by an expenditure limit. For purposes of the expenditure limit calculation, most jurisdictions currently follow the federal rules but not all. In particular, Ontario currently provides its own rules on the expenditure limit calculation with a taxable income factor, which means tax planning to bonus down income may still make sense. With this new federal change, it will be prudent to watch for any relevant provincial announcements. For example, the 2019 Ontario budget confirmed a review of Ontario SR&ED support, so a future change may be possible.

Lastly, although bonusing down corporate income is no longer a necessary strategy for purposes of the enhanced federal refundable ITC for CCPCs, the decision to bonus down remains a relevant consideration in determining an overall owner-manager remuneration plan. There are various other factors to consider, including whether the new passive income rules that restrict the small business deduction will be a concern if income is retained in the CCPC. For more information on those rules, read our article “Passive Investment Income and its Impact on the Small Business Deduction”. Devising an optimal owner-manager remuneration strategy could be more complicated where bonusing down for purposes of the enhanced federal ITC is no longer a deciding factor. Your BDO advisor can help you develop an owner-manager remuneration plan that suits your needs in light of the recent change.

The information in this publication is current as of April 17, 2019.

This publication has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. The publication cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without obtaining specific professional advice. Please contact BDO Canada LLP to discuss these matters in the context of your particular circumstances. BDO Canada LLP, its partners, employees and agents do not accept or assume any liability or duty of care for any loss arising from any action taken or not taken by anyone in reliance on the information in this publication or for any decision based on it.

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