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Canadian controlled private corporations (CCPC) could see more tax returns on their research and development investments, according to proposals in the 2019 federal budget.
Changes to the Scientific Research and Experimental Development tax credit announced in the budget include no longer using prior year’s taxable income to determine expenditure limits at the enhanced rate of 35 percent. Under the Canadian Income Tax Act, CCPC’s could avail themselves to a fully refundable enhanced federal rate of 35 percent on up to $3 million in eligible research and development expenditures – with a catch: the expenditure limit was gradually reduced and sometimes fully eliminated, depending on the corporation’s taxable income and taxable capital employed in Canada.
For instance, there can be a significant grind to the tax credit for a CCPC with taxable income levels in the range of $500,000 to $800,000, with an eventual loss altogether of refundable tax credits. Principally, the new budget eliminates the dependency between taxable income and the expenditure limit. As we shall see next, this repealing has a significant impact on the ITC and hence on the overall cashflow impact for private corporations accessing SR&ED tax credits.
If the proposed changes are legislated, small to mid-level CCPCs with taxable capital of up to $10 million can benefit from this extended refundable SR&ED tax credit, independent of their prior year’s taxable income. It should be noted, as taxable capital begins to exceed $10 million, there is a gradual reduction to the refundable tax credits in the same manner as before the 2019 budget announcement. This new measure will apply to taxation years that end on or after March 19, 2019.
To illustrate the impact, consider a CCPC with prior year taxable capital of $10 million and current year expenses of $3 million considered as qualifying for SR&ED tax credits at the enhanced rate of 35 percent. Prior to the 2019 budget, a differential increase in prior year taxable income of $100K (i.e., an increase from $500,000 to $600,000) would mean two consequences: the CCPC lost $200,000 on its overall SR&ED tax credit; and there is a $350,000- reduction of actual refundable tax credits. Note that at $800,000 of prior year taxable income, the CCPC receives $450,000 of pure non-refundable ITC.
To maintain the enhanced SR&ED tax credit benefits, a common strategy has been for individual shareholders to receive large bonuses as part of their remuneration, thereby lowering taxable income of the corporation to levels close to the $500,000 limit. However, this results in increased shareholder tax costs, as well as other non-tax considerations such as additional cashflow, compliance and management planning. A further nuance is that bonus payments also grind down on the available tax credits.
In summary, such planning has marginal overall tax benefits when factoring the tax cost of both the shareholder and corporation. The new 2019 federal budget eliminates such tedious tax planning and management decisions. It introduces a longer planning opportunity, simplicity and phasing of the tax credit for CCPCs and introduces stability and predictability for tax planning for technology corporations which rely on ITCs as part of their cashflow.
However, while the new budget changes are welcome, there is a subtle and important tax aspect that can easily go neglected. This is related to managing taxable capital threshold below $10M. Specifically, it is not uncommon for Canadian corporations to undertake market capitalization to fuel their research and development work; a debt component directly impacts and increases the taxable capital.
Care and scrutiny must be undertaken to ensure that the CCPC does not fall into the trap of insufficient tax and management planning, hence resulting in year after year increases to overall taxable capital as this could impact the enhanced SR&ED tax credits now feasible from the new budget.
For more information, contact Balaji Katlai, Manager, Canadian Corporate Tax, at 514.228.7858 or [email protected].
Related Topics:Scientific Research and Experimental Development
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