First, we would like to thank all of our clients, partners and families for helping make this a fun and exciting year for MCN. We would also like to wish everyone a Merry Christmas and Happy New Year.
We’re looking forward to working with you all in 2010!
The SR&ED program makes Canada one of the most competitive research and development jurisdictions in the world. Mobile Capital Network, along with its legal partners have the ability to help multinationals leverage the SR&ED program to its fullest. MCN Partner and Principal, Alexei Gavriline, co-authored an article which first appeared in The Canadian, the magazine of the Canadian Chamber of Commerce in Japan, and reprinted in China-Canada Exchange, the magazine of the Canadian Chamber of Commerce in Hong Kong. The article is about the Canadian SR&ED program and the advantages it presents for foreign corporations interested in conducting R&D in Canada while retaining their rights to the intellectual property being created. A copy of the article entitled, “The Moose That Roared” is available here.
To paraphrase the Canada Income Tax Act, Section 181.2, taxable capital (for companies that are not financial institutions) is the excess capital a company has in its possession that exceeds its investment allowance for the year. Taxable capital includes capital stock, retained earnings, long term debt, advances received, surpluses, reserves, etc. The exact definition can be found in the full text of the Income Tax Act available online at http://laws.justice.gc.ca/en/frame/cs/I-3.3//20090714/en or
http://www.iijcan.org/en/ca/laws/stat/rsc-1985-c-1-5th-supp/latest/rsc-1985-c-1-5th-supp.html
Historically, taxable capital has been used to identify and tax “large corporations” that hold excess cash. Because the tax on capital is often viewed as a punitive tax, Canada and its provinces are phasing it out. While some provinces still levy this tax, the federal government has administered a 0% rate beginning in 2008.
Despite the 0% tax rate of taxable capital, taxable capital remains an important parameter because it is a determinant for tax deductions and tax credits including SR&ED, and thereby greatly influences the effective tax rate levied on the company.
For example, the small business deduction allows business income under $500,000 to be taxed at a lower rate (11%) for Canadian-Owned Private Corporations (CCPCs) as opposed to other types of corporations. However, CCPCs that have an excess of $10million in taxable capital, on an associated group basis in the prior fiscal year, will begin to have their small business deduction reduced. This will obviously result in a higher tax bill.
In respect to SR&ED, taxable capital plays important role in determining the expenditure limit for SR&ED tax credits and whether these credits are refundable or not. Thus taxable capital in excess of $10million will reduce the benefit for CCPCs claiming SR&ED tax credits, as at this point the expenditure limit will begin to erode. In certain cases, the maximum tax credit rate of 35% will be reduced to 20% and the federal tax credits will no longer be refundable.
Provinces often administer their own programs and set their own thresholds in respect to the taxable income and taxable capital. A key example is Ontario which sets $25 million threshold for taxable capital in respect to calculating a company’s SR&ED tax credit. Thus an Ontario-based company, regardless of whether it is publically-owned, foreign-owned or private, may still receive a SR&ED refund provided that the company shows less than $500,000 in taxable income and less than $25million in taxable capital in its prior fiscal year. Even if the company shows income and taxable capital higher than these limits, the R&D tax credit may still be refundable depending on the circumstances.
High levels of taxable capital may seriously impinge a company’s tax competitiveness. There are avenues that can be taken to reduce taxable capital for the purpose of determining SR&ED tax credits. Obviously, there is no “one size fits all” solution and professional advice would be highly desirable. If you think your particular situation warrants a closer look, please contact us for a more detailed analysis. For more information, please, visit us at www.mobilecapital.net or contact us at info@mobilecapital.net.
We frequently encounter manufacturing companies that are significantly under claiming on their SR&ED tax credits. The biggest mistake we see is that many of these companies view their new product development efforts as the only area where SR&ED is occurring and forget to look at their manufacturing improvement efforts.
The methodologies of effective manufacturing process improvement, such as the Deming cycle or Six Sigma, often satisfy the requirements of SR&ED eligibility. Companies are quite surprised at how this can SR&ED eligibility can impact the real cost of their improvement projects.
Let’s look at an example: A manufacturing company uses a piece of equipment that has consumable wear inserts. During operation, these inserts are consumed (worn-out) and require monthly replacement. The company’s Manufacturing Engineer identifies a number of possible other materials or coatings designed to reduce the rate of wear on the insert but is uncertain how these other materials will perform in his application. The Engineer designs a test protocol to evaluate each candidate material in the actual machine, the maintenance department carries out the required insert changes at the prescribed interval and the machine operator monitors and records wear rates as the new inserts are being evaluated.
In this above example all the necessary criteria for the work to be SR&ED eligible are met. A portion of the Engineering, Maintenance and Machine operators’ time will be eligible for tax credits. Assuming the costs for this project included $20,000 labour and $5,000 the inserts, the company would be eligible for a tax credit of roughly $14,000.
For an assessment of weather your process improvement efforts qualify for SR&ED funding please contact Mobile Capital Network for a free consultation.
A major piece of advice we regularly give to our clients is to get educated on the SR&ED program. More often than not, our clients respond by saying something like, “Isn’t that why we’ve hired you?” Our answer to that question is “Yes, however….”. “Yes” relates to the fact that MCN will handle the preparation and optimization of your SR&ED claim. The “however” relates to the optimization part of our services which among other things include educating client’s personnel on important aspects of the SR&ED program.
Client education is an integral part of our philosophy of treating the CRA as a customer (see our earlier post at http://www.mobilecapital.net/blog/?p=93).
Here are some areas where SR&ED education plays a vital role:
1. Empowering Employees – In our experience, empowering employees can lead to significant increases in SR&ED claims. One technique we employ to make this happen is our SR&ED seminars. These are 45-minute to 1-hour sessions, where an MCN consultant presents the objectives, benefits and basic criteria of the SR&ED program to client’s employees. Understanding the requirements of the program and seeing how the SR&ED program benefits the company, employees often feel more empowered and are more receptive to keeping notes, logs or other bits of information that can help during the SR&ED technical interviews. Another great benefit of having these SR&ED education sessions is that these sessions often lead to discovery of SR&ED eligible work that tends to be overlooked by employees and therefore is not discussed during technical interviews.
2. Audit Proofing – In rare cases when a SR&ED claim gets reviewed by the CRA, MCN consultants will always attend the CRA review. However, often the CRA reviewers will want to interview your personnel and probe their understanding of SR&ED program and work eligibility criteria. This is because the program is self-assessed. The CRA wants to know that your staff understands the program in order to ensure that the submitted work along with the allocated time/costs is eligible. The more you can say to demonstrate your understanding of the SR&ED program, the more comfortable the CRA reviewers will feel. Your understanding of SR&ED program reduces the chance of material error in your SR&ED claim (the reviewer’s major concern) and thereby ensures the successful approval of the claim. This is yet another reason why we encourage our clients to get educated.
3. Business Process Optimization – The SR&ED program requires that documentation helping to substantiate the claim be captured and kept in one form or another. This documentation may include contracts, email communication, source code/prototypes, time dockets, pictures etc. When employees and management learn more about the SR&ED program and appreciate the importance and financial implications of keeping the house in order, it becomes much easier to implement adjustments to business processes and procedures to capture SR&ED supporting documentation. Having employees on board makes it easier to adjust development approaches and manufacturing processes to ensure that the necessary SR&ED-relevant information is captured in real-time thereby greatly reducing the cost of compliance with the SR&ED program.
MCN offers a comprehensive and proactive approach to organizing SR&ED-related activities and claiming SR&ED tax credits. As a part of our standard SR&ED service, our consultants will be happy to meet with your organization throughout the year to help them understand more about the SR&ED program and optimize the processes and procedures to insure that each SR&ED-eligible activity is properly identified, documented and reflected in your SR&ED claim.
In our practice we find that at times clients don’t fully understand why after claiming SR&ED investment tax credits the cheque they receive from the government or the amount of available tax credit carry forward is different from the amount claimed.
To understand this, let’s look at SR&ED differently. Instead of exploring how SR&ED is treated from the income tax act perspective and what gets deducted from where, let’s look at SR&ED from a practical, business point of view. The view offered in this post will equally apply to OIDMTC, IRAP, SDTF, CIIRDIF, Telefilm and any other form of government assistance.
As soon as we switch from looking at SR&ED as an investment tax credit (an accounting term) to viewing SR&ED as a payment for the services rendered to the government (see our blog posting entitled SR&ED Advice: Treat the CRA Like a Customer), the rest becomes very easy to understand.
As any revenues you collect for your products or services, “revenues” you collect from the government have bearings on your tax situation. It really doesn’t matter in what form these revenues come, be it SR&ED, OIDMTC, IRAP or any other type of government assistance.
In the case of SR&ED, the company has already spent the money on SR&ED-related work so all the SR&ED benefits it receives from the government go straight to the bottom line. This increases the company’s taxable income or reduces losses carry forward. Instead of sending you the cheque and asking you to pay additional taxes, the government withdraws the taxes from the amount it owes you and sends you the cheque for the difference. If you happen to owe the government more than it owes you, the government will ask you for the difference.
If you file your SR&ED claim concurrently with your tax return, then all this gets taken care of in your tax return. In this case, the “revenues” you receive or expect from the government and the taxes owing are reconciled. However if you file an amendment to your tax return to claim SR&ED or OIDMTC, you essentially correct the top and bottom lines on your income statement.
To illustrate what happens let’s look at a simple example. Let’s assume that your SR&ED claim is for $100, you are profitable and your tax rate is 30%. When you file an amendment to your tax return you are essentially “invoice” the government for $100 due to you for your services. When the government acknowledges your “invoice” your taxable income increases by $100 which results in additional $30 in taxes that you now owe to the government. So the government takes its $30 and sends you a cheque for $70. To make things fair, the government also pays you interest on the $70 for holding your money all that time it took the government to process your “invoice”.
If you paid a consultant to secure “revenues” from the government, just as with any other revenues the amount you paid will be your expense; hence your taxable income will be decreased accordingly. The consultant will pay taxes on their revenues.
At Mobile Capital we prepare SR&ED claims that accurately reflect the SR&ED-related work of the client so that the client is fully paid for the services rendered to the government.
To conclude, we would like to make an important disclaimer. We realize that the view expressed above does not reflect the complexity of the matter and cannot be considered entirely accurate from an accounting standpoint. We just hope that it helps business managers not fluent in accounting and finance to understand the process from a business perspective.