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
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.
With 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 firstname.lastname@example.org.