In working with our clients we frequently encounter confusion regarding the ramifications of utilizing contract labour versus salaried labour to conduct SR&ED work.
The decision to structure the relationship between an employer and potential employee or contractor needs to be examined not only for general business implications but also for specific SR&ED implications as it can have a significant impact on a company’s eligible SR&ED expenditures for ITC (investment tax credit) purposes.
A common misconception is that the financial advantages of employing contract labour make this a preferred arrangement. The financial advantages of contract labour include minimizing the employers EI and CPP burden as well as reducing costs associated with various employer funded employee benefit programs. These advantages quickly disappear in the context of a firm conducting SR&ED.
This is best illustrated with a simple example. Let’s compare the two situations where the company in question is a CCPC in Ontario with taxable income less than $500,000. This company is looking to hire an Engineer to assist with their research efforts. The annual fee of this Engineer is $80K and he will spend more than 90% of his working time conducting SR&ED.
If the company hires the Engineer to perform this work as salaried employee (T4’d) the company would realize ITC of $54.8K for this employee. The company would incur EI and CPP costs of roughly $3.2K. The true cost of the labour to the company would be $28.4K ($80K – $54.8K + $3.2K) .
If the company contracts the Engineer to perform the same work the company will pay the same $80K to the Engineer but will not have to make the $3.2K in CPP and EI contributions. However, due to the treatment of contract labour in the eyes of the SR&ED program the company would receive only $33.2K in ITC’s. In this case the true cost of the labour would be $46.8K ($80K – $33.2K).
By using T4’d labour the company is able to realize a savings $18.4K. This clearly illustrates the tax advantages of using T4’d labour instead of contract employees for companies engaged in SR&ED.