R&D TAX INCENTIVES COULD RESULT IN A CASH REFUND

You may not realize it, but your company could presently be engaging in activities that qualify for tax incentives offered by the federal and provincial governments that are among the most lucrative in the world. These tax incentives will help your corporation to save an additional $35 per $100 spent - and all you may have to do is analyze the costs! The cash savings will assist you to finance the cost of your operations.

The tax incentives we are referring to are for Scientific Research and Experimental Development ("SR&ED") carried on in Ontario. Qualifying activities don't just include developing satellites or the next wonder drug; they include developing, enhancing or modifying a new product or process or trying to reduce the cost of manufacturing.

The objective of these incentives is to encourage the advancement of technology in Canadian developed products and processes that will enhance Canada's competitiveness in the international marketplace.

What are the Tax Incentives?

If your corporation is a Canadian Controlled Private Corporation ("CCPC") and you are engaged in eligible activities, you are entitled to a federal tax credit equal to 35% of the first $3 million of eligible SR&ED expenditures made each year. Where current expenditures have been incurred, 100% of this credit is refundable. Where capital expenditures have been incurred, 40% of this credit is refundable. In other words, you don't have to have tax payable in order to use the tax credits - you are eligible for a cash refund! Certain limits may apply.

Ontario SR&ED Tax Incentives

Corporations with a permanent establishment in Ontario who qualify for the Federal 35% refundable tax credit are also entitled to a 10% refundable Ontario innovation tax credit (OITC) - effectively only 4% for capital expenditures. If a corporation were to incur $100,000 of current SR&ED expenditures in a year, the OITC would be worth $10,000!

Eligible Activities

The Canada Revenue Agency has set out three general categories for the classification of SR&ED activities, namely basic research, applied research and development. Typically, most corporations' activities tend to qualify under either the applied research or development classifications since their goals are oriented toward staying competitive by developing or improving a new or existing product or process or creating something that is not otherwise available in the marketplace.

Consider the following examples:

• An existing piece of machinery no longer produces a product quickly enough to make it commercially viable. Through a process of redesign and testing, you might undertake to modify the machinery to increase its capabilities.
• You require a specific piece of machinery to manufacture a unique product. The piece of machinery does not exist on the market. As a result, you undertake to design and develop the machinery. After several designs and attempts you discover that the machinery can not be produced to do what you need.
• An employee has come up with a new product idea. You assign the employee and some co-workers the task of designing and developing the product. Several uncertainties exist at the outset; however, they prevail and eventually develop a saleable product.

Such processes of experimental development may be eligible for the SR&ED tax incentives.

What are your Eligible Expenditures?

Once you have determined that you are involved in eligible activities, the costs that may be included in the calculation for the tax incentives include salaries, wages and benefits of personnel directly involved, materials and supplies consumed and directly related incremental overhead costs. These incremental overhead costs can be tracked directly, or you can elect to use the "proxy method" to simplify the calculation. The proxy amount is calculated as 65% of the qualifying salaries and wages of the employees and owners (subject to limitations) directly engaged in SR&ED activities.

Capital expenditures incurred for SR&ED purposes also qualify for the SR&ED benefits depending on the extent to which the assets are used in SR&ED activities.

So What is the Net Result of These Tax Incentives?

Well, to make a long (and rather complicated) story short, the after tax cost of spending $100 on SR&ED in Ontario in 2010 is $47 where your corporation is eligible for the top marginal tax incentives. That compares to the after tax cost of $83.50 if the same expenditures were incurred and no SR&ED tax incentives were claimed. So if you are interested in saving another $36 per $100 spent, start identifying and claiming your eligible SR&ED activities to maximize your tax savings.

Filing Deadlines

SR&ED claimants have up to 18 months after year-end to file the forms and information required by CRA, including the technical descriptions of the SR&ED projects. The CRA has recently stated that claims not completed by the deadline will be rejected. Ideally, claims should be submitted with the corporation's tax return due 6 months after year-end as this generally results in faster processing of the claim. Waiting beyond 16 months will put the claim in jeopardy if there is incomplete information as it does not allow the claimant time to submit additional information should it be requested by the CRA.

"Information contained herein is of a general nature. No action should be taken without seeking professional advice that takes into account current developments and the specific facts of a particular situation."

[Updated - February 20, 2010]