Delayed reaction: How imminent changes in SR&ED tax credits are going to change your business
Both the 2012 and 2013 federal budgets contained changes to Canada’s Scientific Research and Experimental Development (SR&ED) tax credit program. By far the most significant of these were a series of cuts announced in the 2012 budget the first of which took effect on January 1 2013. A series of progressively more severe cuts will roll out over the next two years.
For any corporation that has tax pay at year end (and for Canadian Controlled Private Corporations who get a cash refund even if there is no tax is payable) these cuts will go straight to the bottom line. Ottawa’s decision on this comes at a time when many other countries – and an increasing number of U.S. states – are expanding their R&D tax credits programs.
Since decoding the full impact of these changes can be a real challenge even for accountants, let’s start with a few ‘big picture’ snap shots before we delve into the details:
* Industry Association CME estimates that the SR&ED changes introduced in budget 2012 will deprive Canadian industry of almost $750-million per year.
* Prices of measuring instruments and other equipment used in R&D will effectively increase by as much as 40%.
* The cost of purchasing research services will increase by up to 30%
At first glance it might seem that the cuts apply primarily to large corporations that are foreign- or public-owned. However, the majority of the changes are cuts in expenditure eligibility that apply to anyone making a SR&ED claim. And certain sectors of industry will feel the cuts more severely than others:
Electronics and biotech companies will be particularly hard hit because their R&D work requires test and measurement equipment the cost of which will no longer qualify to attract SR&ED after January 1, 2014. This applies whether the equipment is either purchased or leased. Long term laboratory equipment leases undertaken based on assumed annual recovery from SR&ED may need to be re-negotiated or terminated altogether. Companies that manufacture or distribute R&D instruments and equipment will see downward pressure on margins as customers seek price concessions to make up the difference.
Furthermore in two years when the temporary extension to the accelerated capital cost allowance for machinery and equipment that was announced in the 2013 budget wears off, the cost of R&D equipment will have to be written of over time instead of being entirely deductible in the current year through SR&ED expenditure pool.
Software development companies which are typically labour and payroll intensive will suffer in two ways: One because a significant portion of their workforce are contractors and after 1-Jan-2013 only 80% of the amount paid contractors qualifies to attract SR&ED. And two, because by Jan 2014 the ‘proxy overhead’ allowance – until now calculated as 65% of T4 wages – will be reduced down to 55%.
It has been well-communicated that foreign- and publicly-owned corporations will suffer a 5% reduction (i.e. 20% to 15%) in their SR&ED benefit rate and there is no change in the 35% benefit rate available to Canadian Controlled Private Corporations (CCPCs). What’s been less well communicated is that CCPC’s will suffer that same 5% cut on amounts in excess of the ‘expenditure limit’. Nominally the expenditure limit is $3M, however this $3M figure can be substantially reduced if either taxable income or taxable capital exceed certain limits. For example a CCPC with prior year taxable income of $800K would see its expenditure limit ground down to $0 and get a benefit rate of 15% instead of 35% and only 40% of that 15% would be as a cash refund.
Another surprise is that the federal level cuts implemented by Ottawa end up altering R&D tax credits at the provincial level as well. For example Ontario offers the OITC which provides a 10 per cent cash refund to all corporations and the ORDTC, that provides a 4.5 per cent non-refundable ITC. Other provinces offer similar and in some cases much greater benefits than above. Both of these credits are calculated on whatever expenditures Ottawa allows at the federal level. Therefore any reduction in SR&ED-eligible expenditures implemented by Ottawa triggers a proportionate reduction in the amount R&D tax credit benefit from the province. So far, only one province has moved to rebalance this address this; in November 2012 Québec introduced a boosted tax credit aimed specifically at the bio-pharma sector.
Cuts made to the SR&ED credit tax program through Budget 2012 could be further amplified by a whole series of new policy documents released by CRA in December 2012. While these documents don’t have the force of law, they paint an accurate picture of how CRA will assess the claim you file and what their auditors expect to see in terms of compliance record keeping. Many industry observers have pointed out that some of the positions set out in these new policy documents are markedly more restrictive in terms of the types of R&D work that qualify to attract SR&ED as compared to previous versions. Dr. Russ Roberts of the Canadian Advanced Technology Association recently wrote on that organization’s website that:
“The result of the new, consolidated policies when used in audits has been supported for a much narrower scope of SR&ED, both in terms of what are SR&ED projects and what work can be associated with them.”
Looking ahead from 2013, the value of SR&ED tax credits to Canadian companies will be shaped by a synergy of three factors: First, a reduction in eligible expenditures. Second, a lower benefit rate on those expenditures. And third, less of the human activity that industry considers to be R&D will be accepted as SR&ED by CRA auditors.
Given the complexity in the nature and timing of these changes budgets, any company that relies on SR&ED for the success of its R&D efforts should consider expert advice on the following planning points:
o Accelerate future capital equipment expenditures before Dec 2013. Pay heed to ‘Available for Use’ rules.
o Buy-out capital equipment leases before Dec 2013
o Consider use of ‘traditional’ overhead method to offset reduction of proxy allowance from 65% to 55%.
o Convert contract staff to employees.
o Safeguard CCPC status.
o Non-CCPC should consider converting to a CCPC.
o Preserve the expenditure limit: Analyze ‘bonus down’ tipping point vis-à-vis declining corporate tax rates.