SR&ED: Expenditure Limits

The eligible expenditure limit can have a huge impact on your tax credits from Scientific Research and Experimental Development (“SR&ED”) programs. Is your tax planning strategy taking this into consideration?

As many small businesses involved in SR&ED activities know, the tax credits available can be a huge tax relief, and in some cases can provide additional cash flow to help sustain research programs. However, the concept of the eligible expenditure limit can often go overlooked, and can come as a surprise to the growing small business when suddenly their tax credits are severely reduced.

If a company has eligible expenditure room, their SR&ED activities can generate a refundable federal tax credit of 35%, in addition to provincial credits like the Ontario Innovation Tax Credit (OITC) of 10% and the Ontario Research and Development Tax Credit (ORDTC) of 4.5%.

If a company does not have eligible expenditure room, the credits are significantly reduced.  The federal credit is reduced to a non-refundable tax credit of 20%, and the OITC is eliminated entirely. The recent federal budget issued in March 2012 proposes a further reduction to the federal credit to 15% starting in 2013.

If you’re a Canadian-controlled private corporation, the formula for calculating your eligible expenditure limit for 2012 is as follows:

($8,000,000 – (A x 10)) x (($40,000,000 – B)/$40,000,000))

Where:
A = the greater of your prior year taxable income and $500,000 and;

B = the greater of your prior year taxable capital minus $10,000,000 and zero

Simplified, so to speak, if your last year’s taxable income is greater than $500,000, your eligible expenditure limit begins to disappear. If it’s greater than $800,000, then your limit is completely eliminated. Similarly, if your last year’s taxable capital (generally equity and long term debt) is greater than $10,000,000, your limit is reduced and if it’s $40,000,000 or higher it’s completely eliminated. If your company is a member of an associated group, this calculation includes all of the associated companies’ taxable incomes and taxable capitals from last year.

What does this mean to the small business? If you’re floating around above the $800,000 taxable income mark, and rely heavily on the enhanced SR&ED tax credits, you may consider declaring a bonus at year end to bring your taxable income below the $800,000 mark in order to preserve next year’s credits. Even a taxable income of $700,000 would allow for $1,000,000 of eligible expenditure limit in the following year! Taking the expenditure limits into consideration is another important piece of the tax planning puzzle for a company involved in SR&ED.