SR&ED: What you need to know about the changing landscape - MaRS Best Practices

MaRS Centre
June 14, 2012
John Sutherland
Scientific research and
experimental development
incentives

© Deloitte & Touche LLP and affiliated entities.
Presenter contact info:
Scientific research and experimental development incentives3
John Sutherland BA, CGA
Senior Manager – Tax
Global R&D and Government Incentives
Phone (416) 643-8048
Cell (905) 379-3261
josutherland@deloitte.ca

Agenda
•  Overview of the Canadian SR&ED program
•  Budget updates – Federal and Ontario
•  CCPCs
•  Program Criteria
•  Ontario Technology credits
•  Stretching SR&ED dollars
4 Scientific research and experimental development incentives

Canadian SR&ED Program
•  Canadian Controlled Private Corporations (CCPC)
Benefits:
–  SR&ED Deduction pool
–  ITCs
•  35% of eligible expenses
–  Refundable on the 1st 3m of SR&ED expenses
–  Taxable Income and Taxable capital thresholds to be maintained for
refund-ability
–  Provincial refund ability
•  20% of eligible expenses
–  40% refund ability on SR&ED expenses in excess of $3m
–  Taxable Income and Taxable capital thresholds to be maintained
for refund-ability
•  Provincial Credits also available

Benefit of the program
•  Other benefits
–  Accelerated write-offs
–  Timing on utilization of expenditures
–  Unused credits carry forward

Federal update

Federal budget
•  Non-CCPC
–  15% non-refundable for taxation year ending after 2013
–  Reduce proxy calculations to 60% for 2013 and 55% thereafter
–  Arm’s length subcontract expenses to be reduced to 80% after 2012
–  No lease expenses after 2013
–  No capital expenses made after 2013
–  No shared use equipment after 2013
•  CCPC
–  35% rate remains unchanged though the base of qualifying
expenditures will be smaller – as per above
–  15% for non-qualifying CCPC or for expenses in excess of $3m or
expenditure limit

Federal budget – Impact
•  Reduction in total benefit in Ontario will range from 6% to 40%
–  Depending on:
•  CCPC small corporation status
•  Mix of employees versus contractors
•  Capital component of claims
•  Materials component of claims

Federal budget – Other SR&ED and research Items
•  Conduct a pilot project to determine the viability of a formal
pre-approval process
•  Enhance the existing online self-assessment eligibility tool
•  Make more frequent and effective use of “tax alerts”
•  Improve the Notice of Objection process to allow for a second review
of scientific eligibility determinations
•  Divert “savings” from reduced SR&ED ITC% to direct incentives
–  Make the Canadian Innovation Commercialization Program permanent
–  Provide support in 2012-13 to the NRC to refocus on business-led, industry
relevant research
–  Double the IRAP Internship program
–  Launch the Western Innovation Program
•  Similar to such programs in other provinces
–  Other plans not yet clarified

Program criteria &
qualifying expenditures

Program criteria
Definition of SR&ED
•  Three types of eligible development:
1.  Basic research
2.  Applied research
3.  Experimental development (90%+ of all claims)
−  Work undertaken… for the purpose of creating new, or improving
existing materials, devices, products or processes, including
incremental improvements

Program criteria (Cont’d)
Eligibility criteria
•  Three essential elements
1.  Technological advancement
2.  Technological uncertainties, and
3.  Technical content

Technological advancement
•  Typically a new characteristic or capability
•  The knowledge gained
•  Transferability of this new knowledge
–  Examples:
–  Integration of disparate technologies
–  Algorithms, methods or capabilities
–  e.g. special caching techniques to improve performance
–  Tools (e.g. speed up development, load balancing)
–  Any technological improvements in proprietary systems
–  Faster, more data, smaller footprint, cheaper, etc
•  Note that success is not a requirement, only an attempt

•  “Technological uncertainty” may occur in either of two ways:
–  Uncertain that goals can be achieved; technological obstacles exist that must
be overcome through experimentation or analysis.
–  Goals can be achieved; however, what path, route, approach, equipment
configuration, etc., will work.
•  Need for experimentation and analysis
•  SR&ED Project STARTS when uncertainty is identified
•  SR&ED Project ENDS when uncertainty is resolved

Scientific or technological content
•  Qualified people involved
–  Employee records can support qualifications
–  Professional, academic, technical training and work experience are all
relevant credentials
•  Systematic investigation
–  Departure from application of proven approaches
–  Experimentation and analysis
–  Testing and evaluation
–  Conclusions reached

SR&ED activities include
•  Technical feasibility studies
•  Review of competing technology
•  Design
•  Prototype build and evaluation
•  Programming
•  Component, system and integration testing
•  Technical documentation
•  Support activities undertaken directly to help
resolve the uncertainties that make the
project R&D

SR&ED activities exclude
•  Market research
•  Routine testing
•  Routine data collection
•  Social sciences or humanities
•  Commercial production
•  Style changes

Other criteria
•  Development must be in a field of science or technology
•  Work must be performed physically in Canada
•  Work must be performed by Canadian taxable entities
•  Claimant and claimed subcontractors
•  Claim must be submitted within 18 months of fiscal year end
•  Expenditures must be paid within 6 months of fiscal end
•  Work contracted by another Canadian entity may be subject to
reduction of eligible expenses by the amount paid
•  And many other less common rules which we will deal with on a case-
by-case basis
–  e.g. Salaries of “specified employees”

SR&ED in a nutshell
Point A
‘base level’
Point B
‘target level’
•  Faster
•  Increased yield
•  More efficient
•  Better performance
•  New capability
•  New application
•  Knowledge
•  Better tools
Barriers,
Constraints,
Obstacles,
Challenges
Advancement
Knowledge base
Technical objective
1.  Idea generation
2.  Idea selection
3.  Prototype, analysis, testing, simulation, modeling, FEA, etc.
4.  Results/conclusions

SR&ED industry examples
Industry Example of SR&ED
Software/ IT Improvements to customized software
Manufacturing Process improvements to reduce production time
and cost
Consumer Goods Production formulations with restricted ingredients to
achieve sought specifications
Pharmaceutical/Biotechnology Improving processes to reduce material waste
Chemicals Developing custom equipment to improve process
performance

SR&ED – What can you claim?
1.  Salaries and wages
2.  Materials consumed and transformed
3.  Contract SR&ED payments (80% after 2012)
4.  Lease expenses (until 2013)
5.  Third party-payments for other people performing SR&ED that taxpayer
can exploit
6.  Overhead (2 methods of calculation)
7.  Certain capital expenditures (until 2013)
•  Less SR&ED contract payments received
•  Less Government Assistance (grants, credits)

Overhead

Traditional or proxy method of calculation
Each year taxpayer can choose between:
•  Traditional Method
–  Calculation of actual overhead directly attributable to SR&ED, or
•  Proxy Method
–  Notional calculation of overhead based on 65% * of directly engaged
labour
* (60% for 2013 and 55% thereafter)

Salary and wages

Salary and wages
•  Employees Directly engaged (proxy)
•  Employees Directly attributable (traditional)
Ø Incremental and related to SR&ED

Materials

Materials consumed vs. transformed
Consumed
•  Implies materials are absorbed, used
up or broken into small pieces
•  Destroyed or rendered virtually
useless as a result of SR&ED
Transformed
•  Materials are incorporated into
product that has some value to the
taxpayer or to another party
•  Subject to ITC recapture when a
disposition occurs

SR&ED Contract payments
(80% after 2012)

127(9) – Definition of contract payment
“Contract payment” means
•  An amount paid or payable to a contractor taxpayer for SR&ED
performed
•  on the claimant’s behalf
•  on an arm’s length basis

Leases (until 2013)

Leases (until 2013)
•  All or substantially all (ASA)
–  90% used for SR&ED
•  Claim actual cost
•  Primarily
–  Used 50% to 90% for SR&ED
•  Claim 50% of cost

Third party payments

Third party payments
•  Payments to any one of the following entities which carry on SR&ED
activities in Canada:
–  An approved association that undertakes SR&ED
–  An approved university, college, research institute or other
similar institution

Capital expenditures
(Until 2013)

Eligible capital expenditures
•  “All or substantially all” (ASA)
•  Intent test
•  “Shared use equipment” (SUE)
•  Use test
Ø Must be new for ITC purposes
Ø Excludes buildings and leasehold interest in buildings
Ø Must be available for use

ITC Recapture

What does it apply to and when?
•  The “property” subject to the recapture rules include:
•  Materials, all or substantially all equipment (“ASA”),shared use
equipment (“SUE”)
•  When sold or converted to commercial use, the itc’s related to these
items may be recaptured

Ontario technology
tax credits often
overlooked

Ontario tax credits
•  Ontario innovation tax credit
•  Ontario research and development tax credit
•  Ontario interactive digital media tax credit
•  Ontario computer animation tax credit
•  Ontario business research institute tax credit

OITC
•  10% Ontario Innovation Tax Credit (OITC) for eligible expenditures
incurred in Ontario
•  Available for all corporations with operations in Ontario
•  Refundable
•  Qualified expenditures up to the expenditure limit ( $3M)
–  Canadian taxable income of the group of companies
–  World wide taxable capital of the group of companies
–  Planning:
•  No 18 months deadline
•  Contract payments from customers outside Ontario

ORDTC
•  Replaces pre – harmonization Ontario deduction for federal ITC
•  Catch: considered to be assistance Reduce ITC
–  Reduce SR&ED pool à ORDTC attracts federal and Ontario tax
•  Unused ORDTC can be carried back 3 years (but not to taxation year
ending before 2009) and carried forward 20 years
•  Taxpayer can waive this non-refundable tax credit –presumably to
increase federal ITC
•  If waived, no immediate difference on cash flow compared to O161 in
companies with losses

Ontario Interactive Digital Media Tax Credit (OIDMTC)
•  Refundable tax credit of 40% since March 27, 2009 for non-specified
products
–  35% for “specified products” (fee-for-service)
•  Eligibility based on product, which must be complete
•  Educate, inform or entertain
•  Interactive (What info and how info is displayed)
•  Multimedia (2 of text, images and/or sound)
•  Available to non-exempt corporations only
•  For work done in Ontario
•  Must obtain a Certificate of Eligibility

OIDMTC: Funding for eligible product
•  Eligible expenditures
–  Salaries and wages
–  Contractors (only 50% of cost eligible before March 27, 2009)
–  Marketing and distribution costs (capped at $100k per product)
•  Benefits
–  40% regardless of size (after March 26, 2009) – non specified product
–  35% specified product

OIDMTC – Digital media game corporations
•  35% tax credit rate for qualifying digital game corporations
•  Incur a minimum $1 million of eligible Ontario labour costs over a 3 year period for
fee-for-service work done in Ontario that is directly related to the development of a
digital game
•  Not required to be at arm’s length with the purchaser corporation
•  Not required to develop all, or substantially all, of the eligible product
•  35% tax credit rate to specialized digital game corporations
–  80% of Ontario payroll or 90% of annual revenues attributable to interactive digital
media game development
•  Minimum of $1 million of Ontario labour expenditures in the taxation year directly
attributable to the development of eligible digital games
–  Entitled to file an annual OIDMTC application
–  Not required to contract with an arm's length purchaser
–  Not required to develop all, or substantially all, of products included

Computer animation and special effects tax credit
•  20% refundable tax credit
•  Ontario labour expenditures for development of computer digital
animation and digital visual effects for use in television or film
•  A certificate of eligibility must be obtained from the Ontario Media
Development Corporation and filed with tax return

Ontario Business – Research Institute Tax Credit
(“OBRITC”)
•  20% refundable tax credit
•  For SR&ED expenditures through a PE in Ontario
•  SR&ED payments made to an Ontario Eligible Institute
•  Business should be entitled to exploit the results of the SR&ED
•  An eligible research institute includes most universities and colleges in
Ontario, hospital research institutes and certain non-profit research
organizations
•  OBRITC is in addition to OITC credit

Stretching your SR&ED dollars
Agreements with suppliers/customers
•  Proactively reviewing agreements to ensure SR&ED tax credits are
maximized
•  Invoices should have proper segregation of materials and services
to avoid/minimize recapture
•  Clear terms regarding performance and ownership of SR&ED

Stretching your SR&ED dollars (Cont’d)
Tracking SR&ED on a contemporaneous basis
•  Meets CRAs requirements
•  Capture additional activities
Purchase of Capital Assets for SR&ED purposes
•  Purchase requisition should state intent
•  Ensuring available for use by the year end

Who is Deloitte?
•  Largest service provider in this field in Canada
•  Integrated team of engineers, scientists, accountants and tax specialists
•  Adaptable work models
–  “A la carte” to full outsourcing capability
–  We provide support from opportunity qualification, through all CRA
technical and financial approvals
Practice overview
Canada GTA
SR&ED Partners 8 3
SR&ED Associate Partners 11 5
SR&ED Senior Managers 58 9
Other Professional Staff 75 31
Total number of SR&ED practitioners 152 48
Professional/Graduate Engineers 71 22
CA’s, CGA’s and CMA’s 81 26

Questions?

SR&ED: What you need to know about the changing landscape - MaRS Best Practices

SR&ED: What you need to know about the changing landscape - MaRS Best Practices

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