Impact of the 2012 Federal Budget on the SR&ED Tax Credit Program

- April 20, 2012

On March 29, 2012, the federal budget was tabled in Parliament and included numerous changes to innovation funding in Canada.

One of these changes is the $1.3B cut to the Scientific Research and Experimental Development (SR&ED) tax credit program through the reduction of the tax credit rate for large enterprises and the range of eligible expenditures for all enterprises.

To compensate for this considerable reduction in corporate innovation funding, the government has announced a $1.1B increase in direct support (subsidies) to research, development, and innovation and a $500M allocation to venture capital.

Major changes to the SR&ED tax credit

  • First of all, the federal budget has not changed the SR&ED program’s scientific or technological project qualification criteria. However, by the end of 2012, the Canada Revenue Agency (CRA) will publish the consolidated application policies that apply to tax credit claims. This consolidation should not change any application policy currently in effect;
  • As of January 1, 2014, the tax credit rate applicable to large enterprises for eligible expenses incurred as of that date will drop from 20% to 15%. For Canadian-controlled SMEs, the good news is that the 35% tax credit rate remains the same;
  • As of January 1, 2014, tax credits for SR&ED-related capital expenditures (capital assets) may no longer be claimed either for acquiring or leasing property. Future expenses should be planned on the basis of this deadline, as capital assets acquired in December 2013 would be eligible for the tax credit even if they are used for SR&ED projects in December 2013 and in 2014;
  • As of January 1, 2013, only 80% of expenses paid to an arm’s length sub-contractor will be eligible for the tax credit. The government made this change to limit the tax credit on the profit margin included in the invoice received from the sub-contractor. The change will also apply to contracts for university or other research centres;
  • The proxy amount will change twice over the next few years. Currently, the proxy amount rate of 65% is applied to salaries directly attributable to SR&ED projects. The proxy amount allows taxpayers to claim SR&ED overhead without having to justify each expense incurred. On January 1, 2013, the rate will be decreased to 60%. As of January 1, 2014, it will drop to 55%. For taxation years that straddle more than one period, an average rate must be calculated according to the number of days in each calendar year. As the proxy amount will be reduced by around 15% in 2014 compared to 2012, certain enterprises may benefit from calculating the total SR&ED expenses, using the traditional method. Nevertheless, keep in mind that these calculations can be very complex;
  • The budget also states that the CRA will improve the objection process. In the near future, it will be possible to obtain a second review of decisions made regarding a science or technology project’s eligibility;
  • Lastly, the CRA will lead a pilot project to determine whether an official pre-approval process for SR&ED projects is possible.

Impacts of these changes on SR&ED tax credits for enterprises

The various federal government changes to the SR&ED program have a much larger impact on large enterprises. The following are the new combined Québec and federal tax credits for Québec-based enterprises:

Canadian-controlled SMEs  Large entreprises
Current As of 2014 Current As of 2014
Salaries (using the proxy method) 82,1% 78,6% 47,0% 38,1%
Sub-contractors (as of January 2013) 47,2% 40,2% 27,0% 19,4%
Capital assets 35,0% 0% 20,0% 0%

SMEs claiming SR&ED salaries are only slightly affected by these changes: the tax credit for SME salaries has been reduced by around 4% and 15% for sub-contractor expenses. As for large enterprises, the impact is much greater. The tax credit for salaries has been reduced by close to 19% and that for sub-contractors by slightly more than 28%.

Improvements to various direct support programs

The savings from cuts to the SR&ED program will be reinvested by the federal government as direct subsidies and other measures through various support programs in certain targeted economic sectors.
The improvements are the following:

  • An additional $110M per year will be granted to the Industrial Research Assistance Program. Thus, the subsidy program budget doubles;
  • $105M will be invested over two years to support forestry innovation and market expansion;
  • $400M will be granted to support private-sector venture capital start-up investments as well as the creation of large private sector venture capital funds;
  •  $100M will be granted to the Business Development Bank of Canada to support venture capital investment activities;
  • Lastly, an amount of $95M over three years starting in 2013-2014 and $40M per year thereafter will be spent on making the Canadian Innovation Commercialization Program (CICP) permanent and adding a military procurement section.

SR&ED Consulting Industry Measure

Over the next year, the government will be conducting a study and consulting with taxpayers to better understand the reasons behind enterprises calling on specialized consultants using contingency fees (percentage fee assignments). The goal will be to determine if measures are needed (that is, if these types of professional fees need to be legislated).

Conclusion

As with any tax change, it is not always easy to see your way clearly. This is why enterprises are strongly advised to consult their tax advisors to discuss the changes. Furthermore, the first changes will be effective within eight months’ time, so now is time to start planning strategies to offset the negative effects of the cuts to the SR&ED tax credit program.

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