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Bulletin # 38 2009 Federal Budget Disappoints Technology Business
Bulletin # 38 2009 Federal Budget Disappoints Technology Business
Bulletin # 38 2009 Federal Budget Disappoints Technology Business
Bulletin # 38 2009 Federal Budget Disappoints Technology Business
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Bulletin # 38 2009 Federal Budget Disappoints Technology Business

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SBL Increase Means Higher Cash Refunds for CCPCs, But Still No Cash …

SBL Increase Means Higher Cash Refunds for CCPCs, But Still No Cash
Refunds for non-CCPCs
On January 27, 2009 – Finance Minister Jim Flaherty delivered the 2009 Canadian Federal
Budget to Parliament. Opposition threats to defeat the government with a non-confidence vote
failed to materialize, and the budget began wending its way through the house on its way to
becoming law. Regrettably this budget generally ignored private-sector R&D as a significant
engine of economic development. Despite numerous pre-budget submission pleas from almost
every sector of industry for better SR&ED tax credits – most notably refundability for non-
CCPCs – there was only one small adjustment; i.e. an increase in the Small Business Limit that
allows already refundable CCPCs to retain an additional $100K in taxable income before most
of the CCPC advantage is lost.

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  • 1. TM Scitax Advisory Partners LP R&D Tax Credit Specialists, Canada & Abroad DIRECTORS:Bulletin David R. Hearn, Managing Director Michael C. Cadesky, BSc, MBA, FCANUMBER 38 | FEBRUARY 4, 2009 2009 Federal Budget Disappoints Technology Business SBL Increase Means Higher Cash Refunds for CCPCs, But Still No Cash Refunds for non-CCPCs On January 27, 2009 – Finance Minister Jim Flaherty delivered the 2009 Canadian Federal Budget to Parliament. Opposition threats to defeat the government with a non-confidence vote failed to materialize, and the budget began wending its way through the house on its way to becoming law. Regrettably this budget generally ignored private-sector R&D as a significant engine of economic development. Despite numerous pre-budget submission pleas from almost every sector of industry for better SR&ED tax credits – most notably refundability for non- CCPCs – there was only one small adjustment; i.e. an increase in the Small Business Limit that allows already refundable CCPCs to retain an additional $100K in taxable income before most of the CCPC advantage is lost. While this is the fourth budget to emerge from Stephen Harper’s Conservative government, it is the first to relegate the technology business sector to such a minor role. Although there were a few token offerings – such as additional $200M to the National Research Council IRAP program and $110M for the Canadian Space Agency – these were overshadowed by the bigger disappointments in other areas, such as the failure to replenish funding for Genome Canada. The increase in IRAP funding is far less significant than it seems, since most companies eligible to draw on that money would likely be entitled to get almost as much in SR&ED tax credits. For example, a Canadian Controlled Private Corporation with an R&D project involving $200K of wages, would likely receive approximately $100K in IRAP funding; however at the end of the year, that company would only be entitled to an SR&ED benefit of $230K as compared to the $330K benefit it would have otherwise received had it not taken the IRAP funding. The fact is that when the reduction of SR&ED tax credits is considered, IRAP is a “wash” for most companies. IRAP funding is only truly useful for companies unable to finance their own R&D outlays in the first place.
  • 2. Perhaps the greatest disappointment of all was that the government missed the opportunity to deliver targeted economic stimulus directly to the technology sector by providing some means – even temporary – for companies not eligible for cash refunds, to monetize their ITCs. Although the “poster” case in point is Nortel, which is on the verge of insolvency despite having $1.8B in SR&ED ITCs, other sectors have similar needs. Inexplicably, the Minister seems to have missed the large number of pre-budget submissions from almost every association industry that pleaded for such refundability. For example, the following excerpt from a letter on January 8th, 2009, in which the Canadian Manufacturers and Exporters urge Mr. James Flaherty as follows: This SR&ED tax credit, which is used by many of our member companies, provides critical support to in-house innovation and commercialization. However, during difficult economic times, when companies are investing more than they are making in profits, they cannot take advantage of the credit. Its real value declines over time, reducing the effective returns from investments in SR&ED projects. Making the SR&ED credit refundable would provide more effective stimulus for companies to sustain their investments in innovation during this period of economic challenge. How the SBL Increase Helps CCPCs So much for the criticism, here’s what they did do: The Small Business Limit (SBL); was increased from $400,000 to $500,000; for taxation years ending after 31-Dec-2008. This is the second major increase in the past few years and it puts Canada near the top of the list for reduced taxation of small business. The closest benchmark is the United Kingdom, where the equivalent threshold is £ 300K (about $530K in Canadian dollars). For the Canadian Controlled Private Corporations (CCPCs) that claim SR&ED tax credits, this is significant in four ways: 1. It means the CCPC can retain more profit in the corporation – where it is eligible for the reduced federal tax rate of 11%. Normally, companies claiming SR&ED tax credits would “bonus out” income, in excess of the SBL, to the shareholders, where it would be taxable at the much higher personal tax rates. 2. A larger portion of the R&D expenditures made by CCPCs will attract a cash refund benefit. CCPCs get a full cash refund benefit at a benefit rate of 35% on only the first $3million of current R&D expenditures. This $3M figure is called the “expenditure limit”. On expenditures above $3million, the benefit rate is reduced from 35% to 20%, only 40% of which is refundable – the remaining 60% is an investment tax credit. Both the reduction of the benefit rate down to 20% and the onset of the 40/60 split is accelerated as the CCPC’s taxable income exceeds the SBL – a phenomenon that tax practitioners refer to as “the grinds”. The increase in the SBL to $500K means that a CCPC can retain an additional $100K in taxable income before the benefit rate is ground down to 20%, only 40% of which is a cash refund. 3. There is an opportunity for more immediate liquidation of the SR&ED benefit. Some of the benefit amount that would normally arrive in the form of a refund cheque, six to twelve-months after the year-end tax returns are filed, can be used to pay-down the taxes owing on theNUMBER 38 | FEBRUARY 4, 2009 S C I TA X B U L L E T I N | PAGE 2
  • 3. additional $100K income retained in the company. This is particularly appealing since the SR&ED benefit from the current year is not taxable until it is received, which is typically in the following year. 4. The increase gives more latitude for associated companies that must share the SBL between multiple companies in the group. Impact of SBL Change on SR&ED Benefit Grind for CCPCs onset Threshold at SBL Benefit Rate 35%, of which Benefit Rate 20%, of 100% is Cash Refund which 40% is Cash Refund Before budget 2009 below $400K $700K Per budget 2009 below $500K $800K (YE’s > 31-Dec-09) Maybe Next Time? Looking ahead to future budgets, we see three options for addressing the non-CCPC refundability issue, without breaking the bank: 1. Institute temporary allowance of partial refundability. For example, Nortel trades in $1.8 B in ITC’s for $600M in cash or loan guarantees. In return they forfeit the carry-forward option on the $1.8B. This would be a VERY smart move for Ottawa because it would restore two-thirds of the taxes that would otherwise be lost if or when Nortel returns to profitability or is bought by some other telecom equipment company that is profitable. The long-term impact of this type of measure could be tempered with the inclusion of a time constraint; e.g. next two years only. 2. Flow through share scheme – it is already working very well in the petroleum and mineral sectors. The same legislation could be adapted to the technology sector. 3. Requiring the banks to accept ITCs as loan collateral. The government would then allow the banks to securitize that collateral by applying to their own profits in case the borrower defaulted. France presently uses this type of scheme. Mr. Flaherty could make SR&ED credits refundable for all companies. However, that would be costly – about $2.5B per year – and could well lead to spiraling demand – some perhaps fraudulent – for SR&ED benefits that would be difficult for CRA to control. For more information on this topic, contact: David R. Hearn, Managing Director, Scitax Advisory Partners (416) 350-1214 or dhearn@scitax.comNUMBER 38 | FEBRUARY 4, 2009 S C I TA X B U L L E T I N | PAGE 3
  • 4. About Scitax... Scitax Advisory Partners is a professional services firm with specialist expertise in Scientific Research and Experimental Development (SR&ED) tax credits. We offer a team of senior technical consultants all of whom have ten or more years experience in the SR&ED field. All Scitax technical consultants have engineering or science backgrounds and at least twenty years industry experience in their particular field prior to consulting. Our primary function is to produce a technical submission package that most effectively communicates your SR&ED claim to CRA in a way that highlights eligibility and expedites processing. We assist you in identifying and preparing all required documentation including project technical descriptions, cost schedules, and everything else your tax preparer needs to file the claim. Once your claim is filed, Scitax will advocate for you with CRA and help you negotiate fair settlement of your claim. While we normally work with our clients existing tax advisors, our affiliated firm Cadesky and Associates can provide a full package of tax services if required. TM Scitax Advisory Partners LPDirectorsDavid R. Hearn, Managing DirectorMichael C. Cadesky, BSc, MBA, FCAScitax Advisory Partners LPTD Centre, 77 King Street West, Suite 2401, Toronto | 416-350-1214 | www.scitax.comDisclaimerThis bulletin is provided as a free service to clients and friends of Scitax Advisory Partners and Cadesky and Associates. The content is believed tobe accurate and reliable as of the date it is written, but is not a substitute for qualified professional advice.© Copyright Scitax Advisory Partners LP, 2009. All rights reserved. “Scitax” is a trade-mark of Scitax Advisory Partners LP.

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