Tax credits: are you getting enough? Just like a boost of Vitamin C is good for the immune system, so too can tax credits benefit your company’s financials. While searching for such credits and compiling necessary information for the tax return process can be arduous and time consuming, the results can be well worth the effort. So when it comes to tax incentives – is your business getting the credit it deserves?
The government creates certain tax credits to help foster the growth of businesses within Canada and internationally, and to promote growth and employment opportunities locally. These credits are earmarked to reimburse companies that invest in innovations which result in new or improved business or production processes, and/or develop new technological advancements.
The Canadian Council of Chief Executives has reported that Canada’s tax incentives are among the most generous in the world. In fact, an estimated $4 billion has been allocated to the Scientific Research & Experimental Development credit by the Federal and Provincial governments in Canada, alone. Small- and medium-sized enterprises (SMEs) are the largest recipients of such tax credits. To date, roughly 75% of these recipients are SMEs.
However, there are still many SMEs that don’t realize they qualify for such credits. Not claiming (or severely underestimating a claim) means potentially missing out on major reimbursements from the government. Aside from the fact that your competition could already be claiming these lucrative credits, don’t overlook the substantial boost these credits could give to your business’ working capital, cash flow and valuation.
There are two major tax credits you could be taking advantage of, in particular:
- The Scientific Research & Experimental Development (SR&ED) Tax Credit; and
- The Ontario Interactive Digital Media Tax Credit (OIDMTC)
A common misnomer is that SR&ED credits only apply to scientific research or technology companies; this is certainly not the case. Historically, this credit was actually intended for the manufacturing sector, primarily. Many companies can benefit from such credits, as long as they are seeking to develop or improve upon business or production processes that would result in new, improved or technologically-advanced products, procedures, devices and/or materials. It should be noted that the following information is applicable to tax filings in Ontario; rules and rates in other provinces may vary.
The Scientific Research & Experimental Development (SR&ED) Tax Credit
How does it work?
Applications to obtain SR&ED credits are submitted as part of your company’s year-end tax filings. While currently Canada Revenue Agency (CRA) only requires a technical summary embedded in your SR&ED tax form, it is imperative to have the proper documents to support your submission, as well, should supporting documentation be requested by the CRA. These documents should contain not only a deeper explanation of your application, but also supporting information: data kept in time records or a time tracking system, T4 slips for employees, meeting notes, mocks ups or screen captures from your website, etc.
This can be the most arduous point in the process. Gathering, sifting through and compiling information is time consuming and let’s face it, can be downright frustrating – but can be very worthwhile in the end: companies that apply for SR&ED are typically reimbursed either 15% or 35% federally and 10% provincially in Ontario via tax credits, or with straight cash. To put this in perspective: a $100,000 SR&ED claim could translate into a potential reimbursement of up to $70,000 in cash.
How do you qualify?
There can be a huge benefit to qualifying – but how do you get a piece of the credit? There are four main questions to answer first:
- Have you created or modified a process or product?
- Have you developed some form of custom equipment or machinery?
- Are you in a start-up or new growth phase?
- Have you tried to create a new product/process/technology but failed in the attempt?
If you’ve answered yes to any of the above – congratulations, you may qualify! Yes, even to the final point – even if the process or product you’ve attempted to create or refine didn’t quite go as planned, the hours of employee human-power put towards this could qualify under this credit.
Take for example, a bakery: if the owners of a bakery and their bakers put time into developing a new recipe for shortbread cookies that allow the shortbread to last longer so the bakery can ship their cookies nationwide, but the recipe fails to increase the shelf life, the owners could still apply their bakers’ time invested into the tax credit, to receive a partial repayment of the attempt. Remember when we said not just science and tech companies can apply for this credit. Even bakeries invest in experimental development!
New activities that can trigger a SR&ED claim are far reaching and can include pilot projects, prototype designs or beta testing. Testing processes or products already in production to create improvements, make processes faster, cheaper, or more environmentally-friendly could qualify; modifications to enhance efficiencies reduce waste, or increase scalability can also be considered. Also keep in mind that spinoffs from your main business, such as waste management processes, machine cleaning procedures and the like can also be considered – these processes improve your business and can also help improve your bottom line.
Above all, there are three basic criteria to keep in mind if you believe you have a credit-worthy application:
1. Advancement – scientific or technological
- a. It’s an attempt to generate new knowledge
- b. Failure in the process is acceptable
- a. The development involves a technological obstacle with a scientificrisk that needs to be overcome*
- b. It wasn’t known whether or not the project would succeed from the outset**
- a. There is evidence of qualified personnel working on the project
- b. A systematic approach was used
*If, for example, you’re developing an algorithm that helps speed up wait times, or developing a paint that better resists heat in the production process, this can be considered a technological challenge to overcome.
**In order to qualify for the credit, there must be a level of uncertainty. Can you adequately explain that the problems you attempted to overcome couldn’t be solved by existing procedures?
As in the example with the bakery, many companies are already investing hours and hours into developing such procedures, processes and materials that can apply for this credit. While the potential reward at the end can be very enticing, some business owners are still hesitant to apply. There are a few common myths that we can dispel if you’re still hesitant:
Now that you have an idea of what type of process can qualify, what costs of that process are then eligible for the credit? There are a variety of eligible expenditures that can be included. Wages, overheads, subcontractors and materials can all be submitted. When it all adds up, these four items alone can be a sizeable investment for your company. Consider the following, at a typical refund rate from the governments, federally and provincially:
Total SR&ED Claim: $160,000, -> Total cash refund: As high as $100,000
Regardless of the business, $100,000 in cash back is a very good return on investment for an effort that had a cost of $160,000.
The corporate filing deadline for these types of claims is 18 months after your year end; and claims cannot be submitted or adjusted thereafter. If a SR&ED claim is filed with a corporate tax return, the CRA will process this usually within 120 days; the average turnaround is actually 74 days. If a claim is filed separately, CRA will process it within 240 days – so the timing on getting your money back does vary – and for some, can be critical. So if you can file this with your corporate tax return, do so, there’s no need to delay receiving your cash from the government.
The Ontario Interactive Digital Media Tax Credit (OIDMTC)
How does it work?
The Ontario Interactive Digital Media Tax Credit (OIDMTC) is a tax credit available to corporations for the creation, marketing and/or distribution of certain interactive digital media products. As with SR&ED, most business owners wouldn’t read further as they don’t consider their work to be in the interactive digital media sphere – but fear not – there are options for claiming this tax credit in other sectors as well.
For this tax credit there are two different types of products that qualify: a non-specified product and a specified product.
A non-specified product – can be the development of an app or similar product that hasn’t yet been sold
- The credit is calculated at 40% of labour expenses, plus up to $100,000 inmarketing and distribution expenses
A specified product – is a product you’ve developed, because someone has asked you to build or develop it
- The credit here is calculated at 35% of labour expenses and no marketing costs would be covered because you already have a buyer
How do you qualify?
Qualified companies can be incorporated provincially or federally and must file an Ontario corporate tax return. As this is the Ontario tax credit, companies must maintain a permanent establishment in Ontario in order to qualify. After all, this credit’s intention is to support the growth of local businesses and employment in Ontario!
Note that to qualify successfully:
- More than 80% of the product or content had to be developed in Ontario
- Of that 80%, more than 25% of the product or content had to have been developed by your company – meaning T4 salaried employees, residing in Ontario.
A qualifying corporation can claim 100% of its eligible labour and 50% - 100% of its eligible third-party labour. ‘Eligible labour’ can include time spent in the three years before the product completion, as long as the employees were working on the specific project.
Claims can only be made when the product is ready to be released and can be made by amending prior years’ tax returns, as long as the years are not statute barred (in most cases, this means you can go back as much as three or possibly four years to amend a claim). Marketing and distribution costs, as mentioned above, can be claimed up to $100,000 per eligible product, as well.
Be aware of a few other factors when putting together your claim. A claim may fail if:
- The product developed is self-promoting
- There is lack of documentation, especially time records, when an employee is not employed 100% on a qualified project.
As with submitting a SR&ED claim, the success of an OIDMTC claim can depend on how precisely the claim is documented. While this can again, be time-consuming, it is a big factor in a claim’s success! So be sure to keep records well-documented and properly archived; or just let the professionals at Richter put this claim together for you and your team, and save you the trouble.
The primary purpose of a product in this credit is to either: educate, inform, or entertain a user, and achieve this purpose by using two of text, sound, and/or image capabilities. The product would therefore be “interactive digital media.” However, in light of recent Ontario budget changes, expenses incurred April 23, 2015 onwards are eligible only if the product is for entertainment or, if the product is for education, if it specifically targets children under the age of 12.
The product is usually ineligible if it is intended primarily for interpersonal communication (i.e. Facebook, etc.) or to present or promote your business, products, services or customer’s product. However products that are developed for sale or license, can qualify.
Examples of acceptable products include:
- Digital media games
- Interactive training courseware
- Mobile/tablet applications
- Online magazine
- Interactive television
- Interactive websites
Along with the tips for success, there are things to avoid, to save your claim from rejection. Above all, remember: don’t double dip among credits! SR&ED and OIDMTC claims should be clearly separated (along with all other government credit claims). If you are submitting a certain amount for say, an employee apprenticeship tax credit, that amount should be subtracted from your total SR&ED or OIDMTC tax credit.
Building for success
In order to minimize the risk of failure when developing a project and submitting a SR&ED or OIDMTC claim, make sure to:
- Use a time tracking or daily log system
- Use employee and subcontractor agreements
- Ensure all invoices and receipts define work rendered in detail
- If claiming SR&ED and OIDMTC, use one consultant to file both claims
Furthermore, third-party professionals can help maximize your claim through proper tax planning by helping map out:
- T4 employee costs vs. subcontracted costs
- Shareholder remuneration to enhance claims
- Consideration of tax implications of a SR&ED claim in one year, on the previous year’s income
- Structure of the company to ensure eligibility for the 35% SR&ED credit, vs. 15%
- Components of some projects that qualify for both tax credits
To ensure you’re getting the credit you deserve, it’s important to seek the help of a professional consultant. Not only can they help determine if you qualify, but they can help prepare the actual claim, assess the suitability of your existing accounting system for capturing project information and participate in the review of your claim, should CRA determine the need. At Richter, our expert partners work on claims like these with a variety of different businesses, and fees are only contingent upon the success of your claim.
SR&ED and OIDMTC can be extremely beneficial, and make investing in research and development all the more enticing. So aside from helping promote work within Ontario, these tax credits can be the incentive to grow your business, create more jobs, and boost your bottom line with cash in hand.