Scitax Advisory Partners LP

Scitax Advisory Partners LP

November 07, 2013 15:28 ET

Tax Changes From 2012 Federal Budget Set To Hit Canada's Tech Sector

Ontario Finance Minister Offers Help (Maybe)

TORONTO, ONTARIO--(Marketwired - Nov. 7, 2013) - Today Ontario's Finance Minister Charles Sousa suggested that Ontario may shortly implement a new "pay or play" R&D tax credit that might cushion the blow that the province's technology business sector is about to suffer in a "delayed reaction" from federal-level tax credit cuts that were announced back in the 2012 federal budget.

2013 year end will mark the last time many of Canada's technology sector companies full benefit from what for the last 30 plus years has been the world's best R&D tax credit incentive programs.

Canada's 2012 federal budget contained a series of significant changes to the Scientific Research and Experimental Development (SR&ED) tax credit program. The first of these changes took effect on January 1 2013 and a series of progressively more severe cuts will roll out over the next two years.

For any corporation that has tax to pay at year end and for Canadian Controlled Private Corporations who get a cash refund even if there is no tax is payable, these cuts will go straight to the bottom line starting with 2013 financial statements.

David Hearn, managing director of Scitax Advisory Partners in Toronto observes: "These changes stack-up with each other so total impact turns out to be rather worse than the figures announced in the budget would suggest. The fact that a change in federal legislation triggers a cut in provincial level tax credits is a particular concern."

Ottawa's budget 2012 cuts alter provincial R&D tax credits because in mist cases these credits are calculated on whatever expenditures count at the federal level. Therefore any reductions in SR&ED-eligible expenditures implemented by Ottawa trigger a proportionate reduction in the amount R&D tax credit benefit from the province.

To compensate for these federal level changes, some Canadian provinces are attempting to adjust their own provincial level R&D tax credits: Shortly after the 2012 federal budget Quebec introduced an enhanced provincial credit for the bio-pharmaceutical sector that is now in effect. In his November 7th economic outlook statement Ontario's Finance Minister Charles Sousa suggested that Ontario may implement an enhanced "pay or play" R&D tax credit that would reward companies for increases in R&D spending from year to year. Such "incremental" tax credit schemes are common in U.S. jurisdictions and are thought to be a way of preventing companies from claiming tax credits on work they would have done anyway.

Mr. Hearn went on to say "At first glance it might seem that cuts Ottawa made in the 2012 federal cuts apply primarily to large corporations that are foreign- or public-owned. However, the majority of the changes are cuts in expenditure eligibility that apply to anyone making a SR&ED claim." and "Ontario's proposed pay or play credit is an interesting idea but we'll have probably have two wait until spring 2014 to see the details and really understand how effectively it will compensate Ontario companies for losses at the federal level".

According to Hearn, certain sectors of industry will feel the federal level cuts more severely than others:

Pharmaceutical, biotech and electronics companies will be particularly hard hit because their R&D work requires test and measurement equipment the cost of which will no longer qualify to attract SR&ED after January 1, 2014. This applies whether the equipment is either purchased or leased. Long term laboratory equipment leases undertaken based on assumed annual recovery from SR&ED may need to be re-negotiated or terminated altogether. Companies that manufacture or distribute R&D instruments and equipment will see downward pressure on margins as customers seek price concessions to make up the difference.

Furthermore in two years when the temporary extension to the accelerated capital cost allowance for machinery and equipment that was announced in the 2013 budget wears off, the cost of R&D equipment will have to be written of over time instead of being entirely deductible in the current year through SR&ED expenditure pool.

Software development companies which are typically labour and payroll intensive will suffer in two ways: One because a significant portion of their workforce are contractors and after 1-Jan-2013 only 80% of the amount paid contractors qualifies to attract SR&ED. And two, because by Jan 2014 the "proxy overhead" allowance - until now calculated as 65% of T4 wages - will be reduced down to 55%.

It has been well-communicated that foreign- and publicly-owned corporations will suffer a 5% reduction (i.e. 20% to 15%) in their SR&ED benefit rate and there is no change in the 35% benefit rate available to Canadian Controlled Private Corporations ("CCPCs"). What's been less well communicated is that in certain circumstances the same 5% cut will also apply to CCPCs.

Contact Information

  • Available for comment and analysis contact
    David R. Hearn
    Managing Director
    (416) 558-7866

    Scitax Advisory Partners LP
    The Exchange Tower
    130 King Street West, Suite 2300
    Toronto, Ontario M5X 1C8