Key SR&ED Policy Change | Current | New |
|---|---|---|
Expenditure Limit
| $3.0 million | $4.5 million |
Expenditure Limit | $10 million and $50 million | $15 million and $75 million |
Enhanced SR&ED Credit | Private corporations | Private & eligible public corporations |
Capital Expenditures | Not eligible | Eligible |
Lease Cost | Not eligible | Eligible |
The government forecasts that these changes will cost $1.9 billion over six years. The CRA stated that $3.4 billion had been refunded in 2023, now with an additional $300 million per year. There is no reason to believe that there would be a greater proportion of the funding in later years and therefore the approximate increase in the SR&ED program will be just under 10%.
Let’s unpack how the government’s “SR&ED modernization” affects most taxpayers.
Bigger Pockets, Bigger Benefits: Who Gains from the New Expenditure Limits?
It is important to understand the demographics of companies that benefit from SR&ED. The chart below is from the CRA’s 2022/2023 data showing the number of SR&ED claims based on the gross income of the business. However, income is very different than SR&ED expenditure. The larger the business, the lower the R&D expenses are as a percent of the gross income. Also, every industry is different where biotech has a large R&D as a percent of gross income whereas electronic equipment manufacturing would have a relatively small R&D expense as a percent of income. A fair number would be 20% of income is spent on R&D. Therefore, for the lower end of the medium-sized companies, 20% of $20M is $4M in R&D expenses.
Number of SR&ED Claims Based on the Gross Income of the Business (2022/23)
Based on our calculations the change in the expenditure limit will affect the largest 15% to 20% of claimants. A vast majority of small and medium businesses do not spend enough on R&D for the increase in expenditure limit to affect their SRED claim.
For those large companies that would fully utilize the $4.5M expenditure limit, it would mean an increased SRE&D claim of over $500,000 per year.
For the thousands of small and medium businesses working tirelessly to innovate with limited budgets, these changes bring little hope. It begs the question: Is the government out of touch with the everyday challenges of Canada’s SMBs?
Taxable Capital Phase-out Threshold Increase
The taxable capital phase-out thresholds are an important concept in determining the expenditure limit for claiming the SR&ED tax credit. These thresholds apply specifically to Canadian-Controlled Private Corporations (CCPCs) and affect the enhanced refundable tax credit rate of 35%. This limit is subject to reduction (or phase-out) based on the taxable capital of the associated corporation(s).
The phase-out from 35% enhanced SR&ED credit to 15% occurs linearly between $10 million and $50 million of taxable capital. Under the new legislation, the phase-out would occur between $15 million and $75 million of taxable capital.
Trying to estimate how many SR&ED claims this would apply to is challenging as taxable capital is the total of the shareholder equity, retained earnings, and long-term debt which is not readily available information. However, it is highly unlikely that there are more than 20% of the CCPCs that receive SR&ED exceed $10 million of taxable capital. This change also benefits the largest 20% of CCPCs that claim SR&ED.
Public Corporations May Qualify for the Enhanced 35% Rate
The government’s news release says: “Extend eligibility for the enhanced 35 percent refundable tax credit to eligible Canadian public corporations on up to $4.5 million of qualifying SR&ED expenditures annually.” It is unclear what the definition of “eligible” public corporations is, however, this is a big win for public technology companies who will increase their SR&ED claim by almost one million dollars if they are claiming more than $4.5 million in SR&ED expenditures.
Less than 15% of SR&ED claimants are non-CCPCs and, typically, public companies are significantly larger than CCPCs. This is another win for large technology companies in Canada.
Capital Costs Added to SR&ED: Game-Changer or Token Gesture?
In the CRA’s 2022/23 fiscal year, the largest industry sector to claim SR&ED was software development accounting for 35% of all dollars refunded. This change will have little impact on those companies. However, companies that have buildings or facilities used for SR&ED activities or machinery and equipment that are directly employed in SR&ED activities will greatly benefit from this change in policy. Depreciation or capital cost allowance (CCA) for the asset can also be claimed as part of SR&ED.
In addition to capital expenditures, the costs of leasing property or equipment used in SR&ED activities were also eligible for claims. If leased equipment or property is used part of the time for SR&ED activities, a company will be able to deduct the proportionate cost of the lease.
It is important to note that this change will most likely apply to both the traditional method and proxy method of claiming SR&ED.
In a knowledge-based economy, the capital and lease costs are dwarfed by salaries. People costs will continue to drive the SR&ED claim and the inclusion of capital costs will add icing to the cake.
Summary
A small tech startup or scaleup with $500,000 to $2 million in R&D costs will see no meaningful change, while a multinational tech giant stands to gain millions annually from these new provisions. It seems clear that the government is focusing on larger entities that some have argued have more efficient R&D relative to their smaller peers. The largest 15% to 20% of companies will benefit from these changes and the smaller the company, the less impact these changes will have. In addition, the government has not simplified the SR&ED program, if anything, the complexity has increased by adding capital expenditures back into the program and allowing public companies to claim a portion of their SR&ED at the enhanced rate. One has to wonder what portion of the $1.9B is for more CRA staff, changes to CRA systems and administration versus benefiting taxpayers.
The Canadian Accountant published that Deloitte Canada increased its revenue by 25% in 2022 to $3.4 billion. The changes align with feedback often championed by larger industry players, such as Deloitte and EY, reflecting the challenges and opportunities faced by larger organizations. In the next phase of the CRA’s modernization plan, we hope to see enhancements that meaningfully benefit the 80% of taxpayers currently left without significant gains.
The changes are a step in the right direction. Coupled with other incentives and federal initiatives, the SR&ED program is a valuable tool for many Canadian businesses. Unfortunately, these changes won’t impact a vast majority of SR&ED claimants. Perhaps the federal government feels that providing a greater incentive to larger companies will give them more reason to remain in Canada. Considering how insignificant these changes are to the largest employers in Canada, it is unlikely that this will have an impact on where to hire R&D staff. It is more likely that the continued decline in the Canadian dollar will have the greatest impact on which country offers the biggest R&D bang for the buck.
One hopes that these changes are part of a larger rollout to reform the SR&ED program. There continues to be a need to simplify the program to reduce the cost of corporate compliance and CRA monitoring. Despite the CRA’s efforts, we know the use of SR&ED consultants has increased to an all-time high of 80%. Expect this to increase and expect large accounting firm profits to increase. Simplifying the application process and expanding support for smaller claimants could better align with the goal of nurturing innovation across all sectors. While the updates aim to strengthen Canadian R&D, there’s an opportunity to extend the benefits more effectively to small businesses, which drives grassroots innovation.
