The Scientific Research & Experimental Development (SR&ED) program has been a cornerstone of Canadian innovation for decades, providing refundable and non-refundable tax credits to corporations conducting R&D in Canada. For many tech startups, SR&ED credits help support early-stage development when companies are pre-revenue and building their R&D programs.
SR&ED credits include the federal investment tax credit (ITC) and a provincial tax credit, depending on the corporation’s permanent establishment (PE) and where the R&D work is performed. Based on the recently-passed Bill C-15, Canadian-controlled private corporations (CCPCs) and eligible Canadian public corporations (ECPCs) can benefit from refundable federal ITCs on up to $6 million of expenditures (updated from $3 million), with an enhanced credit rate of 35% – this is the federal expenditure limit. This applies for taxation years that begin on or after December 16, 2024.
For corporations with a PE in Ontario, there is also a separate Ontario expenditure limit for the refundable Ontario Innovation Tax Credit (OITC), up to $3 million at an 8% credit rate. Many tech startups assume their SR&ED claim will not exceed these expenditure limits and therefore enjoy full refundability. However, as corporations grow, earn revenue, and build capital, these expenditure limits may decrease or be eliminated, reducing the claim to only non-refundable credits at lower rates. Understanding what factors reduce expenditure limits is critical for planning future cash flows.
Federal Expenditure Limit Calculations
The federal expenditure limit is based on a corporation’s prior year taxable capital in Canada. If the corporation is associated with other corporations for tax purposes, the limit is based on the combined taxable capital of the associated group.
Taxable capital generally includes retained earnings, contributed surplus, and indebtedness, minus investments and loans to other corporations.
- Under the new rules, the federal expenditure limit begins to phase out at $15 million in prior year taxable capital and is eliminated at $75 million.
- Corporations with prior year taxable capital of $75 million or more can only claim the non-refundable federal ITC at 15%.
Example: A CCPC with prior year taxable capital of $20 million falls midway between the lower and upper limits. Its current year federal expenditure limit would be $5,500,000, allowing up to $1,925,000 refundable credits. Expenditures beyond this limit earn the non-refundable 15% credit, which can be applied against federal Part I tax in the current year, carried forward for 20 years, or carried back three years to be applied.
ECPCs are treated differently for the phase-out calculation of the federal expenditure limit: it’s based on the average gross revenue from the last three years, starting at $15 million for the full $6 million expenditure limit and decreasing to $0 at $75 million on a straight-line basis. If the ECPC is part of an associated group for tax purposes, the average gross revenue considers the revenue from each associated corporation.
Ontario Expenditure Limit Calculations
A similar methodology applies to Ontario:
- OITC expenditure limit decreases starting at $25 million in prior year taxable capital and is eliminated at $50 million.
- It is also impacted by prior year taxable income: starts to phase out at $500,000 and eliminated at $800,000.
- Once a corporation has no Ontario expenditure limit, it may only claim the non-refundable Ontario R&D Tax Credit (ORDTC) at 3.5%.
Key Considerations and Best Practices
Previously, the federal calculation also considered prior year taxable income, but this measure was eliminated for taxation years that end after March 18, 2019, benefiting CCPCs
In practice, corporations often assume full expenditure limits, but associated corporations with high taxable income or large taxable capital can reduce refundability unexpectedly. Best practices include:
- Reviewing prior year performance before claiming SR&ED.
- Considering strategies to disassociate from corporations with excessive taxable income or capital to restore refundable credit eligibility.
- For CCPCs, elect to use the gross revenue phase-out calculation that’s used for ECPCs, if the taxable capital calculation results in a lower federal expenditure limit.
Maximizing SR&ED Credits with Welch LLP
The key takeaway: be proactive in monitoring taxable capital and income to maximize refundable SR&ED credits.
The SR&ED advisors at Welch LLP are always available to provide guidance and help corporations optimize their R&D claims.
