You’re an inventor and entrepreneur developing a new solution and living off KD and Timmy’s. In Canada this is typical of many new start-ups. Let’s assume you’re a Canadian Controlled Private Corporation (CCPC). There may be a way to add funding for your company even though you may not have enough money to pay yourself.
R&D is subsidized in Canada through the SR&ED program. More info is available here http://www.cra-arc.gc.ca/sred. If you undertake R&D, chances are good that you qualify for the SR&ED program.
The basic process is simple: Declare a salary, make a SR&ED claim, file your personal tax, and you will be ahead of where you would have been if you declared no salary. Let’s use an example of an inventor who spends a year developing a new solution. His fair market salary is $70,000 and he lives in Ontario in 2009.
- Assumed salary applicable to R&D: 100%
- Fair market salary declared on T4: $70,000
- Potential SR&ED claim: $47,950
- Personal tax payable: $15,820
If you did not draw a salary, the company pays you $0, you owe $0 in tax and you cannot make a SR&ED claim. If your company issues a T4 for $70,000, the company will have a liability of $70,000 in salary payable to you, be eligible to receive up to $47,950 in SR&ED funding and you have a personal tax liability of $15,820. The net result is that you and your company will be ahead by $32,130 in cash. If you SR&ED claim is successful, you can now pay yourself $32,130 and the company would have a salary payable liability of $37,870. Assuming the company is making a loss after the SR&ED is taken into account, there is no tax liability for the company.
So remember, even if you don’t have money to pay salaries, in most cases making a SR&ED claim will put you ahead of the game.
Tags: SR&ED, sweat equity
Are you putting me on with this article?
As an ex-Canada Revenue Agency RTA, the saddest thing that I used to see was where people had put in all the sweat equity into wonderful eligible development and all that we could give them was a pat on the head. It wouldn’t have mattered what the ITC percentage was as they had zero labor expenses; 35% or 1000% of zero is the same amount. But it doesn’t have to be so cut and dried (and brutal).
The solution is as Espresso Capital has described in their example. It is quite legitimate and I sat in on many meetings where the senior auditor in our group described just how to do this. In a way it is win-win for everyone and everyone has some skin in the game. The individual gains, the company gains, and the government gains particularly when the company is able to survive and the development leads to entrepreneurial success.
If you think it sounds too much like a shell game then do your own math. Look what everyone has in the game in terms of gains and liability (the company at some point does have to pay you that full salary) and you come out ahead. The major risk is the eligibility of the technical claim and there are ways to reduce that through conversations with experienced CRA staff or experienced industry consultants.
There’s a fly in the ointment.
The company must pay the SR&ED salary within 180 days of year-end to qualify for SR&ED tax credits as cash refund. Since we are talking start-ups, the likely scenario is that the SR&ED consultant charges the company for preparing the SR&ED claim but the company only gets a tax credit for use against future earnings. The employee has paid out the tax but gets only an IOU from the company. You will have a very angry client.
It’s a win-win only if the company has the cash flow to pay the salary. It is a use-able technique if the company was poorly structured (owner not on payroll for first 11 months of fiscal year) but has cash and is not yet past the T4 filing deadline.
It beats paying the owner a bonus.
I’ve used that trick before; it works great. Additionally, I’ve had success in reclassifying payments from a corporation that were “due to shareholder” as employment income.
For example: Joe lends $100,000 to his own company, and takes back $5,000 a month out of cash flow thereafter.
For the claim period, initially the $5,000 x 12 months = $60,000 is considered a “repayment of shareholder loan”. But working with a Joe’s accountant, we reclassified this as “employment income” and issued an amended T4 to Joe for the period for $60,000. Yes, Joe had a personal tax bill to settle, but it was a way to attribute a dollar value to his time in SR&ED.
Not as preferable as the situation described in this article, but it definitely works as well.
The salary for SRED eligible work performed by the owner manager must be an expense to the company, for it to be an expense for tax purposes the salary must be paid within 180 days of the corporate year end, now the critical piece is: “The best evidence of the payment is that the payroll withholdings were paid by the company on time to the CRA.” (per 1987 CTF conference) So the shareholder can finance the company with their after tax money, but the CRA wants to collect as soon as it can.
I follow your example, but the salary would likely be classified as paid to a specified employee, so I would reduce your potential SRED claim to aprox. $43,200, this would be more realistic in the given scenario.
This is all quite interesting. SR&ED is a great program, and I’ve seen some companies survive the economic downturn solely due to SR&ED — it literally kept the lights on so that the companies survived until the the economy recovered.
However, companies need to make sure they don’t see SR&ED as an entitlement. They still need to demonstrate technological advancement. It must be credible and documented. And they need to be aware of the rules – both for claiming SR&ED credits and for paying their employees.
The first problem I see with Garron’s scenario is this: Specified employees (i.e. a person who owns 10% or more of company or who does not deal at arm’s length w/the company) can only claim up to 75% of the time (and presumably salary) for which they were directly involved in SR&ED. That reduces the SR&ED-eligible expenditures in the example from $70K to $52.5K. Max SR&ED credits for this are about $36K in Ontario.
Another problem is that an entrepreneur is unlikely to expend 100% of their time on SR&ED activities. In fact, companies that claim all of their principals’ time as being for SR&ED might trigger increased scrutiny of their SR&ED claim as a result. If you do so one year, you can’t count on getting away with it every year. Be careful here: If you mysteriously claim exactly the 75% limit on SR&ED activities year after year, someone’s going to decide to take a more careful look. Be realistic. As a founder, some of the time you spend on your company will be for bizdev, financing, admin, etc..
Another important point is this: Suppose you do pay yourself with an IOU, the company must still withhold and pay remittances for personal tax, CPP and EI. In Garron’s example, using 2011 tax rates, that would be $15,180 in tax and $6,323 for EI and CPP. That’s $21,503 you need to come up with in cold, hard cash to pay the government while you’re waiting for the SR&ED cheque to arrive. I believe you can wait up to 180 days into the subsequent fiscal year to pay the salary if it is a bonus, but there are two problems here: First, bonuses to specified employees will be scrutinized by the CRA to make sure they are not based on profits. Bonuses paid on profits to specified employees can’t be included in your SR&ED claim. Second, you don’t know how long it will take to process your SR&ED claim, nor do you know how much of your SR&ED claim will be accepted by the CRA.
So… now you’re in a situation where you’ve paid salary via an IOU of $70K. You’ll net about $14.5 in cash (SR&ED claim = $36K, Remittances paid to Receiver General = $21.5). That assumes that the entire SR&ED claim will be approved. And you hope it will be approved in a timely manner so that you aren’t out of pocket $21.5 while you wait for the $36K cheque to arrive.
Just be aware of the risks. Don’t file frivolous SR&ED claims. Claim legitimate SR&ED. Document, document, document! The best damned thing you can do is to methodically record your time spent each day, and that of your employees. Always have supporting documents for your claim. (See http://bit.ly/aSsSh6 for my thoughts on this point).
That $32,130 (or 45.9%) is just the start. That is your next year’s R&D salary, so you receive a $14,747 SR&ED cheque. That’s another R&D salary, and a $6,768 SR&ED cheque. After 5 years, you have received$58,180 or 83% of the original $70K. Pay yourself $70,000 each year, and receive $247,700 or 70.7% of that back over 5 R&D years. You could pay yourself more, perhaps to obtain better personal financing (e.g., line of credit vs mortgage), but increasing rates for personal income tax make high SR&ED salaries unworkable.
Hi,
I tried the same strategy as mentioned in the article in Quebec. My tax claim was for full-time salary $74000 for year ending Dec 31, 2010. I am now liable to pay the salary within 180 days from Dec 31, 2010. I recently received the following SR&ED financial audit request:
“As requested, here is the list of documents that we need to continue our examination of your SR&DE credit claim :
Detail about salary :
- Detailed calculation of the salary rate and the number of hours claimed in SR&ED
- Timessheet of employee involved in SR&ED
- Proof of paiement of the salary within the 180 days folowing the tax year end
Documents used to calculate the provincial tax credit :
- Form RD-222
- Form RD-1029
Any ideas ?