Scientific Research and Experimental Development Tax Credit Program

What is SR & ED?

SR&ED stands for Scientific Research and Experimental Development. The Canada Revenue Agency offers tax credit incentives and refunds for companies that perform any kind of qualifying Research and Development. In simple terms, these are companies that in the course of developing new or improving existing products, processes, or services, become involved in resolving issues encountered in the development. Essentially, if you have developed or created a new process, product, or improved an existing process or product, you may be eligible.

Who Qualifies

Businesses carrying on qualifying SR & ED activities in Canada qualify for the program. The type of business entity, ownership structure and size will affect the amount of the credit and how you receive it.

What tax benefits are available?

Businesses can qualify for refundable tax credits or tax credits that can be used against other income taxes owing.  For example a Canadian Controlled Private Corporation will qualify for a full refund of the tax credits earned on current expenditures and a 40% refund of tax credits earned on capital expenditures.  The balance of the credits not refunded can be used to reduce the income tax otherwise payable by the corporation.

What is a Qualifying SR&ED Project?

Canadian tax law states, “To establish whether or not the work you claim is eligible, we have to examine eligibility at the project level.”

“An SR&ED project consists of a set of interrelated activities that meet the three criteria of SR&ED defined in the current version of Information Circular 86-4, Scientific Research and Experimental Development.:

  1. the attempt to achieve specific scientific or technological advancement and
  2. overcome scientific or technological uncertainty, and
  3. must be pursued through a systematic investigation by means of experiment or analysis performed by qualified individuals.”

What Activities are Eligible for Scientific Research & Experimental Development Tax Credits?

 SR&ED is defined for income tax purposes:

“Scientific research and experimental development means systematic investigation or research that is carried out in a field of science or technology by means of experiment or analysis and that is

  1. a) basic research,

(b) applied research, or

(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto,…”

Technological Advancement Definition:

“Achieving a technological advance would require removing the element of technological uncertainty through a process of systematic investigation … For an experimental development activity to be eligible the technological advance achieved has only to be slight.”

The search for a meaningful advance is satisfied whether or not the activity is successful. In other words, determining that a hypothesis is incorrect also represents a scientific or technological advance.”

 

An Example of What You Could Receive in Ontario for a corporation with income below $ 500,000

Income below $ 500,000 Income below $ 500,000
Non-CCPC Non-CCPC
CCPC Private CCPC Private
Eligible SR&ED Expenditures $100,000 $100,000 $100,000 $100,000
Assumed Proxy for salaries $65,000 $65,000
Total Expenditures $165,000 $165,000
Refundable Tax Credits
Ontario Innovation Tax Credit 10.00% 10.00% 16.50% 16.50%
Federal Tax Credit 30.08%   49.64%  
Total Refundable 40.08% 10.00% 66.14% 16.50%
Non-Refundable Tax Credits
Ontario Research and Development Tax Credit 4.05% 4.05% 6.68% 6.68%
Federal Tax Credit   17.19%   28.36%
Total Non-Refundable 4.05% 21.24% 6.68% 35.05%
       
Total Tax Credits % 44.13% 31.24% 72.82% 51.55%
Total Tax Credits $ $44,133 $31,240 $72,819 $51,546

 (Some conditions apply)

(The credits received are added to the corporations taxable income, reducing the overall benefit)

 

Where the proxy is available the expenditures are increased by up to 65% and therefore the resulting tax credits are increased by 65%.

ORDTC is at a rate of 4.5% of the expenditures less the 10% OITC claimed to bring the actual rate to 4.05%.  This credit is applicable against Ontario income tax only and is available to all corporations with a permanent establishment in Ontario.  Often corporation doing SR & ED will not have enough Ontario tax payable to fully utilize this credit. The credit can be carried forward for 20 years.

OITC is refundable (40% on capital expenditures) and is available to all corporations with a permanent establishment in Ontario.  The credit is phased out as the prior year’s income moves between $ 400,000 and $ 700,000.

The Federal credit is refundable to CCPC with income less than $ 500,000.  Where income moves between $ 500,000 and $ 800,000 the credit is converted from a 35% refundable credit to a 20% credit applied against tax.  The 35% refundable credit is available on up to $ 3,000,000 in current expenditures. The 35% credit is only refundable on capital expenditure at a rate of 40% of the 35% tax credit earned; the balance of the credit can be applied against federal income tax payable.

 

Purchase and sale of commercial real estate by a medical professional

Introduction

What makes Medical Professionals different from many other professionals or business owners is that most Medical Professionals are HST exempt. That means that they pay HST on their purchases and do not get it back. So the cost of HST is very important to consider when structuring any part of their practice.

When a doctor decides it is time to purchase their own office there is more than just HST to consider. They must also consider income tax, creditor protection; Accounting and reporting requirements; and the eventual sale of their practice or the sale of the building. They must also be aware that they must ensure that their corporation continues to qualify as a Medical Professional Corporation.

  • Income Tax – Corporate or personal ownership
  • HST
  • The purchase
  • Daily operations
  • Eventual Sale of your practice
  • Creditor protection
  • Accounting and reporting
  • Qualification as a Professional Corporation

Income tax – Corporate or personal ownership

The first question I would like to discuss is how income tax will affect how the purchase is going to be funded. Generally the money to purchase comes from two sources, your savings are used for the down payment and the balance is provided by your bank as a mortgage.

If your practice is not incorporated and you purchase the property personally you are using after tax dollars to provide the down payment. That means to come up with a down payment of $100,000 you will need to earn $185,185 based on a 46% tax rate. If you were incorporated, the corporation would need to only earn $117,647 based on a tax rate of 15% to come up with $100,000. You can see that there is a significant savings to using a corporation. If your practice is not incorporated you should reviewing the benefits of incorporation on our website.

The benefit of using corporate funds to pay down the mortgage increases the savings by again allowing you to use after tax earnings at the corporate tax rate.

Income Tax – Corporate or personal ownership
Income Earned Personally
Income $185,000
Personal Tax $85,185
After-tax Funds $100,000
Income Earned by a Corporation
Taxable Income $117,647
Corporate Tax -$17,647
After-tax Funds $100,000

HST

HST is an issue at the time of the purchase, throughout the ownership of the property, and again on the eventual sale of the property. In almost all cases a doctor is an exempt supplier and is therefore not registered for HST. That means they do not get the HST paid back.

The purchase and eventual sale

Where a doctor is buying a residential property to convert to commercial use, there is no HST payable at the time of the purchase. Where a doctor is buying a commercial property in Ontario, HST of 13% must be paid by the purchaser at the time of the purchase. If you are buying a unit in an office condominium or a store front building, it is pretty easy to determine that you are buying a commercial property. If however you are buying a single family house to use as your office it can be a little more of an issue.

The determination of whether a house is residential or commercial for HST purposes depends on the use of the property at the time of its sale. If the vendor or a tenant is living in the house, generally it will be residential; if the house is being used as an office, it is commercial. Often the agreement of purchase and sale will indicate what the property is used for; however you need to be careful. Simply saying a property is used for residential purposes, so as to avoid immediate HST does not make it so.

It is your responsibility to ensure you know what the property was used for. If the vendor has represented it was residential and it turns out it is actually commercial CRA will still ask you to pay HST. If CRA comes in a few years after the sale, interest and penalties could be assessed as well. At that point you need to speak to your lawyer to see if you can chase the vendor for damages.

A way to avoid this risk is to include the following comment in your purchase and sale agreement: “HST if applicable is included in the price”. If in fact there is no HST on the sale then, no problem. If there is HST on the sale the Vendor will need to deal with it.

Where the property is commercial and HST is being paid, there are two ways for the HST to be dealt with, depending on the registration status of the purchaser. Where the purchaser is registered, the purchaser self assesses. This could be the case if a doctor used a registered holding company to complete the sale. The purchaser would pay the vendor just the net purchase price and then file an HST return that shows 13% owing on the purchase and claim an Input Tax Credit of 13% to offset the liability to zero. If the purchaser is not registered, like most doctors, the vendor of a commercial property is required to collect the HST from the purchaser at the time of the sale. The vendor then remits the HST to the CRA.

Where the purchaser was not registered and actually pays HST on the purchase the purchaser will get this HST back when it sells the property. So it is important that the purchaser is able to show that HST was in fact charged. Where the HST is paid in addition to the purchase price it is easy to support the payment of HST, however where the agreement of purchase and sale said “HST if applicable is included in the price,” then you must show that HST was in fact applicable. If there is nothing else in the agreement, the onus will be on the purchaser to show that HST was in fact chargeable.

Let’s work through an example, if the purchase price of the building was $1,130,000 and the contract says that “HST is included in the price if applicable.”

If HST was applicable the price would be considered to be $1,000,000 and the vendor would remit $130,000 to the CRA as HST on the sale. The unregistered purchaser would pay the full $1,130,000 however they would get credit for the $130,000 on the eventual sale of the property. When claiming the Input Tax Credit, it is very important that you are able to show that HST was included in the price, as well as that HST should have been charged on the sale. As noted above, the best proof is the vendor acknowledgment. If you are unable to get this acknowledgment, you should at least get support for the fact that the building is in fact a commercial property. You want to ensure that the vendor cannot claim that someone was living in the building. I would also ensure that the lawyer completes the closing statement to show the net purchase price plus the HST.

On the eventual sale of the property, that you have been using for commercial purposes, your medical practice, you will need to charge HST on the new sale price. This will of course affect how much you can sell the property for. Where you originally purchased the property and paid HST, you will be able to claim back the HST paid on the purchase. Where you did not actually pay HST, such as in a case where you purchased a residential house and converted it to commercial, you will not get a refund of any HST.

If we use as an example a sale price of $1,500,000 plus HST you can see how you can recover the HST paid on the purchase assuming a purchase price of $1,000,000 plus HST.

Sale of Property – HST Included
Corporation
Sale Price Inclusive of HST $1,695,000
HST on sale -$195,000
Net Proceeds $1,500,000
Individual
HST to Remit – where no HST paid on purchase $ 195,000
HST to Remit – HST paid on purchase -$130,000
Net payment $65,000

The HST rules will apply in the same way regardless of whether your practice is incorporated or not.

A twist on the rules would be if you used a holding company to purchase the property and then rented the property to your medical practice, whether incorporated or not. The benefit of using a holding company is that it would be registered and if HST was applicable at the time of the purchase you would not need to pay it. The HST would be paid on the eventual sale by your holding company to a new owner. The downside of using this structure is that the practice using the building would end up paying HST on the monthly rent. This is discussed below.

Daily operation

Where you decide to use a holding company to own the property and you get the immediate benefit from claiming the HST on the purchase, you will now need to charge the medical corporations rent. Each corporation is a separate legal entity and transactions between them must be at fair market value. That means if the medical corporation uses the property owned by the holding corporation, the medical corporation must pay rent at fair market value. When rent is charged, HST will be payable.

The rent charged must cover the gross operating cost of the building, including property taxes and insurance. It should also provide an amount for base rent. You could ask your real estate agent for estimate of fair market value (FMV) rent.

If we assume rent of $ 4,000 per month, or $ 48,000 per year, plus other expenses of $ 24,000, that means a total rent of $ 72,000. This represents expenses that would not normally be subject to HST; however, you would now be paying HST of $ 9,360 per year as part of your rent.

Where you hold the property directly in the medical corporation or personally as part of your practice you would save the HST.

Creditor protection

Creditor protection should also be considered. If the property is owned by the medical corporation or by you personally as part of your practice, it would be exposed to the creditors of the medical practice.

Where we are not dealing with a medical professional, i.e. businesses that are registered for HST, we often use a separate holding company to own the real estate to provide some amount of creditor protection.

The problem that medical professionals have is that they now must pay HST on their monthly rental amount as discussed above. Most doctors consider the extra cost for creditor protection to be too high.

Eventual sale of your practice

Another issue to consider is what happens on the eventual sale of your practice. If your practice is incorporated and it is the owner of the building, a sale of the Medical Professional Corporation shares would include the building.

It is possible to split the ownership of the building and the practice; however it would be a complicated and expensive process.

One of the benefits of selling the building and the business together on a share transaction is that the gain might be sheltered from tax by using the $800,000 capital gains exemption.

This is an area you should speak to your accountant about before starting the sales process.

Qualification of your Professional Corporation

Another question I get asked is, how will the ownership of a building affect the qualification of my corporation as a Medical Professional Corporation?

If you will be renting the building to other businesses or professionals outside of your practice your Professional Corporation may be offside under your college’s requirements. Under the legislation a Medical Professional Corporation may only provide services of your profession.

To answer this question, you should look at both the Business Corporations Act (“OBCA”) and the Regulated Health Professions Act (“RHPA”).

The OBCA states that:

5. The articles of incorporation of a professional corporation shall provide that the
corporation may not carry on a business other than the practice of the profession but
this paragraph shall not be construed to prevent the corporation from carrying on
activities related to or ancillary to the practice of the profession, including the
investment of surplus funds earned by the corporation.

Where you intend on using the building to rent to someone outside your practice and you will need to borrow to make the purchase you should consult your lawyer before making the purchase.

Accounting and reporting

Each additional land holding corporation will add about $1,500 to your annual compliance costs.

Tax planning for a medical or dental practice

Introduction

Doctors have lobbied hard over the years to obtain the same tax advantages as other small business people. The right to incorporate was a big win. Now most doctors are including a corporation as part of their structure. They are also including family members as shareholders.

I would like to start our review by looking at the long term savings of incorporation. If we assume that the value of the goodwill of your practice is $ 500,000,  a typical example would be as follows:

One time savings on incorporation:

  • Sale of goodwill to your corporation – immediate reduction in tax on what would have been paid on a dividend – $90,000
  • Purchase of in goodwill by the corporation – total savings over time – $ 45,000
  • Claiming the $ 824,176 (2016 limit) capital gains exemption on the eventual sale of your practice- $ 200,000

Annual savings on $ 500,000 of income:

  • Income splitting with low income spouse – $ 18,000 per year
  • Interest write off on personal debt – $ 12,000
  • Greater tax relief on other expenses – $ 500
  • Potential deferral of tax – $ 150,000

Below find the following topics:

Incorporation of a Medical or Dental Practice
Deferral of Income Tax
Lower overall tax rate
Income Splitting
Avoidance of Canada Pension Plan
RSP Contributions
Capital Gains Exemption
Further Temporary Tax Deferral
Sale of Goodwill to the Corporation
Other Tax Savings
Example of tax savings

Incorporation of a Medical or Dental Practice

General Rules

Incorporation of your professional practice is governed by at least two sets of rules. First is the Ontario Business Corporation Act (OBCA) which allows for the incorporation of various types of professional. The second set of rules will be found in different documents depending on the profession; for example, most medical professionals are governed by the 1991 Regulated Health Professions Act.

Who Can Hold Shares

For most professions the OBCA provides that all of the shares must be owned directly or indirectly by members of the specific profession. However there is an exception that allows ownership of shares for medical and dental professional corporations by family members. Family members include your spouse, children and parents.  They are permitted to own non-voting shares.

Children under the age of 18 must own their shares through a trust.

Medical professionals are prohibited from using a holding company to own voting shares of their professional corporation by the 1991 Regulated Health Professions Act.

Who Can Be Officers or Directors

All of the officers and directors of a professional corporation must be professionals, as well as shareholders of the corporation.

Corporate Name

The name of the corporation must include the words “Professional Corporation””in English or French. Further the name must comply with all other requirements of your profession, for example a dentist must include the word dentist in his/her corporate name.

Accumulation of Surplus Funds

The original OBCA legislation prohibited the accumulation and investment of excess earnings by the Professional Corporation (PC). The rules have now been changed to allow for the accumulation and investment of the surplus funds.

No Limitation of Professional Liability

Generally shareholders of a corporation are not liable for the debts of the corporation; however shareholders of an Ontario Professional Corporation will still be personally responsible for professional liability. Unlike the increasing popular Limited Liability Partnerships, each partner will be held jointly and severally liable with the Professional Corporation for all professional liability claims made against the corporation in respect of errors and omissions that were made or occurred while he or she was a shareholder.

Costs and Benefits of a Professional Corporation

The College of Physicians and Surgeons of Ontario has announced that the application fee for incorporation will be reduced from $750 to $350, effective for applications received after January 1, 2006. The application fee for dental professional corporations remains at $750.

The application fee for dental professional corporations remain at $750.

The Colleges also charge annual renewal fees; the annual fee charged by the College of Physicians and Surgeons of Ontario is $125.

In addition to the set-up costs, the only costs associated with a PC are the annual administrative and accounting costs of maintaining the corporation. Generally these costs are not significant.

RSP Contributions

Part of the tax plan usually includes replacing salary with dividends; as a result the professional may not have any earned income, which in turn means that he or she will not have any RSP contribution room.

Deferral of Income Tax

The 2017 tax rate paid by an Ontario corporation qualifying for the Small Business Deduction in Ontario is 15% compared to the top personal marginal tax rate of 53.5%. Where the profits of the corporation can be left in the corporation, the professional will enjoy a substantial deferral of income tax of about 38.5%.

Further significant savings can be had if the doctor defers the withdrawal of the funds until retirement since it is likely that the doctor’s tax rate in retirement will be lower than the current tax rate.

Lower overall tax rate

After the income has been taxed within the corporation, the funds will be paid out as a dividend, which will be taxed in the professional’s hands. In theory this second exposure to income tax should bring the total tax up to the same total tax that you would have paid if you earned the income directly. Prior to 2014 there was actually a significant savings of about 3.4% when earning your income through a corporation compared to earning it directly. Starting in 2014 the tax rate on dividends was increased so that there was no benefit of earning income in your corporation, unless you are able to income split order payment of the income until you are in a lower tax bracket.

Income Splitting

Now that dental and medical professionals are allowed to issue shares to family members, they will be able to allocate dividend income to these other family members. The savings from income splitting can be significant. For example, if you were able to split $300,000 between you and your spouse you would save about $ 18,000 per year.

Avoidance of Canada Pension Plan

Where the income of the corporation is less than $ 500,000, there will be no need to pay a salary to the professional; therefore there will be no CPP contributions. This will save about $5,128.20 per year (based on 2017 CPP rate). The downside is that the professional may not have a full pension from CPP upon retirement. Our suggestion is to ensure the professional puts the funds saved by not paying CPP into a savings plan. Odds are he/she will have more upon retirement in the savings plan than in the CPP.

$ 824,176 Capital Gains Exemption

The ability to incorporate provides the professional with the ability to sell his or her interest in the practice as shares, which means up to $824,176 (2016 limit) of tax free income.

For members of the medical professions, it may be possible to access more than $ 824,176 in tax free capital gains by having other family members own shares of their Professional Corporation.

Further Temporary Tax Deferral

You will be able defer your tax payments. In very general terms, we could defer all of your income tax for one year; however, part of that tax would catch up with you in the second year. If we assume you are earning $ 400,000 per year, your tax would be about $175,000. If we put the income through a corporation, you would have very long-term deferral (until you retire) of about $133,000. Depending on when you withdrew the funds from the company, you could have a very small taxable benefit related to the interest value of the excess funds withdrawn from the company.

Sale of Goodwill to the Corporation

Where the practice has a significant value associated with the goodwill, it will be possible to sell the goodwill to the new corporation for yet another tax break.

We would sell the goodwill to the new corporation at a price at or below fair market value. This would create a capital gain in the doctor’s hands. The top tax rate for 2017 on a capital gain is 26.75%. This would effectively reduce the doctor’s rate of tax on what would have been a dividend from 45.3% (top margin rate on non-eligible dividends) to 26.75%.

If the goodwill was worth $ 500,000, the approximate saving would be $72,750.

A further benefit would be that the corporation would now have a depreciable asset. Starting in 2017 goodwill purchased for $ 500,000 will be added to the new class 14.1 to be written off at a rate of 5% per year. If we assume a corporate tax rate of 15%, this will save the corporation another $ 38,750. This savings is spread out over many years, so the present value would be much lower.

Interest Expense Write-off

Now that doctors are allowed to have their spouse’s own non-voting shares of their corporation, we will now be able to utilize a fairly common interest write off plan.

Effectively we want to be able to convert personal debt, on which the interest is non-deductible, to investment debt, on which you can get a write-off for the interest payments.

On a $ 500,000 mortgage, where you are paying 5% interest, the savings could be as high as $12,000 in tax every year.

Other Tax Savings

The corporate structure provides a few other tax savings, for example:

Entertainment expense – generally 50% of meals and entertain expense is disallowed as a deduction. If personally you are at a 53.5% tax rate, this will cost you 26.75% in lost tax savings. If the expenses are incurred by the corporation at a 15% tax rate, the lost tax savings is only 7.50%.

Life insurance – generally life insurance is a non-deductible expense. If the life insurance is paid by the corporation, it is still not deductible; however you are using before personal tax dollars, therefore you are still saving the difference between the corporate tax rate of 15.5% and the total personal tax rate of 53.5%.