Is SR&ED refund taxable? Yes.
Oh, you were looking for a bit more detail? Ok. SRED refunds are taxable, yes, but they are taxed advantageously compared to other forms of income in Canada.
The headline item is that the federal part of your tax refund, called the Investment Tax Credit (ITC), is taxed not in the year that it is granted, but in the following year. This feature of ITCs doesn’t reduce the amount of tax you pay, but it does defer the tax bill. This is advantageous.
Along with federal ITCs, you will earn provincial R&D credits. Some, but not all, of these provincial tax credits will be tax deferred for a year just like federal ITCs. The provincial credits earned on the proxy expense portion of your SRED claim are tax deferred. Proxy is a deemed overhead amount which is added to your SR&ED expenditures total by multiplying your total salary expenditures claimed by 55%. Proxy applies only to your salary expenditures, there is no proxy calculated for material or subcontractor expenditures.
So, with a bit of math, the maximum amount of your provincial SRED refund that will be deferred is 35% for a claim with no material or subcontract expenditures (0.55/1.55 x 100% = 35.5%).
Now, in practice, the SRED credit tax deferral is often not as good as it sounds. Recall that you have up to 18 months after your corporate year end to file for a given fiscal year’s SRED credits. Your fiscal year is Dec 31. You file your FY19 SRED in June 2021. You receive your SR&ED refund in September, 2021. You will receive a reassessment for your FY19 taxes that list your SRED credits and refund. You’ll also receive an FY20 reassessment. That’s the government with their hand out, looking for taxes owing on your 2019 ITC credits and your 2019 provincial proxy-based credits. So, you see what happened here? You received credits in 2021 and the government wants their taxes on your refund, also in 2021. What?! No tax deferral. To take advantage of SR&ED tax deferral, you need to file your SRED claims promptly, ideally with your year’s corporate taxes.
How else can you reduce the taxes paid on your SRED refund? The easiest way is to leave your SRED refund in the business. Plough your SR&ED refunds into salaries and other operating expenses. This means that if you’re a private corporation in Ontario, earning under the small business limit, you’ll pay 12.2% on your SRED refund. This represents a big tax savings over taking your SRED refund out of the business and using it as a payment toward a Ferrari. That’s perfectly legal, but it’ll cost you up to 53.53% of your SR&ED refund in combined corporate and personal taxes. Ouch!
Here’s the last word on SR&ED tax refunds. Canada’s SR&ED program is particularly generous toward small business corporations. Small business corporations can earn enhanced SR&ED credit rates on up to $3 million dollars of SRED expenditures. Credits earned up to this $3M expenditure limit are fully refundable. That means the credits are paid out as cash, regardless of your tax position. If you were able to structure your small business corporation so that you qualified for, say, $2M of SRED expenditures annually. That would net you $1.38M of SR&ED credits annually. Yes, you’d have to pay taxes on these SR&ED refunds. If you re-invested the SRED refunds back into the business, you’d pay $168K of corporate taxes on your SR&ED. Was your SR&ED refund taxable? Yes it was. But overall, your corporate tax “bill” would be a direct deposit annually from the Government of Canada for over $1.2M. Depending on your other revenues and expenses, it’s very feasible that you’d never owe net corporate taxes. Sign me up!
Call G6 Consulting to make sure your SRED refunds are done right!
G6 Consulting Inc has over 12 years of experience specializing in the SR&ED program. SR&ED experts such as G6 often work on a contingency basis, with payment only based on a percentage of SRED credits once received. You can contact G6 for a free consultation here. https://www.g6consulting.ca/contact/