High Investment Income Reduces SR&ED Expenditure Pool

Volume No. 08-04

“Investment income can reduce a company’s ability to claim refundable credits.”

There is a 35% refundable tax credit on eligible scientific research and experimental development (SRED) activities for Canadian-controlled private corporations (CCPC’s). The 35% refundable credit is only available ona $3 million expenditure pool as was recently introduced in the February 26, 2008 federal budget. Subsection 127(10.2) of the Act reduces this $3 million SRED expenditure pool. If the SRED expenditure pool is reduced completely, then the CCPC is entitled to a 20% non-refundable tax credit for federal income tax purposes.

If the current year’s taxable income of an associated group exceeds $400,000, subsection 127(10.2) of the Act reduces the SRED pool in the following year for the associated group. For every $1 increase in the associated group’s taxable income in the current year, there is a $10 decrease in the associated group’s SRED expenditure pool in the following year. The SRED expenditure pool is eliminated if the taxable income of the prior year is in excess of $700,000 (on an associated group basis). This change was included in the February 26, 2008federal budget. The policy is to limit the enhanced 35% tax credit to “small” CCPC’s, measured by their taxable income.

Investment income is earned by the associated group could reduce the SREDexpenditure pool in the following year since it is included in the associated group’s taxable income. The threshold is based on taxable income, not active business income. The policy reason for this rule is unclear: What does investment income have to do with carrying on eligible SRED activities in an active business? The rule would make more sense from a policy perspective if only active business income of the associated group reduced the SRED pool in the following year.

Unfortunately this is not how subsection 127(10.2) reads. A planning point to circumvent this punitive rule would be to exclude the investment company from the associated group. This simple planning technique may save the associated group’s enhanced $3 million SRED pool from being inadvertently eroded.

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The material provided in Tax Tip of the Week is believed to be accurate and reliable as of the date it is written. Tax laws are complex and are subject to frequent change. Professional advice should always be sought before implementing any tax planning arrangements. Neither the Tax Specialist Group nor any member firm can accept any liability for the tax consequences that may result from acting based on the contents hereof.