Over the years, we’ve seen any number of owner-manager compensation structures other than just taking straight payroll. The most common arrangements are:
Each of these forms of payment has implications on the company’s SR&ED claim.
Simply stated, dividends are not an eligible SR&ED expenditure, full stop. If the owner-manager is performing SR&ED work, any dividends paid will not generate SR&ED Investment Tax Credits (“ITC”).
An owner-manager can be either an arm’s length or non-arm’s length contractor. In situations where the owner-manager does not have control of the business, it is possible to be considered to deal with the company at arm’s length. In an arm’s length fact pattern, the portion of the remuneration paid to the owner-manager could be claimed as a SR&ED expenditure based on the time spent on eligible activities. For ITC purposes, the amount claimed will be reduced by 20%. Contrast this with payroll which is not reduced by 20% and also attracts the Prescribed Proxy Amount at the rate of 55%. Being paid as an employee vs a contractor almost doubles the SR&ED ITC.
In a non-arm’s length fact pattern, things get even worse. The non-arm’s length rules dictate that the amount paid is not a qualified expenditure of the payer. Expenditures must be claimed by the non-arm’s length SR&ED performer. As an individual, the owner-manager has income but typically no expenditures, so the qualifying expenditures of the owner-manager are NIL.
Similar to the contractor example above, a holding company can be either an arm’s length or non-arm’s length contractor. The arm’s length fact pattern is the same as described above: 80% inclusion for ITC purposes and no Prescribed Proxy Amount.
In a non-arm’s length fact pattern, the expenditures must be claimed in the holding company. Presumably, the holding company will have distributed some form of remuneration to the owner-manager. If the distribution takes the form of salary or wages, a portion of the remuneration paid to the owner-manager could be claimed as a SR&ED expenditure based on the time spent on eligible activities. Dividends or return of capital paid out to the owner-manager would not be eligible expenditures.
With some additional paperwork, it may be possible to transfer the expenditures from the holding company to the payer.
Companies enter into these compensation arrangements for purposes other than SR&ED, usually on the advice of their tax adviser and without consideration of the SR&ED implications. If your business claims SR&ED ITCs, make sure that your tax adviser and your SR&ED service provider are both involved in any conversation about compensation strategies so that all of the ramifications are considered prior to making a decision.
At BeneFACT, we provide our clients with year-round consulting and check-points to ensure they are on track to receive the highest claim amount possible for any given tax year. We are Canada’s largest independent SR&ED firm with a full-time staff of over 60 employees. If you have any question(s), please do not hesitate to give us a call toll free at 1-855-TAX-BACK (829-2225).