In the past, companies making payments to non-arm’s length contractors, who performed SR&ED on their behalf, could claim SR&ED tax credits in respect of those expenditures. These rules have been changed. For example, now when a company makes non-arm’s length payments to an individual who is an independent contractor, or to a management company that renders SR&ED services, the rules restrict or eliminate the amount of the credit available. These rules also control whether the contractor, or the payer, may claim the credits.

Companies (payers) who make payments to non-arm’s length parties for SR&ED services rendered under contract no longer earn tax credits. The credit must be calculated by the party that is performing the services. The credit may then be claimed by either the party performing the services, or transferred to the payer.

To transfer the credit, the contractor must file an election form, accompanied by a legally binding director’s or administrator’s resolution. The form must be filed by the filing due date of the payer’s tax return, and before the notice of objection period runs out on the performer’s tax return, and before that same period for the first taxation year that ends at or after the payer’s taxation year.

Although time consuming, this system works well when it applies to the relationship between two larger companies. It does not work so well when one of the parties is unincorporated, or is a management company. Consider the following example. Tom is the son of the sole shareholder of XCO. Tom is not on the payroll of XCO, but bills XCO for his services. As Tom does not deal at arm’s length with XCO, the company cannot claim tax credits on the amount paid to him. Tom can claim credits, but is limited to his own cost in respect of the services. Because Tom is not incorporated, he cannot pay a salary to himself, and thus has no labour cost in respect of these services. Since there are no eligible costs, there is neither a claim for Tom nor any credits for XCO. The credits that could be claimed under the old rules are now unavailable.

The Strategy
Consider putting non-arm’s length subcontractors on the company payroll, to avoid the application of these new rules. Not only would the salary now constitute an eligible expenditure, it would also attract an additional 65% overhead allowance.

Links

• Definition of “contract payment”

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