Ontario Innovation Tax Credit Changes Offer More Incentives for Small Businesses (2018)

May 23, 2018 SRED

Changes to the Ontario Innovation Tax Credit may make small businesses more likely to file a claim.

Update December 2018: In their fall statement, the Progressive Conservative government has announced it is putting the proposed increase, which had been introduced by the former Liberal government earlier this year, on hold while it reviews the effectiveness of both the Ontario Research and Development Tax Credit and Ontario Innovation Tax Credit. According to an Annex of the Fall Statement 2018, “Ontario will review tax support provided for research and development activity and, as such, the government will not be implementing these changes. The government will ensure that support provided for research and development is effective and efficient.”¹

The Ontario Innovation Tax Credit (OITC) is a “refundable tax credit for small to medium-sized companies on eligible R&D expenditures,” ² and can be claimed when corporations file Schedule 566 with their T2 Corporation Income Tax return. Prior to March 28, 2018 the OITC rate was 8% for eligible expenditures incurred after May 31, 2016; however, changes introduced in the 2018 Ontario Provincial Budget propose to “enhance the OITC to encourage smaller companies to make investments in R&D that will help them grow.” ³

Changes to the Ontario Innovation Tax Credit

In the 2018 Ontario Provincial Budget, the Provincial Ontario Government announced that the OITC would take into account a company’s R&D expenditures as a ratio of their gross revenue.⁴ Instead of a flat 8% rate, the changes propose a tiered rate based on the ratio of R&D expenditures to gross revenue. The budget papers specify:

For eligible R&D expenditures incurred on or after March 28, 2018, if a company qualifies for the OITC and has a ratio of R&D expenditures to gross revenues that is:

10 per cent or less, the company would remain eligible for the OITC at the eight per cent rate;

Between 10 per cent and 20 per cent, the company would be eligible for an enhanced OITC rate that would increase from eight per cent to 12 per cent on a straight-line basis as the company’s ratio of R&D expenditures to gross revenue increases from 10 per cent to 20 per cent; and,

20 per cent and above, the company would be eligible for the OITC at a 12 per cent rate.⁵

This change introduces the possibility for companies with R&D expenditures to gross revenue ratios of above 20% to file claims for OITCs at a rate of 12%, as well as companies with R&D expenditures to gross revenue ratios of between 10% and 20% to benefit from incremental “straight-line” increases from 8% to 12%. In order to claim the enhanced rate, both the R&D expenditures and gross revenue must be “attributable to Ontario operations.” ⁶

The introduction of an enhanced rate is a surprise welcome measure and was described as “a win for the ITAC community” by the Information Technology Association of Canada (ITAC).⁷ Prior to the provincial budget announcement, there was speculation that tax credits for research and development would be cut further.⁸ In 2016 the OITC rate was cut from 10% to 8%, so the new “enhanced rate” of 12% only benefits some companies whose ratios are above 20%, and potentially some companies whose ratios are above 10%. Additionally, as the enhanced rate only applies to eligible expenditures incurred after March 28, 2018 many companies may believe the enhanced rate, though welcomed, is poorly timed.

What is the Eligibility Criteria to Claim the Ontario Innovation Tax Credit?

In order to be eligible to claim the OITC, corporations must:

have a “permanent establishment in Ontario;” ⁹
have carried out SR&ED during the taxation year;
be eligible to claim SR&ED under Section 127 of the Income Tax Act;¹⁰ and,
have filed a claim for SR&ED for the same tax year; and,
not be exempt from corporate income tax.

The OITC expenditure limit is capped at $3 million, and “qualified expenditures” are:

[…] incurred for scientific research and experimental development carried on in Ontario;

[qualified] under section 127 of the federal Income Tax Act (Canada); and,

[…] incurred when the corporation has a permanent establishment in Ontario and the expenditure is attributable to that permanent establishment.¹¹

Corporations who wish to claim the OITC must also file a claim for the federal SR&ED tax credit and file all of the necessary forms and schedules with their T2 corporate tax return. According to the OITC website, “government assistance, non-government assistance and contract payments” will reduce a corporation’s eligible expenditures; however, “under certain conditions, the receipt of a contract payment will not reduce qualified expenditures.”¹² These “certain conditions” are highlighted in the Guide – Ontario Innovation Tax Credit (OITC) Claim, which specifies:

OITC legislation provides for specified contract payments. This legislation permits an otherwise ineligible payment to be considered eligible (by the recipient), as a specified contract payment if the following conditions are met:

a) The payment is a contract payment for the performance of SR&ED carried on in Ontario.

b) The corporation making the payment (the payor):

i) does not have a permanent establishment in Ontario; and,

ii) is not otherwise eligible for either the Ontario Super Allowance or the OITC.¹³

Conclusion

The introduction of an enhanced rate is welcome, as the new rate benefits companies whose R&D expenditure to gross revenue ratio is over 10% it may work successfully in conjunction with the Ontario Small Business Deduction, (which enables small businesses in Ontario to pay a “lower tax rate of 3.5%” after January 1, 2018)¹⁴ to support small businesses in Ontario.