Common Tax Oversights by Tech Businesses

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Technology and Internet businesses all too often become exceedingly focused upon that area of the business that they are most passionate and knowledge about, that being the tech-side of their business, such that it is all too easy to overlook or not give appropriate attention to non-tech aspects of their business, such that they might be missing out on invaluable opportunities to reduce their taxes and increase their business' profitability.

A. Maximizing Scientific Research and Experimental Development (SR&ED) Tax Credits

The SR&ED program is Canada's largest R&D tax incentive, providing over $3 billion annually. While many tech companies are aware of it, they might not be fully optimizing their claims: Broad Interpretation of "R&D": Many companies mistakenly believe SR&ED only applies to "pure" scientific research. It actually covers a wide range of activities aimed at achieving technological advancement or overcoming scientific/technological uncertainty. This can include developing new software algorithms, improving existing production processes, or even failed R&D projects.
Eligible Expenditures: Beyond direct labour costs, companies often miss claiming other eligible expenses such as:
- Materials consumed or transformed in the R&D process.
- Overhead costs directly attributable to SR&ED.
- Third-party payments for SR&ED work.
- Upcoming changes: The government is considering changes to SR&ED, including potentially increasing the refundable credit limit for qualifying CCPCs from $3 million to $4.5 million, and allowing claims for capital expenditures used in R&D (a rule scrapped in 2014). They are also exploring a "patent box" regime.
Systematic Approach and Documentation: Companies may overlook the importance of detailed documentation of their R&D activities, including the scientific or technological uncertainty addressed, the systematic investigation undertaken, and the technological advancement sought. This is crucial for defending claims during a CRA review.
Provincial SR&ED Credits: In addition to the federal SR&ED credit, many provinces offer their own R&D tax credits, which can significantly increase the total benefit. Companies should ensure they are claiming both federal and provincial credits.

B. Leveraging Small Business Deduction (SBD) for Canadian-Controlled Private Corporations (CCPCs)

Lower Corporate Tax Rate: CCPCs benefit from a reduced federal corporate tax rate of 9% on the first $500,000 of active business income, compared to the general corporate rate of 15%. Provincial small business deductions further reduce this rate. Companies should ensure they qualify as a CCPC and actively manage their income to maximize this benefit.
Taxable Capital and Passive Income: The SBD can be phased out for CCPCs with taxable capital exceeding $10 million (fully eliminated at $15 million) or passive investment income exceeding $50,000 (fully eliminated at $150,000). Tech companies with significant passive investments (e.g., from retained earnings) may inadvertently lose access to this lower rate. Careful planning of investments and profit retention is essential.
Income Splitting and Dividends: While the SBD is for active business income that stays in the corporation, strategic income splitting with family members (e.g., by hiring them as employees for legitimate work, or through dividends if they are shareholders) can lower the overall family tax burden, especially if family members are in lower tax brackets.

C. Strategic Use of Capital Cost Allowance (CCA)

Accelerated Investment Incentive: Companies may not fully utilize the Accelerated Investment Incentive, which allows businesses to deduct a larger portion of the cost of eligible capital assets (like machinery and equipment) in the year they are acquired or become available for use. This can provide significant upfront tax deferrals.
Specific Clean Economy ITCs: For tech companies involved in clean technology, there are new investment tax credits for:
- Carbon Capture, Utilization, and Storage (CCUS)
- Clean Technology adoption and operations
- Clean Hydrogen production
- Clean Technology Manufacturing
- These can be substantial, offering refundable credits of 15% to 60% depending on the investment type.

D. Digital Media and Interactive Tax Credits

Provincial Programs: Many provinces, notably Ontario (Ontario Interactive Digital Media Tax Credit - OIDMTC), British Columbia, and Quebec, offer generous tax credits for companies creating interactive digital content, video games, and multimedia productions. Tech companies involved in these areas should ensure they are claiming these specific provincial incentives, which can offer up to 40% of eligible expenditures.

E. International Tax Structuring

As Canadian tech companies expand globally, international tax planning becomes crucial and is often overlooked by smaller players:

Permanent Establishment (PE): Companies may inadvertently create a "permanent establishment" in foreign jurisdictions through their activities (e.g., having employees working remotely in another country, or conducting significant business there), triggering foreign tax obligations they are unaware of. Careful analysis of international operations is needed.
Foreign Affiliate Rules and Repatriation: Structuring foreign operations through subsidiaries can offer tax deferral benefits in Canada until profits are repatriated as dividends. Understanding Canada's foreign affiliate rules, including "controlled foreign affiliate" (CFA) rules and "foreign accrual property income" (FAPI), is critical to avoid unexpected Canadian taxation on foreign earnings.
Transfer Pricing: For companies with cross-border transactions between related entities (e.g., selling software licenses from a Canadian parent to a U.S. subsidiary), ensuring "arm's length" pricing is crucial to avoid transfer pricing adjustments and penalties. This often requires robust documentation.
Tax Treaties: Utilizing bilateral tax treaties between Canada and other countries can reduce or eliminate withholding taxes on cross-border payments (e.g., dividends, interest, royalties) and provide clarity on taxing rights. Companies may not fully leverage these treaty benefits.
BEBEPS 2.0 (Pillar One and Pillar Two): For larger multinational tech companies, the upcoming global minimum tax (Pillar Two) and new taxing rights (Pillar One) from the OECD's BEPS 2.0 initiative will significantly impact international tax planning. Even smaller companies should be aware of these global shifts as they grow.

F. Employee Stock Options and Compensation Planning

Proper Structuring: Tech companies often use stock options to attract and retain talent. Properly structuring these plans can have significant tax implications for both the company and the employees. Understanding the difference between incentive stock options and non-qualified options, and the relevant tax deferrals or deductions, is important.
SR&ED Payroll: Ensuring that salaries and wages for employees engaged in SR&ED activities are properly tracked and claimed as eligible expenditures.

G. Lifetime Capital Gains Exemption (LCGE)

Qualified Small Business Shares (QSBS): For founders and shareholders of a Canadian-controlled private corporation, the sale of shares that qualify as "Qualified Small Business Shares" can allow them to claim a significant lifetime capital gains exemption (currently up to $1.25 million for 2024). Tech companies should be structured to ensure their shares meet these criteria for future exit opportunities.

H. General Deductions and Credits

Overlooked Operating Expenses: Companies might miss deducting legitimate business expenses such as home office expenses for remote workers (if structured correctly), professional development, subscriptions, and travel.
Start-up Costs: Certain start-up costs can be amortized or deducted, and it's important to categorize these correctly.

We understand how computer algoritms and technological processes intersect with the law and commercial aspects of the Internet, and working with corporate business officers, tech entrepreneurs and IT departments as they strive to realize upon the financial potential of the Net, AI and other computer-based technologies. For more information as to how our law firm can apply our knowledge of the law, technology and the Internet to your business pursuits, contact us via email at f="mailto:Chris@NeufeldLegal.com">Chris@NeufeldLegal.com or 403-400-4092 / 905-616-8864.

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