Starting a technology company, setting up an R&D center in Canada or transitioning your technology company to new ownership all require dedication and substantive expertise. In addition to the expected business challenges that come with innovation and rapid growth, there are risks and potential pitfalls that await entrepreneurs and business leaders. In our work with tech companies, we decided to put together this list of common issues we see across the sector that apply to both small and large tech companies here in Canada.
The technology sector offers great opportunities for start-ups and foreign investors seeking to leverage the resources, infrastructure, and incentives available here in Canada. We have worked with R&D incubators and accelerators, municipal investment attraction agencies and foreign direct investment across the country. From hundreds of conversations, we compiled seven practical considerations based on our experience helping tech innovators to grow their businesses in Canada.
1. Foreign-owned (or acquired) corporate innovation labs and R&D centres – don’t forget to set up a transfer pricing structure
When setting up a corporate innovation centre – whether you are a domestic operation that is acquired by a foreign owner or a corporation investing in a new facility from overseas – you need to develop a transfer pricing structure and establish what is taxable in Canada. While it might seem natural to view such labs as simple innovation cost centres because they are not generating revenue, the tax laws in this area are broad in scope and in most cases will require profits to be recognized by the innovation centre, at least to some degree. This step is particularly important, as the Canada Revenue Agency (CRA) has been intensifying its enforcement of transfer pricing laws due to the worldwide focus on the 115 member country OECD Inclusive Framework on Base Erosion & Profit Shifting (BEPS).
2. Big fish buying a little fish – Changes to your SR&ED tax credits on acquisition by a foreign company or larger domestic enterprise
If your business benefits from – or has applied for – research and development tax credits, it is essential to understand how these might change in the event of any merger or acquisition. The Scientific Research and Experimental Development (SR&ED) Tax Incentive Programprovides incentives for companies in Canada to conduct scientific research and experimental development. However, the size and nationality of the parent corporation can make a significant difference in what level of support is provided. For example, a Canadian-controlled private corporation (CCPC) receives a federal refundable investment tax-credit of 35% on qualified expenses up to $3 million. However, if that CCPC is bought by a large Canadian-based company or foreign-based enterprise, the SR&ED tax credit rate drops to 15%, and the tax credit is no longer refundable – i.e., it can only be applied to offset other taxes actually incurred. We have seen this change negatively impact corporate cash flow and valuation of the business.
3. Know when your company’s stock options become taxable – and who pays
Stock options can be a powerful compensation tool for start-ups and high-growth companies to retain and engage employees, but as compensation, they are eventually taxable. By understanding what triggers this tax liability and who is responsible for paying it, you and your valued employees can avoid unpleasant surprises.
4. Government grants are taxable, and the name on the cheque matters
Funds received from government grants are viewed as income by the CRA, and the recipients must account for them on their financial statements and tax returns. Further, it makes a difference how that grant is given, and there are unique considerations for when the grantee is a company, an individual or a group of individuals.
When a grant is given to a company, it becomes corporate income, but when the grant is awarded to an individual, it must be reported on their personal tax return. The situation becomes more complicated when a group of students or researchers receive a grant together, and differences of opinion on how to use the funding can create challenges. It is best to have an agreement set in advance regarding how such grants will be used if won or awarded.
In addition to income concerns, the government grants could be viewed as taxable for GST/HST purposes. A review of the funding agreement and the CRA guidelines is often required to make this determination as a grant may not always be a grant for GST/HST purposes.
5. The recent Wayfair ruling by the US Supreme Court has consequences for businesses selling online into the US
The recent US Supreme Court ruling in Wayfair vs South Dakota has changed the expectations for those selling products across state and international borders. The decision overturned precedent and may make it easier for state and local governments to require businesses that have no physical presence in a jurisdiction to collect and remit sales taxes. The impact of the protectionist Wayfair decision will make remote sellers consider US tax implications in the early revenue stages. Canadian companies should start thinking now about how they might comply with complex and nuanced requirements in the US state and local tax regimes.
While comparable provisions have yet to be implemented across Canada, Quebec has announced a similar obligation that may need to be considered when selling into that province. This may set a precedent for other provinces in Canada to follow suit.
It is important that business owners take the time to understand the potential impact of these tax obligations, which can lead to significant and often unnecessary challenges if not planned in advance.
6. Consider the pros and cons of registering for GST/HST, even before it’s required
Your business is only required to register for GST/HST once your revenue exceeds $30,000-including sales of any associated entities. Despite this, we often advise start-ups to voluntarily register earlier, as once registered, your business can claim GST/HST incurred as an input tax credit for your current business expenses – even before you generate revenue.
Once your business is registered however, GST/HST needs to be charged on all taxable supplies even if you have not met the $30,000 threshold.
There may be Provincial Sales Tax (PST) requirements that need to be considered in certain provinces (BC, SK, MB and QC) if an entity is expanding into these provinces or acquiring an existing business in these provinces.
7. Prepare now for how intangibles will be evaluated in the future
If and when the ownership of your business changes – whether it’s an exit, acquisition or merger – you will have to define and assign a dollar value to intangible assets such as goodwill. In general, the goal is to maximize the tax outcomes for entrepreneurs and family members, but you have to make your plans well before any transaction occurs, not when someone is knocking at the door ready to buy your business.
GST/HST should also be factored into any potential ownership change, as it will generally apply on the value of assets being sold, including intangibles. Relief from sales tax may be available in certain instances but being proactive and ready in advance will help ensure there are no surprises to you or the potential buyer.
Don’t hesitate to seek advice
Your Grant Thornton advisor understands the challenges you face in starting and growing your technology business. We assist entrepreneurs and leaders in the tech sector by helping them maximize potential and identify financial opportunities – while avoiding these pitfalls and mitigating their risk.