newsletter archives
Home Guarantee Services email form Fees About Toronto resources T.O. Land Transfer Tax articles R& D Basics Thank you! newsletter archives

 

 

 

Should you incorporate?

 RRSP questions

 

 

Should you incorporate?


If you've ever considered incorporating and thought, "naw, not now,
maybe down the road", maybe 2008 is a time to reconsider.

There are a bunch of reasons why it may make more sense to
incorporate in 2008 than it did, say, five or ten years ago.
I'm not saying go ahead and do it. I'm just saying that, depending
on your particular circumstances and with appropriate guidance,
maybe it makes sense for you.

Here are those reasons:

1You pay a much lower rate of tax if your business is incorporated
that if your business is operated personally
For one thing corporate rates in Ontario have dropped from 18.6%
in 2007 to 16.5%. The top personal rate in Ontario for 2008 is 46%
. That's a 30% difference. Certainly something to think about-- not
only if you're in the top bracket that kicks in at $123,000 of
taxable income, but even if your taxable income is higher than 
$75,000. If your income climbs above the $75,000 plateau, your
marginal tax rate is 43% . Just one warning: The tax advantage of
incorporating only works if you keep enough assets in your
corporation. If you withdraw whatever your corporation earns for
personal use, you lose the tax advantage of incorporating.

2You can now shelter up to $400,000 of income annually at the low
corporate rate
This favourable 16.5 % rate is a flat rate on up to $400,000 of
active business income per year. A few years back, it was $300,00.
Way back when I started out it was only $150,000. Contrast that to
the lowest marginal rate on personal taxes which is 21%, and when
added to CPP is 31%.

3 You can income split with your wife and older kids
With a corporation, you can income split with your wife and over-18
year old kids-- even if they don't do a stitch of work. A few years
ago, if they didn't actually work, you had a hard time income
splitting with them. But thanks to the decision in the Neumann
case, it's been established that if a wife is a bona fide
shareholder of your company, you can pay her dividends even if she
watches TV the whole day.

4 It may even work even if you have only one client
Now, even if you have only one client, you have a strong case to
argue that you're self employed. Years ago, you'd be considered as
an employee of your client in such a case. The fact that you
invoiced the client instead of being on a payroll mattered not a
whit. The past few years there's been a change to the better. In
situations where the taxpayer had one client only, the tendency of
the courts-- such as in Wolf case-- have been to decide in favour
of the taxpayer

5 Nowadays many people incorporate on line without a lawyer; it's
cheap and fast
If you're a do it yourselfer , incorporating now is cheaper and
easier than it ever was . Many self employed people, by
incorporating online on their own, save lawyers' fees. Also, with
programs such as Quickbooks, you can save loads in bookkeeping and
accounting fees. 

6 If you think you may be a candidate for an R&D grant, you'll
need to incorporate to collect the big money doled out
More people are now migrating to computer related fields. If you
have cutting edge technological skills in any area of science and
technology, you could be eligible for very generous government
assistance through their SR&ED credit program. But, in order to
collect any substantial amounts, you have to incorporate. Else, the
amounts are rather meagre.


There's a tax free lifetime capital gain on the sale of shares of
small business corporations. There are a number of complex
requirements to qualify. But, if you do, there's a lifetime capital
gains exemption of $750,000 on the sale of such shares. That means
if the corporation cost you nothing and you sell its shares for
$750,00, you don't pay a cent in tax.

8 If you're a MD doctor or dentist in Ontario, unlike a few years
back, you can now incorporate and have your wife and over- 18 year
old kids own shares in the company. As I mentioned in point 3
above, this allows you to income split with them.

Your comments and suggestions are always welcome

 

 RRSP questions

 


Here are some typically recurring RRSP questions:

How much taxes will my RRSP contribution save me when it's time to
file my tax return?

It will save you taxes at your marginal tax rate. Say your taxable
income is $100,000 and you're an Ontario resident, your marginal
tax rate is 43%. So a $10,000 RRSP contribution saves you $4,300; a
$20,000 RRSP contribution saves you $8,600.
Here are the marginal rates for Ontario for 2007 at various taxable
incomes:
Top rate is 46.4% for taxable income over $118,000
Next rate is 43.4% for taxable incomes from $73,000 to $118,000
From $36,378 to $73,000 your rate starts at 31.1%, creeps up to 35%
at $69,500, then jumps to 43.4% at $73,000.
Below $36,000 the rate is 21% unless you're so close to rock bottom
that you're not paying tax at all.



Can I contribute to an RRSP now in Feb 08, then make a withdrawal
immediately so as to get a deduction for 2007 taxes without having
to pay taxes on the income till 2008 taxes become due?

Yes. You absolutely can. You can use RRSP's as a tax deferring tool
by contributing to an RRSP-- in January and February of any year--
and then immediately withdrawing the same amount. You'll get a
deduction for the previous year's taxes but will have to include
the amount of the RRSP withdrawal in your income for the year you
withdrew it.

You can also use RRSP's as an income averaging tool. Say in one
year your income is up in the 43% bracket range and the next year
you take a sabbatical which gives you space to include additional
income in the 21% tax bracket.. So, it may make sense to get a big
deduction in the 43% bracket year and include it in the 21%
bracket year.

A few cautions: You will have some tax withheld from the withdrawn
amount; You should make sure you don't run afoul of the spousal
RRSP attribution rules if your spouse has made a spousal
contribution in the past two (three if you include this year)
years; you should make sure you're onside as far as the 90 day
rules go if you recently made an HBP withdrawal.


How do I unlock a locked- in RRSP?
It depends on your province. Some provinces don't seem to have any
options for unlocking a locked in RRSP's. Ontario has an unlocking
option for persons experiencing extreme financial difficulty.
Here's something I wrote to a lady from Alberta who was trying to
unlock her locked-in RRSP.

For residents of Ontario, far as I know, there is only one way to
unlock a locked in RRSP-- or for that matter, a LIF, LIRA or LIRA.
And that is, to apply to the Financial Services Commission of
Ontario (FSCO) to have access to the funds. 

Before you even attempt to apply, though, you must show that you
are experiencing extreme financial hardship. This could be due to
either low income, risk of being evicted from home, need to come up
with a deposit to rent a place to live in, need to pay for medical,
or need to renovate a home to accommodate a disabled person. 

Also, be aware that you will have to pay a fee of between $200 and
$600 to the FSCO to access your funds. The way to apply is to go
the the FSCO website--easily found on Google-- and download the
relevant application forms.

A bit of advice: Don't fall for schemes that promise you access to
your locked in funds. Deal directly with the FSCO. They have staff
that are there to help you.

But, you mentioned you're in Alberta. Check out Alberta Finance
Policy Bulletin #32 at www.finance.gov.ab.ca. They talk about a 50%
unlocking option. But I understand that this option was only
available till 12-31-07. So, it may be that you have no option to
unlock your locked in RRSP or other pension fund if it's in Alberta.


Does it make sense to get an RRSP loan to contribute to an RRSP?

If your income is way up in the 43% or higher bracket , it usually
does make sense to get a RRSP loan at prime to save taxes, as long
as you intend to use the tax savings to pay down the loan and you
intend to keep the RRSP till retirement. Example: You borrow
$10,000 at prime for an RRSP loan. If you're in the 43% bracket,
you save taxes of $4,300. You pay down the loan, so now you're only
paying prime on $5,700 or about $300 per year. Sounds like a good
deal to me to pay $300 in interest to get a return of $4,300 in tax
refunds.


When does it not make sense to contribute to an RRSP?

Here's what I tell my clients: If you're going to contribute to an
RRSP, only do so if you intend to keep the money there till
retirement-- or, if you intend to withdraw the money to buy an HBP
or for the LLP (Lifelong Learning Plan). Otherwise, it could cost
more in taxes when you cash in that what you save when you
contributed to the RRSP in the first place. Example: You
contribute $10,000 each year for five years, then you take the
whole bundle out in one big payment. Say your income is at the
borderline between the 35% and 43% tax brackets. What happens is
that your contributions will save you tax at the 35% rate, but your
withdrawals will tax you at the 43% rate.


Writing an R&D project description


You can't afford to write a weak description and hope for success.
Here is where you impress or fail to impress the CRA technical
people who are going to decide whether or not your project is
eligible. 

So, put a strong effort into writing your project description. You
really need to put your best step forward.

You must demonstrate several things

1 That you are capable of performing a real R&D project. 

Tips to enhance your credibility

List all your academic degrees
List all projects you previously worked on-
Use highly technical language which would typically only be
understood by one with a high degree or scientific knowledge
Refer often to prototypes, constructs, proprietary code, systematic
work etc.
If you own a patent, mention it.
If your work for a company resulted in the company's getting a
patent, mention it.
If you've ever published an academic paper, mention it
If this project can be submitted to a peer group for evaluation, do
so and say in the project description what you have done

Use advanced programming and math tools where possible

2 That you actually performed the work

Tip 

Include a flow chart describing the work. A multi branched
flowchart with many nodes and good descriptions can impress the
technical auditors and be very persuasive evidence that you
performed at a high technical level.

This achieves several things. 
First, it shows there was a sysytematic process throughout the
project. That is, you'd have to follow a certain planned course of
action to get some where.

Second, it points toward the advance you are seeking to achieve.

Third, you can use the chart to describe the various hypotheses you
have formulated.

Fourth, by showing that the various nodes where two or more new
branches emerge, you demonstrate uncertainty (in that you weren't
sure at the outset of the project which road you'd end up following)

Third, 

Here's an even better tip. Include TWO flowcharts. The first one
sketches your intended course of action before you actually started
on the project. 

The second flowchart is a complete revision of the first flowchart
based on the knowledge you gained during the course of the
project-- and part of that knowledge was the resolution of
uncertainties.


Resolving uncertainties is itself an advance in science and
technology.,

Tip

Include picture(diagrams) of prototypes, if possible. Include,
diagrams/pictures at various stages of the development of the
prototype.

Include, if possible, some executable prototype code -- very
powerful and persuasive stuff.

That you have available documentation

Refer to daily work logs
Mention that all testing was documented

In writing your project description, you should address, as a
minimum, the three criteria of 1) scientific or tech advance ; b)
uncertainty and c) scientific content.

Before you write your first draft, read again the IC864R3 for the
definition of each of the three criteria.

Then, make sure you write why the project was an advancement. What
is out there now. What, in technical or scientific terms, does you
work seek to advance?

Tip

Don't be satisfied with a simple advance. Try to make the advance
more complicated, more elaborate. Remember, you don't have to
actually achieve all you set out to do. Just a minor advance will
work. But, when you set out to do the work, show that you had
actually much more grandiose plans. You never know how the CRA
might challenge your claim, so it's better, as a form of insurance,
to throw in the kitchen sink as to what you were planning to
achieve.

That will go far towards persuading the reader that the project
itself was an R&D one.

How did you originally plan to achieve that advance? How did the
work turn out?

It's a good idea to describe your original plan and to show how
that plan had to be continually re-evaluated and changed during the
course of the project.

Remember two things. You don't have to achieve a big advance. A
minuscule advance also qualifies. Second, the advance has to be in
science and technology, not in the functionality of the product.

Next, you say where the uncertainty lay. You say what, at the
outset of the project made you uncertain as to its outcome. You
talk about the bumps along the road, the unexpected turns that made
you re-evaluate your approach. You don't want to convey the
impression that your path was smooth sailing.

On the contrary, you want to show that your path was strewn with
all sorts of expected and unexpected difficulties. Describe, in
scientific or technical terms what those difficulties were.

Then, you talk about scientific content. All this means is that you
describe the process of your work in that you formulated
hypotheses, you tested those hypotheses, you observed to what
extent the testing confirmed the hypotheses or required you to
formulate other hypotheses etc.


Insider tip

If you include an employee's work as part of the R&D claim, be sure
to describe in some detail the nature of that employee's R&D
activities. Otherwise, the government may assume he's just included
so that you can make a larger R&D claim.


Don't

Don't say that your project will create jobs for the economy, or
will improve the environment. Those are turn-offs! The auditors
will think this claimant is missing the entire point. Sure, it's
great if your project can accomplish this type of thing. But, your
focus is on technological and scientific advances, not the ultimate
effects of these advances.

Don't give the impression that you knew all along the straight path
to your desired tech achievement. On the contrary, you must convey
the impression that the path was strewn with difficulty, that you
had to change course many times , that the goal involved testing
etc.

Big insider tip

Try to get an opinion from a Ph.D. that your project meets the 3
criteria listed in IC864R3 (tech advancement, uncertainty,
scientific content). And, ask him to write a short note-- with his
permission to include the note in together with your project
description-- that he has looked at your work and that he is of the
opinion that the work meets the 3 criteria in IC86-4R3 that are
required for a project to be an eligible R&D project. This is very
powerful and adds credibility to your submission. It is especially
recommended if you have even the slightest doubt that your project
qualifies as eligible R&D.

Tip

If you're operating a business and you're claiming a large portion
of your wages as being R&D, anticipate a measure of scepticism from
the government auditor. After all, how can you claim 75% of your
wages as R&D when you're running a business? To minimize this
scepticism you may want to a) not go overboard in your claim and b)
include a blurb in your project description justifying the large
amounts of time you spent on the project. 

So, what you might want to do is: a) claim a reasonable -- not
outlandish-- amount of time- say 50%. Then write in your project
description that typically you worked in the business an eight hour
day for five days a week. That's 4o non R&D hours. But, in evenings
and weekends you put in an additional 40 hours to give you an 50-50
split between R&D and non R&D time.

If you want to be a bit more aggressive, you can even justify a 60%
R&D claim by saying all you needed to work in your business was 32
hours a week leaving you 48 hours a week to work on your project.


Tip

Data collection activities aren't eligible unless they are specific
to the goals of the project. So, you may just want to put something
in your project description to the effect that all data collected
were for the purpose of x which supports the goal of the project.

XXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXXX
XXXX
Here's the case I told you about that illustrates how the court
decides whether a project is or isn't R&D by testing whether it
meets the 3 criteria


Northern Hydraulics case
http://decision.tcc-cci.gc.ca/en/1998/html/1998tcc97531.html

back to top


How much money can you expect from an R&D claim?


Let me illustrate with an example:

Say you're an incorporated IT professional. In your spare time you
work on an eligible R&D project. Your company invoices it's clients
$120,000 per year and pays you a salary of $100,000.

If you send half your time on R&D, (i.e., the time your work on
your project is equal to the time you work on earning money for the
company) then your R&D salary is $50,000. To this you add a "proxy"
amount of 65% which brings your R&D base to 50,000 x 1.65=$82,500.
The government subsidizes 45% of this by cutting your company a
cheque for 45% of $82,500= $37,125. (Or, that amount less whatever
taxes the company must pay.)

That's the deal in its ideal form. It's a great deal too, because
you're making $120,000 a year and, looking the R&D cash as an
offset to taxes, you're paying no taxes!

Can the company pay you more than $100,00 (after all, it's your
company)? And, can you claim more than 50% of wages as R&D wages.
The answer is the company can pay you about to $150,000. Beyond
that, there's no subsidy available. But, it usually doesn't make
sense to do that because that will push you into the 43% and 46%
tax brackets.

And, yes you can claim up to 75% of your wages as R&D. But that may
be difficult to justify because if you're earning $100,000 in your
company it's hardly credible to say you achieved in by working only
a few hours a day.

Just one thing before I leave. That proxy thing I mentioned before
is sort of a freebie that the government gives you by adding 65%
onto your claim. But, it only works with wages, not management
fees. So, if you're planning on making an R&D claim, make sure the
company pays you not management fees but wages.

Paying wages is a bit of a hassle because you have to send in
monthly cheques to the government for source deductions. But, if
you're set on making an R&D claim, you have little choice

Are you really self employed?


Are you one of the many IT professionals (or others) who incorporate
companies and invoice the clients
they provide services to. If you have no more than a single
client, it may raise a concern as to whether the CRA considers you
self employed or not. There's a risk that the CRA might consider
you an employee of your client.

That could mess your plans up: 1)Many of your expenses would be
disallowed; 2)you wouldn't be allowed to take advantage of the low
corporate tax rates; 3) if you made an R&D claim, it would be
disallowed

Here is some relevant material. You can minimize the risk by
soliciting business from other potential clients. Of course, it's
better to provide services to at least two clients-- the more
clients, the better.

Also, from the material enclosed, you may get a sense of factors
the courts consider in deciding whether someone is employed or self
employed. 

You should also know that if you got the job through an agency,
your odds are better that you'll be treated as self employed.

About 10 years ago, it was a forgone conclusion that if someone had
only one client, he was an employee of that client. That changed
with the 2002 Wolf case which was decided in favour of the
taxpayer. Since then, the trend in the courts has been mostly
favourable to the taxpayers. But not always, as you can see from
reading the cases.

Anyway, when you have time, you may find the reading a bit
interesting.

By the way the decisions of the FCA carry considerably more weight
than the TCC.

Also, in terms of numbers, it seems about 2/3 of the cases ( of the
30 cases I see cited in my annotated edition of the Income Tax
Act) were decided in favour of the taxpayer and 1/3 in favour of
the CRA.


Here they are:


Wolf case- FCA 2002
http://decisions.fca-caf.gc.ca/en/2002/2002fca96/2002fca96.html


Royal Winnipeg Ballet
http://decisions.fca-caf.gc.ca/en/2006/2006fca87/2006fca87.html


Hervieux case (this case was decided in favour of the CRA)
http://decision.tcc-cci.gc.ca/en/2007/2007tcc729/2007tcc729.html

St John's case
http://decisions.fca-caf.gc.ca/en/2004/2004fca345/2004fca345.html

Kilbride case
http://decision.tcc-cci.gc.ca/en/2007/2007tcc663/2007tcc663.html


Lang case 
http://decision.tcc-cci.gc.ca/en/2007/2007tcc547/2007tcc547.html

CRA's view
http://www.cra-arc.gc.ca/E/pub/tg/rc4110/rc4110-e.html


By the way, the reason I think it's good for you to read the cases
is: 1) so that you can form a rough idea as to how strong your
position is ( that you're not an employee, but rather self
employed) from a judicial point of view based on the decisions
handed down, and 2) so that by reading which points carried the
most weight in deciding the outcome of the cases, you can structure
your arrangement with your client to strengthen your position. 
For example, as you can read in the more recent cases, the 2002
Wolf case is quoted to support the point that intention of the
parties carries great weight. So, you may want to draw up a written
agreement with your client to the effect that it is your intention
to provide services as a self employed contractor and that neither
of you have any employer-employee obligations toward each other.

The FCA decisions, i.e., Wolf and Royal Winnipeg Ballet, carry
greater weight than do the TCC ones. That's why you see them quoted
more often in the more recent cases. So, if you can find support
for your position in those two FCA cases, you're on solid ground.

A short cut to writing an R&D project description

If you think your work can pass as eligible R&D project, but
you're hung up even starting to write a project description, here's
a tip:

First, draw your project flowchart. Make sure it's a nice complex
multi-branched flowchart with all sorts or forks and decision
points.

Then label it a bit.

Spend a lot of time drawing and labelling the flow chart --and
maybe referencing it with footnotes-- even before you start writing
your narrative.

Then write a narrative describing what's on the flow chart. Talk
about the paths you travelled to get from start to finish. Don't
miss the snags and points of impasse where you had to go back and
change course. Don't forget to use technical language.

Your narrative is simply putting into words what the flowchart
describes.

As I mentioned before, having two flowcharts is even better. The
first flowchart would be what you drew at the beginning of the
project; the second one would be a re-drawing of the first after
you encountered unexpected tech challenges and had to re-plan the
steps needed to reach your goal.

This can persuade the auditor that your project has addressed
the three criteria ( technological advancement; technological
uncertainty and scientific content) required for an R&D project to
be eligible.

The ending point would be the technological advance. (You would
describe the end point and explain why it would be a technological
advance compared to what's out there now.) The snags and forks
along the paths would demonstrate the technological uncertainty.

If you show that every change in direction was because you
formulated an hypothesis and tested it, that should show a
systematic and scientific approach.

 

 

 

 

Home ]

Copyright 2013 B.C. Chastkofsky C.A.
Last modified: January 01, 2013