Startup Cfo + Flow Sred Presentation 032409

Montreal StartupTax Credit Workshop

March 24, 2009

Tax Credits for Startups

www.startupcfo.ca www.flowventures.com

AGENDA1. Part I:

Money Red Tape Pitfalls How the Government Sees It

2. Part II: Being Eligible Financial Strategies Bad Behaviours Good Behaviours

Copyright © 2009 – StartupCFO Enterprises Inc., Flow Ventures

An illustration


The Facts…Raised $ 500KSpent $ 200K on “eligible salaries” $100K of salaries are for founders / specified

employees$ 40K of salaries for front end (not “eligible”)$20K subcontractors$ 10K capital expenditures$ 5K materials consumedNo IRAP or other grants


Our filing strategy1st claim, so go for maximum (assuming real

advancement taking place)Claim SRED for everyone except front end

developerClaim proxy methodClaim E-biz tax credit for the front end guy


The Maximum RefundSummary:

Bottom Line: Spent $225k, refunded $186,583 (68%)

$ out

Salaries 240,000$ Subcontractors 20,000$ Materials 5,000$ Capex 10,000$

275,000$

$ in

SRED (173,250)$

E-biz (13,333)$ (186,583)$

Net $ out 88,417$


SREDFederal Quebec

Salaries

employees other than specif ied employees 100,000 100,000

specif ied employees 100,000 100,000

Costs of material consumed 5,000

Arm's length contracts 20,000 10,000

225,000 210,000

Capital expenditures 10,000

235,000 210,000

Proxy 113,750

Quebec credit for SR&ED (78,750)

Other government and non-government assistance

SR&ED expenditures for ITC purposes 270,000 210,000

ITCs refundable @ 37.5% (after April 21, 2005) 78,750

ITCs refundable @ 35% 94,500

Current expenditures 270,000 x 35 % =

Total ITCs calculated 94,500 78,750

173,250


QC E-Biz Tax CreditE-biz credit: 1/3 salary up to $20K

$ 40K * 1/3 = $ 13.3K


Red Tape

And lots of it…


SRED: Project descriptionTechnical description

o Factual, non-salesy, jargon-free description of o Goals for your experimental development, applied

research, etc – what technological advancements were you trying to achieve?

o Obstacles you had to overcome to achieve those advancements?

o Work performed – “how” did you overcome…o Results: Advancements in technical knowledge,

functionality, etc (don’t need positive results in order to claim credits)

o Do these for each projectNew simplified T661


SRED: Forms to fill outFederalT2 (Federal Income tax return for

corporations)T 661 – Claim for SRED, with SchedulesSchedule 31 – Investment Tax Credits

QuebecCO-17 (Quebec tax return)RD-222V (SRED claim)RD-1029.7-V (tax credit on salaries)


SRED: Back-up documentation

Technical: Project descriptions and plansTimeline and/or timesheetsTest results, QA logs, source codeDetailed records of problems encountered

(should be compiled throughout the year)Financial

Detailed records of money spent (in Canada) on salaries, subcontractors, materials, capital equipment and eligible support expenses


Timeline….CRA service standard:

120 days from filing to refund

Reality:Filed - Month 1Selected for an audit – 4 months laterFinancial audit – - 2 months laterTechnical audit – sameAsked for backupWrite new report – 2 months later9 months from filing: Still waiting…


Tax Credit TimelineYour fiscal year

Jan Dec Mar

Do your taxes

Document R&D Prepare claim

Apr Jul

Wait… Audit $$

Sep

21 Months


QC E-Biz Tax CreditAnnual application for eligibility

CorporateEmployees

Includes:Financial statementsOrg chart & job descriptionsBreakdown of revenues

Timing: TBD

You can’t double dip!


Pitfalls

Why you might not get the refund you deserve


Basic SRED Eligibilitysystematic investigation or search carried out in a field of science or technology by means of experiment or analysis . . . to advance scientific knowledge or to achieve technological

advancement

Experimental development to achieve technological advancement to create new materials, devices, products, or processes, or improve existing ones;

applied research to advance scientific knowledge with a specific practical application in view;

basic research to advance scientific knowledge without a specific practical application in view; and

support work in engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, etc that directly supports, the eligible experimental development, or applied or basic research.


SRED in Real Life

You have to have legitimate R&D according to their rules

You have to speak their languageYes, there is a grey area

What you didWhat auditors

understand

Your SREDclaim


SRED is Getting TougherYour claim is competing with all other claims

they’ve seen (now and in the past)Standard for “innovation” – Could you present

your R&D at a conference of industry peers?What did you learn (that wasn’t obvious)?Can you describe (in detail) the activities you

did to support your R&D? Do they make sense?

Auditors are starting to reject claims or offer only 50%


SRED: What you can doHave excellent backup documentationWrite the claim throughout the year, not at

year-endBe very careful with how the claim is

writtenBe prepared for an auditDon’t be too greedyDo not have amounts you owe to the gov’t

(e.g. GST/QST)


QC E-Biz Tax Credit75% of revenues have to be in an eligible

industry:Computer Systems Design and Related Services

(NAICS 541510)Software Publishers (NAICS 511210)Data Processing, Hosting and Related Services

(NAICS 51821)You have to re-apply each year

This is a new program so expect the unexpected


The Government’s View


What the gov’t cares aboutJob creation is the #1 priorityThey care that your projects “fit” not that

they’re “good”Once your file is on their desk their priority

is to get it OFF their desk

They want to give you the money


Who are these people?Technical auditors (CRA)Fiscal reviewers (CRA, Revenu Quebec)Investissement Quebec


Being Eligible


Good SRED ProjectsAdvancements from an established baseline:

Applying new linguistic research into software that improves search results

Creating a new architecture that solves security & synch problems in AJAX

Creating a faster, smaller runtime environment for interpreted applications on mobile device

We took the current state of technology (X) and advanced it (Y) by doing (Z)


Bad SRED ProjectsBuilding features, doing “routine”

developmentI built a content management systemWe fixed bugs and improved the speed of our

Web siteTwitter doesn’t work on my TV remote, so I

built an appWe made our application multi-lingual


How bad projects can become good

Bad GoodWe built a Twitter client for my TV remote

We discovered a method for bi-directional communication via infrared to allow remote control devices to communicate with Web services via the Internet

We implemented Soundex to improve search results

We improved the efficacy of Soundex by extending it to include semantically similar concepts

We built a MMORPG We solved a major problem in distributed computing by creating a new predictive algorithm for minimizing out-of-synch errors among clients


SRED Eligibility: Bottom LineNothing qualifies “automatically”,

everything has to be documented and defended

Auditor subjectivity plays a big role (unfortunately)

The rules change

Monthly internal R&D audits ensure you don’t forget what you did which = better backup and bigger claims


Financial EligibilitySpecified vs Regular employeesCdn (eligible) vs foreign contractors

(ineligible)Only one person can claim (i.e. you or your

sub-contractor)Double-dipping: effect of other tax credits

on SREDWhat if I’m profitable? When do I love CCPC

status?


Optimizing the financial result


Optimizing your claim…How aggressive should you be?

Early years – claim 100% salaries (assuming all of those salaries are being spent on real advancements)

Later on – lower the % (because the work mix changes, less real ED)

Can shift staff from claiming as SRED to e-biz over time

Remember – the program is being strictly enforced (especially for web software)


Optimizing your claim…(cont.)What records do I need?

See the list from our financial audit (above)Timesheets or loose time recordsADP, payroll registerSIN #s & addresses for all subcontractorsDescription of work with above credentials on

all subcontractor invoices


Optimizing your claim… (cont.)Hiring vs. outsourcing?

Hiring Considerations:Pros:

Full time committed team memberAdvance skill set & capabilities of your companyShould be core to your bizFully eligible for SRED

Cons:More expensive (full time cost, benefits, severance,

computers, etc)Don’t hire in non-core areas


Optimizing your claim… (cont.)Hiring vs. outsourcing?

Outsourcing Considerations:Pros:

Cheaper – pay only for what you need, when you need it

1/2 eligible for SREDCons:

Lose knowledge and skillsCan loose time coordinating

From a SRED perspective: Goal is to promote employment. Salaries 2x more eligible than subcontractor $.


Optimizing your claim… (Cont).Financing your credits

Options to finance both filed & accrued creditsBank (RBC, Banque Nationale) with Investissement Qc

guaranteeSeveral private sources (RD Cap, Accorn, Stanley

Finance, Lawrence Group…)Finance up to 75% of filed. Lower % on accrued

(usually)All in cost – about 10% (interest & fees)Banks – focus on balance sheet, covenants,

historyPrivate – focus on claim quality. More flexible on

financial position


Bad behaviours


Bad behavioursHiring too many people / overspending /

high salaries:Don’t assume you will get the creditsDon’t forget it takes a long time to get your refundNever spend $1 just to get 60 – 75 cents in creditsHire based on clear, strategic need

Doing too much:This issue is way beyond tax creditsIn most markets winner takes all (or most)Best solution does not always winSpeed matters. Get into market as early as possible


Good behaviours


Good behavioursSRED encourages you to…

Have disciplined development practicesHave good documentation (Wiki, specs,

requirements etc)Understand where you need real R&D and

where you can be “good enough”SRED allows you to…

Invest in better qualityRewards people via SRED bonuses


Links and resources


http://www.cra-arc.gc.ca/sred/ (The Feds)http://www.revenu.gouv.qc.ca/eng/entreprise/impot/

societes/credits/rd/ (Quebec)http://irap-pari.nrc-cnrc.gc.ca/main_e.html(Grants)http://www.cra-arc.gc.ca/E/pub/tg/rc4472/rc4472-

e.html(program overview)http://www.cra-arc.gc.ca/E/pub/tg/t4088/README.html(guide to filling out the T661)http://www.investquebec.com/en/index.aspx?

page=1281


THANK YOU!


SRED: Financial documentation example


SRED: Financial documentation example


Technology

Startup Cfo + Flow Sred Presentation 032409