Employees or Consultants for SRED work?

Many companies choose to use consultants to conduct R&D. Among the reasons for doing so are the perception that they can avoid the extra costs of paying for the employer’s portion of CPP and UI. They also feel that they can also avoid termination costs when the need for the consultant ends.

The numbers do not support this argument.

A salaried employee earning $50,000 per year costs an employer $53,147, including CPP and EI premiums. A consultant earning the same rate costs $50,000, a savings of 5.92%. This seems to support the perception.

However, the employee engaged in SR&ED activity generates $82,500 in Eligible Expenditures; a consultant only $50,000. For a CCPC in Ontario the employee will generate total tax credits of $37,579 (75 cents for every dollar of salary cost). Using a consultant generates only 45.5 cents of tax credits per dollar spent. This is due to the 65% Prescribed Proxy Amount (PPA) that can be added to the claim for  wages and salaries.

The changes in the SR&ED program contained in the 2012 Budget create an even larger payback on the use of employees for SR&ED, even though the PPA is reduced to 55%. This is because only 80% of contract expenditures can qualify. The same $50,000 consulting fee that today creates a $50,000 eligible expenditure will, commencing January 1, 2013, be worth only $40,000.

The end result of these changes is that a $50,000 expenditure on salaries will generate $35,301 in credits; the same amount spent on consultants will only generate $18,220 in tax credits. The ratio in favour of employees over consultants increases from 1.65 to 1 to 1.94 to 1.

What has been absent so far in this discussion has been the termination cost associated with employees. This can be avoided by using employment contracts. Also, it should be remembered that using consultants opens the risk that CRA may consider them to be employees, which can result in CPP and EI premiums to the employers, along with penalties and interest for not withholding and remitting.

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