Refundable vs Non-Refundable Tax Credits: What Differences for Your Company in Canada

Definitions of Refundable and Non-Refundable Tax Credits

• Non-Refundable Tax Credit: This type of credit serves to reduce the amount of tax you owe. If your non-refundable tax credit exceeds your tax payable, it can reduce your tax liability to zero, but no further. In other words, the excess credit will not be paid out to you. For example, if your company owes $5,000 in tax and you are entitled to $7,000 in non-refundable tax credits, those credits will eliminate your tax payable (bringing it to zero), but the extra $2,000 of credit will not be refunded. It is simply lost (or, in some cases, carried forward to another year, depending on the type of credit).
• Refundable Tax Credit: This credit, on the other hand, can not only reduce your tax payable to zero but also allow you to receive a tax refund if the credit exceeds the tax you owe. In other words, the government will pay you the difference. For example, if your SME owes $5,000 in tax and you qualify for a refundable tax credit of $7,000, that credit will first cancel out the $5,000 tax payable, then the $2,000 surplus will be sent to you as a refund. Even if your company has no tax payable at all (for instance, if it is in a loss position or just starting up), a refundable tax credit still allows you to receive money from the tax authority.

How a Refundable Tax Credit Works

1. Apply Credit Against Tax Payable: If you have a refundable tax credit, you apply it against your tax payable.
2. Credit ≤ Tax Payable: If the credit is less than or equal to your tax payable, it operates like any other credit by reducing your tax.
3. Credit > Tax Payable: If the refundable credit exceeds your tax payable, the excess amount will be refunded to you by the tax administration, typically by cheque or direct deposit.

Refundable vs Non-Refundable Tax Credits in Canada: Comparison

• Impact on Tax Refund: A refundable tax credit can generate a refund if you do not owe enough tax to use it fully. It is money that goes into your company’s coffers or your pocket at the end of the fiscal year. In contrast, a non-refundable tax credit cannot generate a refund. Its benefit is limited to reducing tax to zero; beyond that, there is no tax refund even if you have excess credits.
• Use in Low Income or Loss Year: If your SME is a start-up or is going through a less profitable year (e.g., a loss year where little or no tax is owed), refundable tax credits are crucial. They still allow you to benefit from financial support despite a very low or nil tax payable. Conversely, non-refundable credits will have no immediate effect in such a situation (you could even lose their benefit if you cannot use them that year, unless there are carry-forward provisions).

Advantages of Refundable Tax Credits for SMEs

1. Maximizing Tax Assistance: With a refundable tax credit, every dollar of credit is guaranteed to be received or used at 100 %. You don’t have to worry about “wasting” part of the credit for lack of sufficient tax payable. This is ideal for SMEs benefiting from incentive measures (e.g., credits for research, innovation, or training) while still lightly taxed in their initial phase.
2. Improved Cash Flow: Receiving a tax refund through a refundable credit can improve your company’s cash flow. These additional funds can be reinvested immediately in the business: hiring staff, purchasing equipment, repaying debts, etc. For a small business, a refund of several thousand dollars can represent a financial lifeline.

Examples of Non-Refundable Tax Credits in Québec

• Québec Basic Personal Amount (personal credit): This is the amount an individual can earn without paying provincial tax. This credit, granted to all residents, reduces basic tax but is non-refundable. If you don’t have enough taxable income, you will not receive the full amount as a cheque; it only serves to reduce your tax payable.
• Charitable Donations Tax Credit: When your SME (or you personally) make donations to registered charities, you can claim a provincial tax credit for those donations. This credit reduces your tax by a percentage of the amount given but is non-refundable. It will reduce your tax payable to zero at most, but no further.
• Dividend Tax Credit: If, as a business owner, you pay yourself dividends or receive dividends from corporations, Québec (like the federal government) grants a dividend tax credit to avoid double taxation of dividend income. This credit is non-refundable. It reduces your personal tax, but if your dividend credits exceed your tax payable (for example, if your other income is low), the excess will not be refunded.

Types of Tax Credits Available (Federal and Provincial)

• Research and Development (R&D) Tax Credits: Federally, the SR&ED (Scientific Research and Experimental Development) program offers small businesses a tax credit, part of which is refundable. Québec and other provinces also have their own R&D credits, often partially refundable for SMEs.
• Investment Tax Credits: Several credits encourage the purchase of equipment or technology. For example, the federal government offers green energy incentives, and Québec provides the investment and innovation credit to boost SME productivity. These credits lower your investment cost by reducing tax payable.
• Hiring and Training Tax Credits: To encourage employment, the federal government offers a credit to companies that hire apprentices in certain trades (applied against corporate tax). In Québec, a refundable tax credit covers part of workplace internship salaries. Other programs exist for employee training, helping offset skill development costs.
• Sector-Specific or Regional Tax Credits: Certain industries benefit from special credits. For example, the film, television, or multimedia industries can claim refundable production tax credits. Similarly, credits exist to stimulate investment in strategic regions or sectors (video games, innovative manufacturing, etc.).

Differences Between Québec and Federal Tax Credits

• Different Rates and Amounts: Often, for the same eligible expense, the federal and Québec governments do not offer the same credit percentage. For example, charitable donations entitle you to credits at both levels but with different reduction percentages. Additionally, some credits exist only at one level: Québec offers, for instance, a solidarity tax credit (for low-income individuals) with no direct federal equivalent (which instead offers the GST/HST credit).
• Refundability of Credits: In general, Québec business tax credits are more often refundable than their federal counterparts. The province thus seeks to directly support SME cash flow, whereas the federal government often favors non-refundable credits (tax reductions). For example, Québec offers IT companies a refundable credit of 24 % of eligible payroll (CDAE), whereas there is no equivalent refundable federal credit in this domain.

Tax Refund vs Tax Reduction: Clarifying the Terms

• Tax Reduction: This simply refers to any measure that decreases the amount of tax you would otherwise have to pay. A tax reduction can come from a non-refundable tax credit, a refundable tax credit (up to the amount of tax), or even a tax deduction. For example, if you were to owe $10,000 in tax and, after applying your credits, you only owe $4,000, you have obtained a tax reduction of $6,000. It is a tax relief.
• Tax Refund: A refund occurs when you have paid too much tax relative to your final tax liability, or when refundable credits exceed your tax. In the context of credits, a tax refund is the money the government pays back to you when your instalments or tax credits surpass what you owe.

Conclusion