Series A Due Diligence in Canada: Tax Filings to Fix First

What do Series A investors check in a Canadian startup's taxes, and what do we fix first?

Investors look for tax that will become the company's debt, or that cuts what the company is worth. Fix them in this order: amounts the company should have withheld, collected or remitted, then deadlines that forfeit money, then paperwork.

A case stops being simple when years are missing, staff or contractors are outside Canada, a US investor or parent is involved, or a CRA review is open. Gather CRA business account statements for each program account (corporate income tax, GST/HST, payroll, non-resident), notices of assessment, filed T2s and SR&ED claims, payroll summaries, and the minute book with the share register and option grants.

Has every T2 been filed, including loss years?

A resident corporation files a T2 every tax year, even with no tax payable (CRA). The return is due six months after year-end.

A late-filing penalty is 5% of unpaid tax plus 1% per complete month late, for up to 12 months (T2 guide). A loss-making startup with no tax owing may face no penalty, which is why loss years get skipped. The real cost is elsewhere: the SR&ED deadline runs from the T2's due date whether or not the T2 was filed, and investors rely on loss balances that an unfiled year leaves unsupported. To file missing years, see catching up on unfiled corporate returns.

Does Schedule 50 match the cap table?

Schedule 50 lists every shareholder holding 10% or more of a private corporation's common or preferred shares (CRA). Investors compare it with the share register and cap table. A mismatch, such as a founder's holding company missing or a share issue never recorded, raises questions about who controlled the company, which feeds into CCPC status. Correct the register first, then the schedule on the next T2 or by requesting a reassessment.

Did we register for GST/HST when we had to, and claim input tax credits?

A business must register once its worldwide taxable sales, including zero-rated sales to customers outside Canada, pass $30,000 in one calendar quarter or over four consecutive quarters (CRA; ETA s. 240). Net tax counts tax that "became collectible", not only tax actually charged (ETA s. 225). So a company that should have charged GST/HST but did not can owe it out of its own pocket unless customers pay it later.

Investors also check the other side: input tax credits on costs are claimable only for a limited time, usually four years. Gather sales by province and by customer location, and the date sales first passed the limit. For the test itself, see when to register for GST/HST. Quebec's QST and the provincial sales taxes in British Columbia, Saskatchewan and Manitoba are separate; see provincial sales tax.

Are payroll remittances, T4s and T4As up to date, and why do investors care?

Investors care because directors at the time can be personally liable, with the corporation, for source deductions the company failed to withhold or remit, plus interest and penalties (s. 227.1). The CRA must assess a director within two years after the person last ceased to be a director, and a director who took the care a reasonably prudent person would have taken is not liable (IC89-2R3). The same rule covers unremitted GST/HST.

Remittances more than seven days late, or never made, carry a 10% penalty (CRA). Check that each payroll account balance is nil, that T4 slips match the payroll summary, and that contractors who are really employees are flagged. Some provinces add a payroll tax: Ontario and British Columbia charge employer health tax on payroll above an exemption amount; Ontario's covers stock option benefits (Ontario; British Columbia). For the mechanics, see running payroll and reporting payments to subcontractors.

Were our SR&ED claims filed on time, and is any review open?

An SR&ED claim (Form T661, with Schedule 31 for the credit) is due 12 months after the T2's filing due date, so 18 months after year-end (CRA). If the prescribed information is not filed by then, the expenditure cannot be deducted as SR&ED (s. 37(11)–(11.1)). There is no catch-up for a missed year.

Investors check three things: each year's claim date, whether refunds were received or are still in review, and whether the claim used the CCPC rate. The 35% refundable rate applies to a private startup only if it was a CCPC throughout the year (s. 127(10.1)); otherwise the basic 15% rate applies (CRA). Gather T661s, Schedule 31s, project records, and any CRA review letters. For filing a claim, see claiming SR&ED on your corporate return.

Can we show we are a CCPC, and will the round change that?

A Canadian-controlled private corporation is a private Canadian corporation not controlled, directly or indirectly, by non-residents or public corporations, or by any combination of them (s. 125(7)). Shares held by all non-residents and public corporations are also counted together as if one person owned them, so several unrelated foreign funds can end CCPC status without acting together. The proof is the share register, voting rights, shareholder agreements and any rights to acquire shares.

Losing CCPC status ends the tax year immediately before that moment, which means an extra T2 (s. 249(3.1)). It also changes the SR&ED rate going forward. Whether US investors end CCPC status, and whether founders should crystallize the lifetime capital gains exemption first, is covered in losing CCPC status to foreign investors.

Does our option plan's paperwork match how Canada taxes the options?

The tax treatment depends on whether the company was a CCPC when it agreed to issue the shares, so the grant date and status on that date must be documented (s. 7(1.1)). For a CCPC's grant to an employee dealing at arm's length with it, the benefit is taxed when the employee sells the shares, and the employer withholds no income tax, CPP or EI on it; a founder who controls the company is not at arm's length; for a non-CCPC, the benefit arises on exercise and income tax and CPP are withheld (CRA).

The benefit is reported on the T4 in box 14 with code 38, and the deduction for up to 50% of it under codes 39 or 41. The $200,000 vesting limit applies only to non-CCPCs in groups with revenue over $500 million. Investors match each grant to a board approval, the exercise price to value at grant, and each exercise to a T4. For employees' tax and US-parent plans, see stock options for employees in Canada.

Did we report payments to non-residents and our US affiliate?

Payments abroad carry their own withholding, and directors can be liable for those too (s. 227.1).

Intercompany charges with a US affiliate also need a supportable price; see pricing between your Canadian and US companies and withholding on services in Canada.

Are shareholder loans and founder expenses cleared?

A loan from the corporation to a shareholder is included in the shareholder's income unless an exception applies (s. 15(2)). The common exception is repayment within one year after the end of the corporation's tax year in which the loan arose, if the repayment is not part of a series of loans and repayments (s. 15(2.6)). Personal costs paid from the company account usually land in this loan account.

Investors want the balance cleared before closing, by repayment or by salary or dividends with tax handled correctly. See shareholder loans.

How do we fix what we find: late filing, reassessment or voluntary disclosure?

The fix depends on what went wrong:

A VDP application must come before an audit or investigation starts, be complete, involve interest or a penalty, be at least one year or one GST/HST reporting period past due, and include payment or a payment request (CRA). For relief levels and process, see reviews, audits and voluntary disclosure. Start early: a disclosure or late SR&ED review can outlast a round's closing timeline.

Example

These examples are illustrative; figures are in Canadian dollars.

Vancouver software company that never registered for GST/HST

Year one: sales of C$20,000, below the limit. Year two: its sales, all to customers in British Columbia and Alberta, pass C$30,000 over four consecutive quarters, but the company does not register. By the round it has billed C$400,000 to those customers, after the date it had to register, without GST/HST. At 5% GST alone, about C$20,000 became collectible. Unless customers agree to pay it after the fact, that cost falls on the company, plus interest and penalties. British Columbia's provincial sales tax is a separate question.

Toronto startup that skipped a loss-year T2

Year two ends December 31 with a loss and C$90,000 of SR&ED credits to claim. The T2 was due June 30 of year three; the company skips it to save fees. The SR&ED deadline was June 30 of year four. At due diligence in year four's autumn, the T2 can still be filed late, but the C$90,000 claim cannot.

Founders' personal costs in the company account

Founders paid C$60,000 of personal costs from the company account in a year ending December 31. Booked as a shareholder loan, it must be repaid by December 31 of the following year, not as part of a series of loans and repayments. Otherwise the C$60,000 is included in the founders' income for the year the money was taken.

Different for you?

• Your company is a US corporation, or a US parent sits above the Canadian company: see US tax clean-up before investor due diligence and moving a Canadian startup under a Delaware parent.
• A US fund leads the round: check losing CCPC status to foreign investors before signing, and get corporate tax help.
• The round is large: see SR&ED and small business limits after a large round.
• Several years are missing, or directors may be exposed for payroll or GST/HST: see catching up on unfiled corporate returns and get corporate tax help.
• The CRA has already written to you: see reviews, audits and voluntary disclosure.
• You sell or hire in Quebec: see doing business in Quebec from another province.