Raising capital under the Nova Scotia Innovation Equity Tax Credit regime
What is the Innovation Equity Tax Credit?
The Nova Scotia Innovation Equity Tax Credit (“IETC“) is a non-refundable personal and corporate income credit intended to encourage investors to make equity capital investments in eligible Nova Scotia small and medium corporations, who are engaged in innovative activities that contribute to inclusive economic growth. The IETC is available to eligible investors who invest in an eligible corporation (an “approved corporation“) that has applied for and been issued a certificate of registration under the Innovation Equity Tax Credit Regulations (the “Regulations“). The IETC is administered by the Nova Scotia Department of Finance and Treasury Board (the “Department“) and can be claimed by both eligible corporate and eligible individual investors.
The tax credit for an eligible individual investor is equal to 35% of the eligible investment made in an approved corporation, and increases to 45% for eligible investments made in approved corporations with a primary business that falls within the oceans technology or life sciences sector. Eligibility is determined using the North American Industry Classification System (“NAICS“), and generally includes industry groups relating to equipment manufacturing and production in the oceans technology sector, and pharmaceutical, medical, and scientific research and development services in the life sciences sector. More information on eligible classifications under the NAICS can be found in the IETC Guidelines. The maximum annual tax credit for individuals is currently $87,500 for the 35% tax credit rate and $112,500 for the 45% tax credit rate. The minimum investment amount for an individual investor in an IETC-eligible investment round is $1,000, and the maximum annual investment for an individual investor across all IETC-eligible investor rounds in which they participate is $250,000.
The tax credit for an eligible corporate investor is equal to 15% of the eligible investment made in an approved corporation. The maximum corporate tax credit is currently $75,000. The minimum investment amount for a corporate investor in an IETC-eligible investment round is $50,000, and the maximum annual investment for a corporate investor across all IETC-eligible investor rounds in which they participate is $500,000.
An eligible investment can be made in an approved corporation for newly issued common voting shares, preferred shares that are not redeemable or retractable for four years from the date of issuance (the “Holding Period“), or convertible debentures. Convertible debentures may be converted to common or eligible preferred shares during the Holding Period, but cannot otherwise be repaid, redeemed or repurchased during the Holding Period. Our experience has been that interest can be payable on convertible debentures, though the Regulations are silent on this point.
Importantly, investments cannot be replacement investments (i.e. transferring an existing investment to another security in order to qualify for the IETC), cannot be eligible for another tax credit or deduction, and cannot be made primarily for the purpose of obtaining the IETC.
Once an investment is made in an approved corporation, investors are required to keep their investment within the corporation for a minimum of four years to avoid repaying the tax credit – there can be no transfer, repurchase or redemption of the investment during such time. The holding period is subject to limited exceptions, such as a transfer on death of the investor or if the corporation ceases to conduct business due to financial failure. A wind-up or dissolution for reasons other than financial failure results in a pro rated repayment obligation based on the portion of the four years that elapsed prior to the wind-up or dissolution. Importantly, the approved corporation is jointly and severally liable for any required tax credit repayments its eligible investors are required to pay, so it is essential that the approved corporation monitor and control any transfers.
Although the IETC is a non-refundable credit, unused portions of the personal tax credit may be carried forward for seven years and carried back three years for taxation years after December 31, 2018. Unused portions of the corporate tax credit may be carried forward for seven years or carried back three years for taxation years after April 1, 2019.
Section 37A of the Income Tax Act (Nova Scotia) and the Regulations govern the administration of the IETC, and provide its legislative authority.
What corporations are eligible?
The Regulations provide that a corporation is eligible if it:
- is a taxable Canadian corporation;
- carries on a business in Nova Scotia (and is registered in Nova Scotia);
- was incorporated less than 10 years ago;
- has its head office in Nova Scotia;
- uses all or substantially all of its assets in an active business;
- has less than $15 million in assets (including assets of associated corporations);
- has fewer than 100 employees (including employees of associated corporations);
- pays at least 50% of its remuneration to employees or fulltime contractors who are residents of Nova Scotia and report to or deal with a permanent establishment of the corporation in Nova Scotia;
- has authorized capital consisting of at least one class of common voting shares;
- is developing or implementing new technologies or applying existing technologies in a new way to create new products, services or processes; and
- does not fall under any of the restrictions below.
Further, the Regulations provide that a corporation is not eligible if:
- its principal business includes any of the following:
- developing, leasing or selling real property;
- hotel ownership or management;
- retail, including food and beverage services;
- oil or gas exploration, development and production;
- film, digital animation, or digital media;
- membership based recreational activities (e.g. golf courses, fitness clubs, sports centers, etc.);
- financial or insurance services;
- it is incorporated for a self-regulated professional practice;
- it is a business for which public financial support would be contrary to public policy;
- it has been issued a Film Industry Tax Credit, Digital Media Tax Credit, Digital Animation Tax Credit, or Capital Investment Tax Credit;
- it has been approved for or received a payroll rebate or an innovation rebate from Invest Nova Scotia (formerly Nova Scotia Business Incorporated); or
- it has raised (along with all associated corporations) more than $5 million through previous specified issues.
Who is an eligible investor?
The Regulations define an eligible individual investor as a resident of Nova Scotia who is at least 19 years of age. If investing specifically in a convertible debenture, the individual investor cannot be a director of the approved corporation or a shareholder owning 25% or more of the approved corporation. An individual does not include a trust, other than certain RRSPs.
An eligible corporate investor is defined as a Canadian corporation that:
- is registered to carry on business in Nova Scotia;
- has a head office in Nova Scotia; and
- is not a qualifying venture capital fund under Section 27B of the Income Tax Act.
If investing specifically in a convertible debenture, the corporate investor cannot be an associated corporation of the approved corporation or a shareholder owning 25% or more of the approved corporation. Additionally, corporate investors may not make an investment in an approved corporation if the investment results in a corporate investor or their affiliates, associates, shareholder, directors, or officers owning directly or indirectly 50% voting control in the approved corporation.
How does a business apply to be an approved corporation?
A certificate of registration must be acquired prior to accepting any investments that are intended to qualify for the IETC. That being said, typically the certificate of registration, when ultimately issued, is dated as of the date the complete application was provided. Accordingly, it is possible for investments made prior to the date the certificate of registration was received to qualify for the IETC, although relying on this is not advised given that approval is not certain until the certificate of registration is issued.
To apply, the following documents must be sent by email to the IETC Administrator (currently, this is Samantha Thomson (Samantha.Thomson@novascotia.ca)):
- completed application form (can be electronically completed and signed by an authorized officer);
- financial statements for the previous tax year, with either a review engagement report or an auditor’s report;
- T2 Corporate Income Tax Return for previous tax year for the applicant corporation;
- T2 Corporate Income Tax Returns for the previous tax year for all corporations associated with the applicant corporation;
- updated and notarized shareholder register (including information on all share transactions: name of investor, date, type and number of shares bought, sold, or transferred);
- corporate chart/structure, if applicable;
- shareholder agreements, if any;
- debenture agreements, if any;
- proposed investor forms (in the form provided by the Regulations) completed by at least three eligible investors (if a convertible debenture offering, at least one eligible investor needs to purchase shares);
- a two to three-page business plan, including:
- a description of major activities and revenue sources;
- a description of how the corporation is developing or implementing new technologies or existing technologies in a new way;
- amount of funds to be raised through the specified issue, and information on how and when the funds will be used;
- a list of directors (including names, addresses, and background information); and
- the total amount raised across all specified issues by the applicant corporation and all associated corporations; and
- constating documents (certificate of incorporation, articles of incorporation and memorandum of association).
As a note of preparation, if approved the funds raised through IETC must be used for the specific business activities of the approved corporation noted in the application (the proposed use of funds is a specified field in the application). All funds must be used by the approved corporation within four years after the expiry of the certificate of registration. Additionally, funds raised through the IETC are prohibited from being used for:
- acquiring securities;
- purchasing land (other than land that is required for the active business that the approved corporation is primarily engaged in);
- paying dividends;
- repaying a debt to a director, officer or shareholder of the approved corporation (or one of their associates as defined in the Regulations);
- redeeming or purchasing previously issued shares of the approved corporation (or associated corporation);
- retiring a liability of a shareholder of the approved corporation (or an associated corporation);
- funding the purchase of all, or substantially all, of the assets of an existing proprietorship, partnership, joint venture, trust or company;
- funding the purchase of any services or assets at a price that is greater than the fair market value.
Issuance of tax credits
If approved, the corporation will receive a certificate of registration indicating its approval, which will include details of the allowed timeframe in which the corporation can make its specified issue and raise IETC-qualifying investments.
Once approved and eligible investments are received, the approved corporation may apply for tax credit certificates that are required in order to allow their eligible investors to claim the IETC. To do so, the following documents must be provided to the IETC administrator by email:
- up-to-date and notarized share register (including all share transactions from the time of incorporation, and the types of shares sold/bought);
- investor data report (in an Excel spreadsheet);
- a copy of each share certificate or convertible debenture issued to each eligible investor, including the terms of the share/debenture;
- signed statements from each eligible investor (in the form provided in the Regulations); and
- a signed statement from an authorized officer of the corporation.
Once approved, these certificates are issued to the investors for use to claim the applicable credit when filing their personal or corporate income tax return for the year of the certificate.
Ongoing requirements once approved
Annual return requirements are ongoing for the duration of the approved corporation’s four year term. An annual return must be submitted to the IETC administrator, which includes (also via email):
- annual report;
- up-to-date and notarized shareholder register;
- financial statements for previous tax year, with a review engagement report or auditor’s report (note this may be a higher standard of accounting review than some early-stage companies would otherwise obtain for their financial statements); and
- T2 corporate income tax return for the previous tax year.
Importantly, an approved corporation’s IETC approval can be cancelled, and its certificate of registration revoked, in certain circumstances including, notably, if in the four year period following the expiry of an approved corporation’s certificate of registration it:
- does not pay at least 50% of its remuneration to employees or fulltime contractors who are residents of Nova Scotia and report to or deal with a permanent establishment of the corporation in Nova Scotia;
- relocates its head office out of Nova Scotia; or
- ceases to use all, or substantially all, of its property in an active business.
The IETC is an extremely advantageous tool for Nova Scotia early-stage companies looking to raise capital locally. In particular, because of the unique combination of the de-risking of eligible investments through the credit, and the restrictions on such things as redemption and repayment of investments prior to the expiry of the four year holding period, in many cases companies are able to negotiate commercially favourable terms on the securities they issue in an IETC-eligible investment round.
However, as a result of the significant value of the credit relative to the amount invested, the government is very concerned with the potential for fraud. Accordingly, the requirements to apply for and maintain eligibility under this regime can be fairly onerous and quite technical. The foregoing summary simply seeks to provide readers with a very basic outline of some of the more salient aspects of the program. However, any early-stage company seriously considering proceeding with an IETC-eligible investment round is advised to consult with legal counsel in order to ensure compliance with the various rules and regulations governing this tax credit, which in some cases can be fairly nuanced.
This client update is provided for general information only and does not constitute legal advice. If you have any questions about the above, please contact the authors.
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