Manufacturing lobby group warns of dire consequences if SR&ED eligibility weakened

Changes will undercut advanced manufacturing

Canada's biggest industry lobby group is urging the federal government to kill the proposed changes to the scientific research and experimental development (SR&ED) tax credit program to prevent even more R&D conducted in Canada leaving for more attractive jurisdictions — particularly R&D associated with advanced manufacturing. Canadian Manufacturers & Exporters (CME) further warns that the proposed changes outlined in the last federal Budget will discourage foreign investment at a time when companies are evolving to manufacturing processes that are "less labour-intensive, more productive and more R&D-oriented".

CME calculates that the changes to SR&ED will reduce the cost of the program to government (federal and provincial) by $747 million annually in foregone revenue, compared to the $500-million estimate made by the department of Finance (federal only). Furthermore, it will negatively impact Canada's level of business expenditures on R&D (BERD) as a percentage of GDP, which — at 1.00 (2008) — is already well below the OECD average. CME estimates that the SR&ED changes will shave a further 0.03% starting in 2017.

The data are contained in a CME report entitled Business Research and Development Incentives in Canada: The Impact of proposed changes to Canada's SR&ED tax credit. If the CME's estimate of a $663-million reduction in the federal portion of R&D tax credits proves accurate, it will increase the challenge of reinvesting that amount elsewhere in the R&D ecosystem. In the last Budget, the government pledged to invest the savings generated from changes to SR&ED in direct support programs for business, in response to a recommendation in the Jenkins report (R$, October 11/11).

SR&ED changes

The measures introduced in the Budget include a reduction in the investment tax credit for larger firms from 20% to 15%, the elimination of spending on capital as an eligible expenditure, lowering the proxy rate companies can claim for overhead expenditures from 65% to 55% and reducing SR&ED contract payments. The changes will lower the federal cost of SR&ED by $663 million as well as reducing provincial tax credits by $84 million. Most provinces have SR&ED top-up incentives for business R&D (see chart).

"This reduction to the BERD/GDP ratio will mean Canada will continue to fall behind the research intensity seen in other jurisdictions globally, which will lead to greater gaps in productivity, innovation and product commercialization," states the report. "These calculations only look at the impact on businesses currently doing R&D in Canada ... Reduced tax incentives will (also) make Canada less attractive internationally."

"Canada's global ranking as a location for R&D activities is dropping and will accelerate if the proposed changes are implemented as planned. Rather than the proposed changes, CME believes Canada should be making changes to the SR&ED program that will incentivize multi-nationals to invest in R&D in Canada, including introducing globally competitive support, such as refundable tax credits, accelerated depreciation rates for capital expenditures associated with R&D, and further simplify the calculation process for overhead expenses claimed in SR&ED." — CME report on proposed changes to SR&ED tax credit

The government's decision to reduce SR&ED eligibility to boost direct support has been criticized by several industry lobby groups. In addition to the CME, the Information Technology Association of Canada and the Canadian Advanced Technology Alliance have also expressed concerns (R$, October 31/11). CME members are most likely to be adversely impacted by the elimination of capital expenditures as an eligible expense, as manufacturing companies spend considerably more on capital than information technology or those in which software development comprises the bulk of R&D activity.

"The decision ... to completely eliminate capital expenditures from the SR&ED tax credit without providing an alternative fiscal incentive will definitely put Canada as a disadvantage to most other industrialized and emerging nations," states the report.

CME cites a previous report on advanced manufacturing it conducted last year in conjunction with Industry Canada. It found that large manufacturing firms are re-organizing their global production and R&D between low-cost and industrialized nations. If the SR&ED changes are approved, it contends that Canada's ability to attract high value-add activities will suffer.

The CME report notes that since large firms have the most impact in boosting BERD, it excludes the enhanced (35%) rate SR&ED provides to eligible Canadian-controlled private corporations when making international comparisons. The exclusion of the small-firm rate drops Canada from having the third most generous R&D tax credits to the ninth, or middle of the pack.

The proposed reduction in the ITC rate from 20% to 15% would reduce Canada's "rate of support" for large R&D performing companies from about 18 cents for every dollar spent to 13.6 cents.

"Assuming that other countries do not change their R&D supports, Canada will rank as the 17th most attractive country to conduct R&D activities for large corporations globally," states the report. "If we included the changes to the definition of eligible expenditures as proposed by the budget, Canada's subsidy rate would further decline."

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