AG takes hard line against processes and administration of SR&ED tax credit program

Persistent problems in closing off on the aging files of certain firms claiming federal R&D tax credits has handed the Auditor General of Canada (AG) ammunition to blast the Canada Customs and Revenue Agency (RevCan) over its handling of the scientific research & experimental development (SR&ED) program. The AG report, released April 11, charges RevCan with inconsistency, documented cases of unfairness and unclear eligibility rules in its administration of the program. It also raises "serious concerns about the process" with which RevCan handled a particularly large single claim that was approved after being the subject of two expensive scientific audits.

Accepting the recommendations as they apply to the current operation of the program requires a certain leap of faith, considering the report's preoccupation with the so-called "bulge" claims that appeared in 1994 and stretch back to 1985. In the intervening years, there has been extensive consultation with industry, a key conference in 1998 and the formulation of a 13-point action plan aimed at speeding up processing times and reducing uncertainty about the program. Considerable progress has been achieved in implementing the plan and RevCan minister Martin Cauchon has committed to see the process complete by the year's end.

"The problems they are seeing in the program are similar to those we saw two years ago. They're looking at a program that was, and is in trouble, but we're in the process of working to try and turn it around," says Russ Roberts, a consultant and senior policy director for the CATA Alliance. "What's totally missing from the report is where we are now and where we will be in six months."

As for the aging claims by firms from the telecommunications and financial institution sectors, Roberts says they represent a "residual group of bulge files" that have floundered because RevCan has put the bulk of its energies into speeding up the processing of current or more recent claims.

"A lot of the report's commentary is focused on the bulge files. They're being terribly retrospective," he asserts, adding that the AG criticism of the program's weak uptake of smaller firms signals a misunderstanding of a key reason for why SR&ED was introduced in the first place. "This program is an attempt to rebalance the tax structure for multinationals working in Canada. It helps to lower the after-tax cost for companies dedicated to R&D as a strategy. Therefore it favours multinationals of that type working in this country."

The AG report is also critical of RevCan's slow handling of large claims, which often take several years to process .The AG discovered by looking at 25 of the 100 largest claimants that most of the science and audit reviews covered the taxation years between 1988 and 1993. In response, RevCan says it will attempt to process large claims within 365 days of receiving them and has initiated several new measures to achieve the shorter timeframe.

One large claim that receives particular attention from the AG concerns a telecommunications firm or financial institution that refused to accept the conclusion of two scientific audits which approved only part of its claim. Following the second audit, Rev Can's head office "took over responsibility for settling the file", finally receiving "tens of millions of dollars more in tax credits" than the substantial sum already approved. The claim was complicated by the fact that another firm had been paid to conduct the work in question, and that the second firm also claimed tax credits for the same work.

RevCan acknowledges that the claim in question was not handled well. In its response to the AG report, it states: "In this one instance, existing mechanisms were not fully used to resolve the difference of opinion. The CCRA has already taken action to address this specific occurrence."

The AG report also questions the value of SR&ED to the nation's economic well-being, pointing to a 1997 joint evaluation by RevCan and the Finance department showing that "participants in the program had spent 38 cents over and above every dollar in federal incentives that they received". Relying on such a narrowly focused study misses many of the benefits R&D brings to an economy, particularly one that is striving to be more innovative.

"Economic analysis of tax credits are very weak in many countries. It's a frustrating aspect of program evaluations of this type and a tough one to get in an academic sense. Tax structures have multiple purposes," says Roberts.

The AG also takes exception to the recent draft paper -SR&ED Project Definition - Principles - that was presented to industry at a January conference, reflecting the difficulty of running a program in which two departments are involved at different levels. The paper focuses on eligibility in several sectors and contains recommendations that the AG contends "modifies the level of eligible SR&ED work and expenses and could result in additional costs in tax credits". It further states that the paper "deviates from the current practice of defining, documenting and reviewing claims" and calls on the Finance department to ensure they reflect current tax policy.

"Industry feels it is owed more than what Revenue Canada says it is owed to them and that can result in program creeping," says an official from the AG's office. "With subtle changes like that, you incur costs. If it moves from where Revenue Canada is today it will involve more money, but if you change something you have to ensure it meets the policy objectives."

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