The Canadian Advanced Technology Alliance (CATA) is calling for a refundable, labour-based digital innovation tax credit for smaller information and communications technology (ICT) companies and the creation of a third-party organization to determine eligibility of ICT claims. The recommendations are contained in a CATA draft discussion paper — the latest salvo in a long-running CATA campaign to convince the Canada Revenue Agency (CRA) to improve the administration of the Scientific Research & Experimental Research (SR&ED) tax credit program.

"The ICT sector has taken the brunt of the negative downturn over the past few years and SR&ED was hit more heavily than others," says Dr Russ Roberts, CATA's senior VP tax, finance and advocacy and author of the discussion paper. "Is SR&ED the right mechanism to support innovation in the sector? ICT needs to come to grips with how it asks for support because it represents 40% of SR&ED claims at least."

"Third party redress is terribly important," he adds. "After 30 years of complaints it's essential."

Roberts says the documentation CRA is seeking runs counter to how ICT development projects are documented, adding that the methodologies are not conducive to what CRA is supporting. CATA estimates that the previous government's cuts to the SR&ED program reduced the assistance it provided by $700 million annually, or $4.2 billion over the past six years.

Eliminate retrospective claims

Another irritant is the CRA's allowance for retrospective claims up to 18 months after a firm's year-end. This usually results in windfall profits for those able to provide the necessary documentation, even if the development work being pursued was not originally conceived as SR&ED eligible. In the ICT sector, development cycles are far shorter than R&D conducted in other sectors such as pharmaceuticals or aerospace and often records are not maintained and the people that conducted the work have moved on.

The CATA discussion paper estimates up to $700 million could be freed up if CRA discontinued retrospective claiming.

"The CRA should not allow for 18-month retrospective claims," says Roberts, who helped establish the SR&ED program. "The documentation required is complex and often needs an advisor to prepare. It's not conducive to the minds of ICT developers," says Roberts.

To address the problems, Roberts proposes replacing refundable credits for the ICT sector with a digital innovation or "patent box" tax credit requiring upfront certification in the concept phase. Non-refundable SR&ED claims which typically apply to larger firms (with taxable revenues) could be improved with eligibility certification in the concept phase augmented by "above the line" accounting such as that used in the UK.

A recent paper by Brian Cookson of RDP Associates — comparing the Canadian and UK tax credit systems — bears out the claim that CRA interpretations and documentation requirements are overly onerous and discourage ICT innovation. The UK has leveraged a similarly focused system to dramatically improve its R&D/innovation ranking. And whereas the UK tracks and regularly reports on the effectiveness of its R&D tax credit program, the CRA does not. A 2015 study of the UK system found that "For every £1 of R&D tax credit given out, £1.53 to £2.35 of additional expenditure by UK firms is generated", compared to just $1.38 in Canada.

"In Canada, the CRA doesn't support the SR&ED program as an incentive. They focus on recovery although they deny it," says Roberts. "In the UK, effective administration has been the key and the goal is to improve the country. The changes in their administration worked and the change is impressive. Companies have to explain upfront what they want to do with their program."

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