Dr Russ Roberts, senior VP, Tax, Finance & Advocacy, CATAAlliance

SR&ED: Can we afford not to do better?

By Dr Russ Roberts

Despite billions of dollars of assistance through the Scientific Research and Experimental Development (SR&ED) tax credit program each year, there is still concern about the lack of R&D investment by Canadian businesses, and their lack of focus on growth and exports. Is it not time to revisit SR&ED, identify what it is contributing to business innovation and growth, and what the inefficiencies are? Can we not free up funding to support incentives more specifically focused on promoting growth and export through innovation, and improve SR&ED? Can we afford not to find out what can be improved instead of simply continuing to support the status quo?

Recent economic studies suggest that SR&ED can be optimized and better structured to provide an environment more conducive to the growth of businesses (R$, December 1/15 & December 10/15). There is recurring concern about the impact of the Canada Revenue Agency's management philosophy on the effectiveness of SR&ED. Witness the commentary received by the Jenkins expert panel and the Finance department.

The last decade has seen significant changes in the way the government allowed the CRA to approach the SR&ED program. Actions taken that were apparently aimed at taming its growth, reducing the federal deficit, and freeing up limited monies for direct R&D funding include:

• introducing the legislative measures in the 2012 federal budget;

• supporting the CRA's increased focus on non-compliance in its reviews of claims;

• supporting the CRA's new, restrictive administrative practices and narrow policies for what is eligible for SR&ED; and,

• supporting the CRA's change to historical policy which had provided assurance to Canadian-controlled private corporations using the refundable portion of the program that once assessed, refundable tax credits would not be revisited — other than, of course, in the case of events such as fraud. This change leaves information and communications technology (ICT) start-ups vulnerable to financial stresses should a review occur.

Nonetheless, the program is still the primary source of support for R&D for the business community.

What we have today is a program that has become increasingly complex, one in which claimants' advisors play an increased role in identifying SR&ED, filing claims and dealing with the CRA. The objectivity of CRA reviewers and management has been questioned, including by the courts. And, the CRA has demonstrated difficulty in achieving and maintaining an effective balance between the incentive nature of the program and their normal role in tax compliance.

The new "consolidated" policies and associated review practices have resulted in a more micro-oriented approach to SR&ED than in the past — one that can result in the fragmentation of an SR&ED project into multiple, small projects related to individual uncertainties. With this low-level focus, it can be difficult, particularly in ICT claims, to isolate to the satisfaction of CRA reviewers ineligible work from work that is eligible. This new approach evolved from a basic textbook depiction of the scientific process that cropped up in early jurisprudence, tempered by recent court decisions that reflect a broader, higher level perspective of how SR&ED is recognized.

Courts favour claimants

An increased number of Notices of Objections and court cases are associated with the program's recent evolutions. While the CRA is reconfirming the vast majority of the recent positions taken by reviewers on appeal, the courts are trending in favour of claimants in key cases. In contrast to the CRA, the decisions of the courts are more sensitive to the incentive nature of the legislation and tempered by it.

The courts are repeatedly questioning the objectivity — not the credentials or professionalism — of CRA opinions. In 2009, the minister of National Revenue's own consultant strongly questioned the objectivity of the CRA's second opinion and appeals processes. He argued that the CRA needs to provide truly objective redress. Is it not time CRA addresses the need for objectivity?

Even the best incentive on paper has little value, unless administered with sensitivity to the incentive nature of credits and with predictability. Today, the uncertainties are sufficient that some advisors are cautioning their clients to significantly discount the SR&ED credits when they're making decisions on where to invest. Even so, over 60% of what is filed is being processed with minimal hassle. It's the reasonableness and the predictability of the reviews that is the challenge.

Leadership critical

It is my experience that when there has been clear ministerial leadership, the CRA has operated with a more sensitive mindset. A challenge for CRA managers is that some CRA employees see SR&ED simply as a "giveaway program". After 30 years of hearing this, the question remains how to change this mindset. Or, can it be? I would argue that the government needs to find ways to correct this mindset on a permanent basis.

We know that current CRA management is aware of the issues and is working to promote better balance and predictability; and to provide clearer explanation of how the policies work. However, past experience suggests any improvements achieved may be transitory without strong, ongoing encouragement from the minister.

The SR&ED legislation is complex and there are many different beneficiaries of the credits. No substantive microeconomic studies have tried to sort out who is receiving what for doing what, and how beneficial the multiplicity of provisions in the legislation are. That is, after 30 years, and repeated calls for the in-depth review of the SR&ED program, is it not time to evaluate the nature and magnitude of the impact of the program on the various sectors of the Canadian economy that use it, and then focus the program on its most productive elements?

For example, it's possible that a lot of what's currently being claimed as SR&ED may actually have been found after-the-fact. Work can be claimed in a current year, but earned in previous years in situations where claimants had not identified the need for SR&ED. Are serendipitous claims and their windfall credits consistent with a well designed incentive program, or is some structural change to the legislation needed?

Dr Russ Roberts is senior VP, Tax, Finance & Advocacy at CATAAlliance. roberts-bishop@sympatico.ca