Jenkins Panel: SR&ED

The release of the Jenkins Panel report on federal support for business innovation has unleashed a torrent of debate over a suite of proposals designed to enhance Canadian innovation by boosting corporate R&D spending. The tone of reaction is becoming more granular as businesses, their respective associations and policy makers dig into the report's details, raising questions about the viability of the panel's six omnibus recommendations and the government's ultimate response.

The recommendation eliciting the most vigorous response and debate calls for reductions in the federal tax credit program by Canadian-controlled private corporations (CCPCs) with the "savings" earmarked for direct support programs for innovative small- and medium-sized enterprises (SMEs). The Scientific Research and Experimental Development (SR&ED) tax credit program accounts for 70% of the $5 billion and 60 programs examined by the Panel.

At issue is the recommendation to limit SME eligibility for the SR&ED program to labour costs, phasing out previously eligible costs in the areas of capital equipment, materials, overhead expenses, contracts and third-party payments to organizations such as post-secondary institutions. SMEs account for $1.3 billion or about 40% of the $3.5 billion annually in foregone revenue the program incurs.

The Panel recommendation contains a number of caveats to make the transition more palatable, including raising the rate for labour costs from the current 35% for CCPCs and 20% for other (typically larger) corporations. It also suggests moving to a labour-based tax credit for larger firms (which account for more than $2 billion in annual SR&ED claims) be undertaken over a number of years and that firms should be provided with "compensatory assistance to offset the negative impacts of this approach on large firms with high non-labour R&D costs".

"Internationally, Canada is considered a model in how we do indirect support. Many other countries are following our lead. However, the panel was persuaded that the program could be improved tremendously," says Jenkins, adding that the panel chose to recommend restricting eligibility criteria rather than tinker with the definition of eligible work under the program. "One must be very humble when one is considering changes to the tax code and other countries have found out the hard way … We were not persuaded that we should embrace the current status of the Oslo approach for broader innovation simply because the track record is so early and we may do more harm than good."

The Panel is silent on how much the reduction in foregone revenue its SR&ED recommendation would achieve. If implemented, it would certainly remove hundreds of millions of dollars from SR&ED. The Panel further asserts that additional savings would be realized by making the claims process simpler and reducing the need to pay consultants to determine compliance. It estimates that compliance costs for smaller firms is equal to 14% of the value of their claims, while larger firms spend approximately 5%.

While R&D labour costs comprise a large portion of SR&ED claims by smaller firms, many others — particularly in sectors such as manufacturing — incur costs in areas the Panel proposes be eliminated.

"Our members have a higher level of non-labour claims so there's some concern," says Jayson Myers, president of Canadian Manufacturers and Exporters. "Most of our firms do a lot of product development and prototyping and 90% are SMEs. Our approach is we would like to have seen an expansion of refundability. Times are tough and profits are being squeezed. We want companies to do R&D even if they're not profitable."

Myers says he's encouraged that the report advocates a larger Industrial Research Assistance Program (IRAP), particularly as its support covers a wider range of activities than those currently eligible under SR&ED.

"The government could adopt the IRAP definition for support and apply it to SR&ED," says Myers. "We suggested that IRAP could also play a role by doing the technical audits for SR&ED claims."

Myers notes that there are two important aspects of SR&ED not addressed by the Panel — the increasingly stringent requirements of the Canada Revenue Agency (CRA), which administers the tax credit, and an ongoing review of SR&ED which overlaps with the work of the Panel.

The Panel's silence on compliance problems experienced by firms and the parallel review of SR&ED by CRA is also of concern to Dr Russ Roberts, SR&ED advisor to the Canadian Advanced Technology Alliance (CATA). While Roberts acknowledges that the overall report has "a lot of very good ideas", he's concerned that SR&ED is becoming increasingly inefficient and costly for firms seeking the credits.

"The move to a labour-based credit is based on an attempt to simplify but that doesn't get to the root of the problem … There are very significant costs within what is expected in a firm to learn whether they have a successful SR&ED project and the problem is increasing. The community needs to be involved to gain consensus," says Roberts. "The new review procedures at CRA involve a very narrow perspective of what entails a project and a narrow concept of what is eligible. We're hearing a lot about it."

The consulting industry is also critical of the proposed changes to SR&ED which the Panel says has profited handsomely from the program's complicated criteria.

David Hearn, a principal at Scitax Advisory Partners, says it's "total nonsense" that a labour-based tax credit will reduce reliance on consultants. "Companies really use consultants to decode the technical criteria to determine the eligibility of activity. They need help to deal with the science side of it," says Hearn. "The policy shift at CRA is driving up compliance costs."

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