Innovation advocates argue for makeover to Canada's R&D tax credit program
November 14, 2018
Canada’s largest funding program for incentivizing R&D by the private sector is “broken” and needs a major overhaul, say innovation advocates and business consultants.
The federal Scientific Research and Experimental Development (SR&ED) tax credit program should be redesigned and administered by an independent third party rather than Canada Revenue Agency, says the Canadian Advanced Technology Alliance (CATA).
“The CRA’s total control of the development and application of policy and procedures is too inconsistent and unpredictable for any innovation tax incentive,” Russ Roberts, CATA’s senior vice-president of tax, finance and advocacy, said in an interview with RE$EARCH MONEY. “We’re asking that the program be moved to a third party who can set up the administration so it’s focused on delivering an incentive, not a compliance, program.”
RELATED: CATA renews call to improve tax-based incentives for successful technology innovation (R$ Oct 11/16)
“The SR&ED program is broken from the point of view of (Canada Revenue Agency) over-reaching on the compliance . . . especially for the smaller businesses. It’s not encouraging research and development,” says Jeffrey Dale, president of Snowy Cloud, a management services company, and former president of the Ottawa Centre for Research and Innovation.
Finance Canada has been conducting an internal review of the SR&ED program, “to make sure that it remains effective and efficient,” department spokesperson Anna Ameson said in an emailed response to RE$EARCH MONEY's questions. The government’s review of more than 90 of its business innovation programs across 20 federal departments and agencies will result in a reduction in the total number of programs “by up to two thirds,” Ameson said, adding that the Department of Finance “does not speculate on possible legislative changes."
The SR&ED program offers small and medium-sized businesses a tax credit of 35% on the costs of eligible R&D, and large corporations a 15% tax credit. In 2016, the program was worth $2.7 billion to Canadian businesses.
“The program really does make a difference for us,” says Joy Romero, vice-president of technology and innovation at oil and gas company Canadian Natural Resources Limited. “Without it, we would not have done as much [R&D] work as we have.” However, she says her company is seeing more uncertainty in CRA’s review process and less predictability in whether certain R&D projects are eligible for the tax credit.
Some businesses giving up on the program
The biggest problem with the SR&ED program, critics say, is that CRA and its claims reviewers have significantly narrowed the interpretation of what qualifies as R&D eligible for a tax credit. The result is more audits and more claims being rejected and challenged in court. As of December 2016, there were more than 150 cases working their way through the Tax Court of Canada, according to Scitax Advisory Partners in Toronto.
“The interpretation of what is R&D is so restrictive now that not too many companies would really meet the criteria of what CRA wants to enforce,” says Brian Cookson, president and managing director of international consulting firm RDP Associates.
Wording in the federal Income Tax Act governing the SR&ED program is inconsistent, making it open to different interpretations by reviewers across various CRA offices, Roberts says. The consequence is “surprises that occur in audits, particularly for smaller companies that have been filing for a number of years and then CRA reviews their claims and tosses them out . . . That’s a huge shock to a company.”
Some companies back out of the program after undergoing time-consuming, complex and often costly audits, only to have their claims disallowed, Cookson says.
Dale is also seeing businesses bailing on the program. “It wasn’t just that they didn’t get the credit. It was the fact that they spent so much time and energy to try and get the credit, and when they didn't get it, it was a double-hit.”
Funding for tax credits steadily declining
Another issue is that successive federal governments have steadily reduced the funding available for the SR&ED program, with $5.9 billion in aggregate tax credits being removed between 2009 and 2016, according to research by CATA.
A separate study, by economist Kenneth J. McKenzie and research associate Darian Crisan at the School of Public Policy at the University of Calgary, found that R&D tax incentives started to decline after 2013, when the federal government reduced the SR&ED credit for large firms and imposed other restrictions. “Since then the tax (credit) has certainly fallen, there’s no question about that,” McKenzie says. In 2013, the federal plus provincial tax credits amounted to an average 28% reduction in the after-tax costs of doing R&D for businesses of all sizes, their study found. That fell to 19% from 2014 to 2016.
Another problem is that there is no measurement or public reporting of whether the SR&ED program is actually effective in increasing R&D spending by businesses. “There’s never really been any benchmarking done of the SR&ED program to talk about whether it has been beneficial for the Canadian economy,” Cookson notes. Many other countries with similar tax incentives, including the U.K., Netherlands and France, publish metrics each year to gauge their programs’ effectiveness.
Canada has a poor track record in commercializing new products. But to address this problem, since the SR&ED program disallows any commercialization costs to be claimed, it “would need to be expanded or a new tax incentive would need to be developed,” Cookson says.
Dale says the SR&ED program should be reorganized into three components: a non-refundable credit to support initial development costs by startups; a program offsetting tax and other levies for research initiatives linked to new product or service developments; and a corporate grant program that supports national and provincial industrial strategies for developing disruptive innovation.
Along with a new program administrator, CATA is calling for a new tax credit for digital innovation and an “Innovation Box” providing tax breaks to support the commercialization and export of Canadian innovations.
UPDATE Nov. 15/18:
The CRA provided emailed responses to our questions after this story was published. In an email, Paul-Noel Murphy, communications manager for the Ontario region, said in determining the eligibility of R&D, the CRA in 2012 changed its administrative policy following a decision from the Tax Court of Canada (Northwest Hydraulic Consultants Ltd. v. The Queen). “The policy was updated to reflect the five eligibility questions outlined by the judge and a two-step approach to determine eligibility was introduced,” he said.
To help claimants access the SR&ED tax credits more easily and quickly, the CRA offers a free, on-demand pre-claim consultation service, a free pre-claim review, and a free advisory service for first-time claimants to meet in person with CRA staff, Murphy said. The CRA also has established new service standards so that claims are processed within 60 to 180 calendar days, depending on whether a claim is accepted as filed or is selected for review, he said. “The CRA is committed to, and is presently engaging meaningfully with its stakeholders to continuously identify improvement opportunities. The CRA welcomes any exchange of information and collaboration that helps us identify, address and resolve administrative issues.”