Other companies may follow

Canada's top corporate R&D spender — Research In Motion Ltd (RIM) — is considering offshoring future R&D projects as a result of recent cuts to the scientific research and experimental development (SR&ED) tax credit program. And it's not alone: 18% of companies surveyed by the Canadian Manufacturers and Exporters (CME) said they would "shift R&D to other jurisdictions" if capital was eliminated as an eligible expenditure under SR&ED, while 69% said they would "reduce overall R&D activities and expenditures".

Speaking at the ACCT Canada conference in Ottawa December 4th, RIM's director of government relations, Morgan Elliott, said the Waterloo ON-based Blackberry maker is scouting various foreign locations for a major R&D project it is about to launch.

In an interview with RE$EARCH MONEY, Elliott said it would represent the first time that RIM has located a big R&D program outside Canada. He blamed a 5% drop in the general SR&ED tax credit used by large or foreign-owned companies (from 20% to 15%) and the elimination of capital as an eligible expense, among other changes. The new rules came into effect December 5th when the government passed its sweeping Bill C-45 (Jobs and Growth Act, 2012) omnibus bill. The cut, estimated to reduce the SR&ED program by about $500 million annually, was opposed by the Opposition NDP who recommended the government delay introducing the cuts for five years to allow further consultation with businesses.

While other factors such as talent also play a role, Elliott said SR&ED could be the deciding factor when globally oriented firms decide whether to keep their R&D in Canada or move it to a more attractive jurisdiction.

"SR&ED is the single biggest government initiative to keep our R&D jobs here," said Elliott, adding that the changes to SR&ED made by the Finance department were not those recommended by the Expert Panel Review of Federal Support to Research and Development, commonly known as the Jenkins report.

In 2011, RIM spent $1.542 billion on R&D, up 10.8% from the previous, year, according to new data from Research Infosource.

"The Budget measures do nothing to improve the R&D-to-GDP ratio — quite the opposite," says Martin Lavoie, director of policy (manufacturing, competitiveness and innovation) for CME. "In Canada, 75 companies do half of all corporate R&D. If you lose RIM, it will take a lot of smaller companies to make up the difference. Big companies have the option to go elsewhere. Look at a company like Magna. It's in 18 countries and when they're making decisions they look at their bottom line."

The Jenkins report recommended several changes to SR&ED as part of a strategy to re-balance direct and indirect federal support for business R&D. The recommendations urged government to "simplify the SR&ED program by basing the tax credit for SMEs on labour-related costs. Redeploy funds from the tax credit to a more complete set of direct support initiatives to help SMEs grow into larger, competitive firms."

More specifically, it recommended basing the tax credit for Canadian-controlled private corporations (CCPCs) on labour-related costs to reduce compliance and administration costs. To offset the smaller based upon which the tax credit was based, it said the rate should be increased from the current 35%.

Its advice on larger firms was clear: "Over time, the government should also consider extending this new labour-based approach to all firms, provided it is able to concurrently provide compensatory assistance to offset the negative impacts of this approach on large firms with high non-labour R&D costs".

The 2012 Budget responded by proposing a series of changes:

* eliminate capital as an eligible expense for all firms claiming the tax credit, effective January 1/14;

* reduce the tax credit rate for non-CCPCs from 20% to 15%, effective January 1/14;

* phase in a reduction in the proxy amount used to determine overhead expenditures from 65% to 55% with full implementation by January 1/14; and,

* allow only 80% of contract payments to be used to calculate the tax credit, ostensibly to "remove the profit element from arm's length contract payments".

Both Elliot and Lavoie contend that the majority of the SR&ED Budget measures did not originate from the Jenkins report but instead were made unilaterally by the Finance department. As PriceWaterhouse-Coopers noted in a post-Budget analysis, the Jenkins panel did not recommend a decrease in the general tax credit rate, nor did it suggest reducing the overhead proxy rate (it called for a review) or leaving the rate for CCPCs at 35%.

"The Budget was not at all in line with the Jenkins report. Some of the Budget measures were like a rabbit out of a hat. I have no idea where the 5% reduction in the general rate came from," says Lavoie.

CME has been one of the most vocal opponents of the changes to SR&ED. In a report released last month, it estimated that changes to the SR&ED tax credit would reduce the cost to the government by $747 million (compared to the Finance department's estimate of $500 million), pushing Canada's lackluster business expenditures on R&D (BERD) even lower (R$, November 9/12).

CME estimates that manufacturing accounts for about 14% of Canadian GDP and 55% of corporate R&D spending, as well as about half of manufacturing companies that use SR&ED annually. Many of these companies are not considered large, Lavoie notes, as the threshold for those claiming the higher CCPC rate is $400,000 in taxable income. Of the 2,600 companies that use the general rate, he estimates about 2,000 are small- and medium-sized firms, most of which don't have the option of switching jurisdictions to perform R&D.

The change in the general tax credit rate is particularly challenging for small growing companies that are about to move from CCPCs to non-CCPC status. Not only does SR&ED become non-refundable, it also dramatically reduces the rate they are eligible for - a rate that can only be obtained if the firm is profitable.

"The changes are a barrier to growth. There's no incentive to be a larger company because you lose 20% (of the tax credit's value) right away," says Lavoie. "Manufacturing has had its share of issues over the past 10 years and we know R&D is the only solution for long-term viability, so why punish us with these changes?"

Contrary view

Despite the warnings of the CME, not all firms are as worried about the SR&ED changes. GE Canada is investing in research across Canada and does next to no manufacturing in the country. President and CEO Elyse Allan says that, despite the changes, GE is a "strong supporter" of the program.

"We're not overly concerned about the changes they've made ... It has been very useful to us and it's been a key tool in helping us make the investments that we have made (in Canada)," says Allan. "We would have preferred they didn't (make the changes) but the fact that it is still there, we can still access it — that's still important to us. It will be helpful."

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