A court ruling on the federal Scientific Research and Experimental Development (SR&ED) tax credit further complicates a government program already rife with problems and in need of reform, say innovation advocates.

The Tax Court of Canada ruled in September that any form of financial contribution to a company from government, including repayable loans, will reduce the company’s eligible SR&ED tax credits if the terms of the financial contribution are different than those of an ordinary private commercial loan agreement.

In a decision by Justice Sylvain Ouimet, the Tax Court ruled that $81.6 million provided to Montreal-based CAE Inc. through the federal Strategic Aerospace and Defense Initiative (SADI) program constituted “government assistance.” CAE manufactures flight simulators and develops aviation training programs.

Such assistance, in the form of an interest-bearing, unsecured, non-forgivable loan, “does not constitute an ordinary commercial agreement,” so it thereby reduced CAE’s SR&ED tax credits, the court ruled.

CAE had appealed to the Tax Court after the Canada Revenue Agency (CRA) reduced the company’s SR&ED-eligible expenditures by $81.6 million for the 2012 and 2013 taxation years. The CRA said the SADI loan constituted government assistance, so it wasn’t eligible for SR&ED tax credits even though the aerospace company used it to pay for R&D.

The Tax Court agreed with the CRA’s position that the SADI loan fell within the definition of “government assistance.”

SR&ED program 'in sore need of modernization'

The SR&ED tax credit is a popular program that provides upwards of $3.1 billion per year to Canadian companies. It is meant to encourage innovation and entrepreneurship by reducing the costs of R&D.

“SR&ED is an extremely important program and supports innovation in Canada, but it is hugely complex and we hear about frustration and a heavy reliance on costly consultants to navigate and manage eligible costs and correctly file information to the CRA,” Dana O’Born, director of strategic initiatives for the Council of Canadian Innovators (CCI), said in an email to Research Money.

“On first blush this tax court ruling just further adds to the complexity,” she said.

As Research Money has reported, the CCI, as well as the Association of Equipment Manufacturers, the Canadian Advanced Technology Alliance and other organizations, have called for reforms to the SR&ED program.

During the recent federal election campaign, both the Liberal and Progressive Conservative parties promised to reform SR&ED “and ensure that a streamlined system efficiently achieves the objective of the tax credit, which is to incentivize innovation in Canada,” O’Born said. “As MPs return to work in Ottawa, we hope this is a top priority for the government.”

Jill Tipping, president and CEO of BC Tech, said the Tax Court ruling isn’t surprising, given there’s a well-established precedent that government assistance reduces the SR&ED tax credits otherwise available to a company.

“But the inclusion of non-forgivable, interest-bearing loans within the definition of government assistance highlights the made-in-Canada ‘innovator’s dilemma,’” Tipping said in an email to Research Money.

Canada’s innovation programs don’t work seamlessly together and, as seen in this Tax Court case, sometimes conflict, she said.

“SR&ED itself is in sore need of modernization to ensure that today’s most impactful innovation investments qualify for tax credits, such as investments in intellectual property,” Tipping said.

Canada is exiting the COVID pandemic with a significant debt burden and an urgent need to accelerate the country’s economic growth driven by innovation, she added. “Ensuring that incentives are consistent and aligned so that Canadian companies invest the most possible in Canadian innovation is key both for the tech sector and the economy as a whole.”

Several government incentive programs impacted by court ruling

Lawyers for CAE are currently analyzing the Tax Court’s decision, Pascale Alpha, director of global communications for CAE, said in an email to Research Money.

The case concerns the characterization for tax purposes, as government assistance or not, of an amount received as an unconditionally repayable loan, she said. “It is not a question of reimbursement."

CAE is committed to repaying its loans from government, she noted. “We have always made our payments and will continue to make them in accordance with our agreements with the governments."

“The impact of this decision for these years (2012 and 2013) is not material to CAE financially,” Alpha added.

However, as a result of the Tax Court’s ruling, Toronto-based Scitax Advisory Partners, which helps companies prepare their SR&ED claims, said in a bulletin: "tech companies must be aware that using any government loans can undermine SR&ED [tax credits].”

Government incentive programs that are now more likely to be assessed as reducing SR&ED tax credits include: loans from the Business Development Bank of Canada and Export Development Canada, the Strategic Innovation Fund, Sustainable Development Technology Canada and the Canada Emergency Wage Subsidy, Scitax said.

“The Tax Court ruling will almost certainly be appealed to the Federal Court of Appeal,” according to Scitax’s bulletin.

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