August 2, 2012

Consultation Regarding the Impact of Contingency Fees on the Effectiveness of the Scientific Research and Experimental Development Tax Incentive Program

Consultations Responses: Please note that the Department of Finance publishes consultation responses in PDF format and language of submission only.

 

Note: A consultation is not a poll. Please do not send multiple or duplicate submissions.

Related Documents

Harper Government Launches Consultations on Contingency Fees for the SR&ED Tax Incentive Program

Invitation for Comments

Written submissions may be made in either official language and should be mailed to the address below by October 1, 2012. Submissions will be used by officials of the Department of Finance and the Canada Revenue Agency only for the purposes of this consultation exercise.

Please note that, if you agree, your submission will be posted on the Department of Finance website. Please clearly indicate in your communication whether or not you grant permission for your submission to be posted (or a portion thereof, which should be clearly identified). If you do not provide explicit permission, we will not post your submission. If you consent to the posting of your submission on the Department of Finance website, please ensure to provide the submission electronically in PDF format or in plain text.

If you do give permission, please provide the following information:

Please indicate whether you would like to be contacted in English or in French.

Questions on the consultation process may be addressed to:

SR&ED Consultations
Department of Finance
140 O’Connor Street
Ottawa, Ontario
K1A 0G5

SRED-Consultations-RSDE@fin.gc.ca
613-947-6563
Fax: 613-943-2486

Once received by the Department of Finance, all submissions will be subject to the Access to Information Act (ATI Act) and may be disclosed in accordance with its provisions. If a request pertaining to your submission is received under the ATI Act, you will be consulted under Section 27 of the ATI Act.


Introduction

The Scientific Research and Experimental Development (SR&ED) tax incentive program encourages Canadian businesses of all sizes and in all sectors to conduct research and development (R&D) in Canada that will lead to new, improved, or technologically advanced products or processes. The SR&ED tax incentive program is the single largest federal program supporting business R&D in Canada, providing more than $3.6 billion in tax assistance in 2011.

Small and medium-sized businesses sometimes rely on third-party tax preparers charging on a contingency-fee basis to complete their SR&ED claims. A contingency fee is a charge for services that is only payable if there is a result favourable to the client, and is generally calculated as a percentage of the amount of the SR&ED tax credits the client receives. Over recent years, the Government has increasingly heard concerns about this practice from various stakeholders, including in relation to the prevalence and magnitude of these fees.

Economic Action Plan 2012 announced a study of contingency fees charged by tax preparers, on the basis that the Government is concerned that contingency fees may be diminishing the benefits of the SR&ED tax incentive program to Canadian businesses and the economy. 

The Government is undertaking this consultation on SR&ED contingency fees to better understand why firms choose to hire third-party tax preparers on a contingency-fee basis, why these tax preparers charge such fees, the prevalence of this practice and the size of the fees being charged, and the impacts of this practice on the benefits derived by Canadian businesses and the economy from the SR&ED tax incentive program. While this study is focussed on contingency fees, the Government is generally concerned about all types of billing arrangements that result in high compliance costs for taxpayers.

The Government is seeking the input of all interested stakeholders. This consultation process is carried out jointly by the Department of Finance and the Canada Revenue Agency, and will help inform the Government’s determination as to whether action is required regarding this practice.

Written submissions are invited until October 1, 2012.

Background

Description of the SR&ED Tax Incentive Program

The federal income tax incentives for SR&ED activities are intended to provide broad-based support for SR&ED performed in every industrial sector in Canada, and to support small businesses in the performance of SR&ED. The rationale for this tax support is that the benefits of SR&ED activities extend beyond the performers themselves to other businesses and sectors of the economy.

All businesses undertaking qualifying SR&ED activities are eligible for assistance under the SR&ED tax incentive program. Work eligible for the SR&ED tax incentive program involves systematic investigation or research carried out in a field of science or technology by means of experiment or analysis. In general, three broad categories of work are eligible:

The SR&ED tax incentive program has two components – an income tax deduction for eligible expenditures, as well as an investment tax credit applied to the eligible expenditure base:

The Canada Revenue Agency is responsible for the administration of the SR&ED tax incentive program. To receive benefits under the program, claimants must be carrying on eligible activities and file an income tax return along with the prescribed claim form, which provides information on the financial, scientific and technical aspects of the SR&ED activity to the Canada Revenue Agency. The prescribed claim form must be submitted within 12 months of the filing due date of the income tax return for the year in which the SR&ED expenditure was incurred.

To assist new or potential claimants, the Canada Revenue Agency provides a range of information and services, including an eligibility self-assessment tool, first-time claimant services, and a pre-claim project review service. In addition, Economic Action Plan 2012 announced that the Canada Revenue Agency will:

Use of Third Parties to Prepare SR&ED Claims

Firms undertaking eligible SR&ED activities may claim the credit on their own or hire a third-party tax preparer that will assist in preparing and filing the claim form, and providing advice about the relevant requirements in applying for benefits under the SR&ED tax incentive program. The services of specialized SR&ED tax preparers appear to be widely available, and contact information for numerous consulting firms, accountants, and national accounting firms in Canada that provide SR&ED consulting services are easily accessible through the Internet. Third-party tax preparers may offer the possibility of various payment structures for their services, including contingency fees, hourly-based fees, or flat fees. This consultation exercise focuses on all types of third-party tax preparers that charge on a contingency-fee basis for the preparation of SR&ED claims.

There are indications that the number of firms choosing to hire a third-party tax preparer (whether charging on a contingency-fee basis or not) is relatively high:

Considerations

Rationale for Contingency Fees

There are currently no restrictions on the size of contingency fees being charged to prepare SR&ED claims.[3] It has been reported that these fees are relatively high, and may represent 30 per cent or more of the total SR&ED benefit received by these firms. In these circumstances, it is reasonable to consider whether alternative billing practices might result in lower compliance costs without affecting the quality of service.

The Government would like to better understand why certain SR&ED performers use the services of third-party tax preparers on a contingency-fee basis to prepare their claim forms.

The Government is interested to learn why some SR&ED performers prefer to pay for these services on a contingency-fee basis rather than a more traditional billing method.

The Government is also interested to learn more about the size of the fees being charged and whether businesses are more likely to hire tax preparers on a contingency-fee basis only for a first-time claim or on a recurring basis.

The Government would also like to understand the motivations of tax preparers for charging on a contingency-fee basis, and the relative importance of this type of revenue for tax preparers.

Effects of Contingency Fees

The use of high contingency fees may increase average compliance costs for taxpayers that successfully claim SR&ED tax incentives. This is most likely to be the situation for firms whose SR&ED claims are above a certain threshold, where the contingency fees are likely to exceed the amount that firms would otherwise pay had they chosen a more traditional billing system (e.g., hourly rate or flat fee). Higher compliance costs result in a lower proportion of the tax incentives going to the firm conducting R&D, which may ultimately reduce the incentive effect of the program. This is especially true if businesses pay contingency fees for the services of SR&ED consultants on a recurring basis.

As the fee received by tax preparers charging on a contingency basis is related to the size and result of the claim, this billing practice has been criticized on the basis that it provides an incentive for tax preparers to encourage their clients to take aggressive positions that push the bounds of the law and its interpretation. If true, this practice would increase the costs for the Canada Revenue Agency to administer the SR&ED tax incentive program, in addition to increasing the overall fiscal risks associated with the SR&ED tax incentive program.

In economic terms, high compliance and administration costs reduce the “net welfare gain” associated with the SR&ED tax incentive program. The net welfare gain is the difference between the value of the positive externalities[4] generated by the SR&ED tax incentive program and the costs to society to provide the program, including, for example, the need to raise additional taxes to finance the program, and compliance and administrative costs. In a 2007 working paper, Finance Canada estimated the net gain to be 11 cents for every dollar of tax expenditures on the program[5]. Any increase in compliance and administration costs due to a broader use of high contingency fees (or, indeed, high non-contingent fees) would reduce the estimated net welfare gain of the SR&ED tax incentive program.

On the other hand, the widespread use of contingency fees may also impact the efficiency of the SR&ED tax incentive program in positive ways:

The Government is seeking input from stakeholders in order to assess the impacts of contingency fees on the cost-effectiveness of the SR&ED tax incentive program in meeting its objective of providing broad-based support for the performance of R&D.

In particular, the Government is interested in stakeholder views about whether contingency fees systematically result in higher costs to the SR&ED performer compared to the more traditional billing methods.

The Government is also interested in understanding the potentially positive impacts associated with contingency fees, including an increased awareness of the SR&ED program and greater accessibility.

Examples of Restrictions in Canada and Other Countries

There are currently no restrictions in Canada regarding the use of contingency fees to prepare SR&ED claims. There are, however, limits to the fees that may be charged by firms that buy refunds of tax at a discount. There are also some restrictions on the use of contingency fees by consultants that operate outside the tax system.

The Tax Rebate Discounting Act limits the “discount” that may be charged by tax preparers that acquire a right to a refund of tax. A tax discounter is a person who acquires, for consideration, a right to a refund of income tax from a taxpayer. Typically, a tax discounter pays the amount due to the taxpayer immediately, less a certain percentage that is kept as a fee. The tax discounter then receives the funds in respect of the refund after the income tax return has been processed by the Canada Revenue Agency. Under the Tax Rebate Discounting Act, the maximum amount that a tax discounter can charge for its services is 15 per cent of the estimated refund if it is $300 or less and an additional 5 per cent of any amount over $300. The Tax Rebate Discounting Act would typically not apply to SR&ED claim preparers as they would not be considered “discounters” under the Act, that is, they do not acquire for consideration a right to a refund of tax.

The Lobbying Act disallows the use of contingency fees by consultant lobbyists that are hired to access government programs. Since 2008, making or receiving any payment or benefit that is contingent on the outcome of a consultant lobbyist activities is prohibited. To enforce this prohibition, consultant lobbyists are required to confirm in their returns to the Commissioner of Lobbying that they are not receiving any contingency fees.

Many jurisdictions regulate contingency fees charged by solicitors involved in litigation activities. For example, contingency fees were prohibited in Ontario prior to 2002. In 2002, the Solicitors Act was amended to permit contingency fees in certain circumstances, in order to improve access to justice. Ontario requires solicitors who are party to a contingency-fee agreement to sign a formal statement, which among other elements must confirm that the solicitor and client have discussed other options for retaining the solicitor (such as an hourly-rate retainer), that the client has been advised that hourly rates may vary among solicitors and that the client can speak with other solicitors to compare rates. The agreement must also include a statement on how the fee is to be determined using a simple example and how the contingency-fee arrangement can be terminated (and the consequence of termination for each party).[6]

It is important to note that professional associations self-regulate the behaviour of their members. As such, tax advisors must adhere to professional and ethical codes of conduct. For example, the rules of professional conduct for members of the Canadian Institute of Chartered Accountants allow the use of contingency fees, provided that the fee arrangement does not impair the professional judgement or objectivity of the member, and that the client agrees in writing to the fee arrangement.   

Some countries restrict the ability of tax preparers to use contingency-based billing.  In the United States, tax practitioners, including attorneys, certified public accountants and other authorized individuals, are generally precluded from charging a contingency fee for services rendered in connection with any tax matter before the Internal Revenue Service (IRS), including the preparation or filing of a tax return, amended return or claim for refund or credit. This limitation, however, does not apply for services rendered in connection with the IRS examination of, or challenge to (i) an original tax return, or (ii) an amended return or claim for refund or credit in certain specified circumstances. Contingency fees are also permitted for interest and penalty reviews, and for services rendered in connection with a judicial proceeding.

In other countries, such as Japan and Australia, tax preparers are required to be registered with the tax authorities and their registration number must be included in any submission made by their clients to the revenue authority. In order to be registered, the tax preparers are required to meet a minimum level of qualifications and to adhere to a minimum standard of behaviour. In Japan, the National Tax Agency provides guidance, supervises and regulates certified public tax accountants (CPTA) and can take disciplinary action for misconduct including reprimand, suspension or termination of business. Australia requires any third-party that provides service or advice regarding taxation law (e.g., preparing a return or representing a taxpayer in dealings with tax authorities) to have a certain level of qualifications and experience, and be considered a “fit and proper” person.

The Government is interested to learn the views of stakeholders on the various types of restrictions that currently exist in Canada and other jurisdictions and whether one or some of these approaches (or others types of restrictions) could or should be considered in the context of contingency fees charged by tax preparers in Canada for the preparation of SR&ED claims.

In addition, the Government is interested in stakeholders’ views about whether other actions could limit the use of contingency-fee arrangements, for example through further initiatives by the CRA to assist firms in completing their claims, or through other forms of disincentives to the use of contingency fees.

Invitation for Comments

Written submissions may be made in either official language and should be mailed to the address below by October 1, 2012. Submissions will be used by officials of the Department of Finance and the Canada Revenue Agency only for the purposes of this consultation exercise.

Please note that, if you agree, your submission will be posted on the Department of Finance website. Please clearly indicate in your communication whether or not you grant permission for your submission to be posted (or a portion thereof, which should be clearly identified). If you do not provide explicit permission, we will not post your submission. If you consent to the posting of your submission on the Department of Finance website, please ensure to provide the submission electronically in PDF format or in plain text.

If you do give permission, please provide the following information:

Please indicate whether you would like to be contacted in English or in French.

Questions on the consultation process may be addressed to:

SR&ED Consultations
Department of Finance
140 O’Connor Street
Ottawa, Ontario
K1A 0G5

SRED-Consultations-RSDE@fin.gc.ca
613-947-6563
Fax: 613-943-2486

Once received by the Department of Finance, all submissions will be subject to the Access to Information Act (ATI Act) and may be disclosed in accordance with its provisions. If a request pertaining to your submission is received under the ATI Act, you will be consulted under Section 27 of the ATI Act.

ANNEX

Table 1: Share of SR&ED Performers Using an External Consultant, 2009
Use of External Consultant Number (Unit)  Share
Small and Medium-Sized CCPCs*    
  Yes 7,938 35.9%
  No 7,856 35.5%
  Both** 6,331 28.6%
 
  Total 22,125 100.0%
Other Firms    
  Yes 1,259 35.8%
  No 1,307 37.2%
  Both** 947 27.0%
 
  Total 3,513 100.0%
Total    
  Yes 9,197 35.9%
  No 9,163 35.7%
  Both** 7,278 28.4%
 
  Total 25,638 100.0%
* Includes all firms eligible for refundable tax credits.
** Firms that have indicated that they used an external consultant and also indicated that an employee directly involved in the project or other employee of the company was involved in filling out the T-661 form (the SR&ED claim form).

[1] Scientific Research and Experimental Development Tax Incentive Program Claimant Satisfaction Study

[2] Survey of Regulatory Compliance Costs, Statistics Canada, 2008.

[3] However, professional rules of conduct for lawyers in many jurisdictions such as Newfoundland, Nova Scotia, Manitoba, Saskatchewan, and Alberta require the fees to be fair and reasonable. 

[4] The “positive externalities” associated with R&D activities refer to the fact that the creation of knowledge does not only benefit the firm conducting the R&D, and spills over to the overall economy.

[5] The result of the 2007 study was representative of all firms claiming the SR&ED tax incentives.

[6] Solicitors Act, Ontario Regulation 195/04, Contingency Fee Agreements.