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TELUS Corporation's Submission in Response to Joint Finance Canada Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:

TELUS Corporation
8 - 555 Robson Street
Vancouver, British Columbia
Canada V6B 3K9

Robert McFarlane
A Member of the TELUS Team

November 30, 2007

Nancy Horsman and Peter C. Armstrong
Joint Finance Canada - Canada Revenue Agency SR&ED Consultations
140 O'Connor Street
L'Esplanade Laurier
Ottawa, Ontario
K1A 0G5

Dear Madam and Sir:

Thank you for allowing us the opportunity of presenting our thoughts as to what is the current state of Canada's SR&ED tax incentive program and our recommendations on possible courses of action to improve Canada's incentive program.

TELUS Corporation (referred herein as to "TELUS" or "the Corporation") is the largest telecommunications Corporation in Western Canada and the second largest in the country. We provide a wide range of wireline and wireless telecommunications products and services including data, Internet Protocol (IP), voice, video and entertainment services. Our strategy is to unleash the power of the Internet to deliver the best solutions to Canadians at home, in the workplace and on the move. TELUS' 2006 annual revenue was $8.8 billion with 10.8 million customer connections including 5.1 million wireless subscribers, 4.5 million wireline network access lines and 1.1 million Internet subscribers.

The evolution of the telecommunications industry over the past two decades has been dramatic. On its website, TOTEL PTY LTD, a global telecommunications research organization, describes the Canadian telecommunications industry as follows:

Canada has one of the best-developed national broadband infrastructures in the world, using a range of network architectures and technologies. It has achieved the highest overall broadband penetration of the Group of Seven industrialized countries. In April 2006, Canada was placed eighth in the world for broadband penetration. Broadband deployment continues to progress under active government encouragement, with 95% of Canadians now living in communities served by high-speed Internet access. The introduction of affordable pricing, tiered services and capped charges have all helped to drive the penetration of broadband services. The high penetration rate of PCs has also been a major contributing factor as is the previous high penetration of narrowband Internet access services. In 2006, 77% of Canadian households with Internet access used broadband connections.

Canadian TV and video markets are experiencing significant changes, characterized by convergence with digital media, broadband and telecommunications services. Media convergence gained pace in 2005 and 2006 with increasing merging of video, data and voice applications, in particular digital TV, broadband and VoIP services. Cable TV operators and telcos, and to a lesser extent satellite companies, are increasingly competing for the triple play consumer. The slow but steady transition from analogue to digital TV is increasing the use of new products and services such as Video-on-Demand and High Definition services. Increasing broadband penetration continues to drive the triple play market, with well over half of all Canadian households subscribing to broadband in 2007. Broadband penetration is also seeing the emergence of IPTV and is driving the migration from traditional circuit-switched telephone lines to VoIP telephony, with VoIP subscriber numbers growing rapidly during 2006.

TELUS depends upon an active research and development program in order to meet the market demand for faster and more comprehensive telecommunications services. TELUS has invested heavily in scientific research and experimental development (SR&ED) over the past two decades and, recently, was listed as one of Canada's top corporate R&D spenders for 2006. Over the past 5 years TELUS submitted SR&ED claims in the following amounts (in millions of $):

2001   3.6
2002   46.4
2003   23.7
2004   45.0
2005   141.9
2006   130.8 (estimated-claim will be filed June/08)

TELUS has been an industry leader in the development of new services and technologies including quantum leaps in wireless communications, data transmission, high speed internet and TELUS TV. The Corporation has been recognized by its peers in industry for a number of awards for technological advances related to SR&ED projects undertaken by TELUS:

  • In October, 2006 the TELUS Geomatics team was the recipient of three 2006 Channel Elite Awards presented by the Computer Dealer News recognizing the achievements of IT channel professionals who build technology solutions for the public and private sector. The awards were presented for Geoexplorer, an SR&ED project to build a world class hosted spatial information and data integration application. The seven services developed by TELUS that use GeoExplorer as the base application are:

1. Automated Vehicle Location (AVL) Services – integrates GeoExplorer with cellular and satellite networks to dynamically track and monitor client vehicles in real-time to address issues of fleet and personnel safety, maintenance, optimization and control;

2. Emergency Notification Services – integrates GeoExplorer with interactive voice response systems and incident management software to track and manage incidents and emergencies, and keep emergency personnel, the general public and key stakeholders informed during emergencies;

3. Asset Management Services – integrates GeoExplorer with asset management tools and client asset databases to enable clients to manage corporate assets;

4. Business Demographics – clients can quickly summarize numerical demographic information for a given geographical area and view the information on GeoExplorer;

5. Public Web Mapping – open public Internet access to municipal, provincial and federal government information using interactive maps;

6. Satellite Data Resale – SPOT satellite imagery is integrated with GeoExplorer and viewed on-line (TELUS has exclusive rights to SPOT satellite imagery in Canada); and

7. GPS Phone Location Services – similar to AVL Services but tracks GPS enabled cellular phones instead of vehicles.

  • In April, 2005 TELUS received the Global Innovation Partner award from Cisco Systems recognizing the development of Angel, highly customized managed security software that provides network access control for enterprise accounts.
  • In April, 2005 TELUS received the Partner of the Year award from Cisco Systems as a result of the development of new managed VoIP solutions including IP-One. In addition, the publishers of Communication Solutions magazine recognized TELUS' VoIP leadership in the development of the IP-One platform, by giving TELUS its "Product of the Year" award.
  • In November, 2004, and for the fourth year in a row, TELUS won an Award of Excellence at the Canadian Information Productivity Awards (CIPA), the largest Canadian business awards program in the field of information management. The 2004 award was in recognition of outstanding innovation in the category of efficiency and operational improvements for the successful implementation of Channel Self-Service, a web-based toolkit that allows dealers to provide faster and more comprehensive in-store service to wireless customers.
  • In April, 2004 the Association of Professional Engineers, Geologists and Geophysicists of Alberta (APEGGA) awarded TELUS the APEGGA Project Achievement Award for the TELUS Next Generation Network. This prestigious award is given to a project demonstrating engineering, geological or geophysical skills and representing a substantial contribution to technical progress and the betterment of society. The TELUS Next Generation Network Project was an industry leading achievement by TELUS to conceive, research, develop and implement a carrier-class single IP-based network to carry all forms of communications traffic including voice, data and video.
  • In 2002 TELUS won the Award of Excellence at CIPA for its Web Activations solution allowing customers to self-activate their newly purchased wireless phones in real time using the web. TELUS was identified as a visionary organization making the most innovative and effective use of technology to address critical business needs.
  • In 2002, the "Next 21" profile in the National Post distinguished TELUS as an e.Business Innovator in Canada, highlighting the work done through the Web Enable e.Demand initiative, aimed at streamlining processes through the deployment of technology solutions for procurement, inventory and warehousing, collaborative forecasting and fulfillment.

Although TELUS has invested significantly in SR&ED in the past, regrettably the Corporation's experience has been generally negative with the program itself, incurring substantial costs to prepare and defend the claims with less than satisfactory results. Between 1992 and 1998 the Corporation filed SR&ED claims which were substantially denied by Canada Revenue Agency ("CRA"). CRA took a similar approach with other Canadian telecommunications providers and, in 2000, the Auditor General of Canada prepared a report critical of the Canadian SR&ED tax incentive program. In response, CRA initiated settlement discussions with the telecommunications providers and, in the spring of 2002, settled the claims from 1992-1998 by allowing, in TELUS' case, 85% of the amounts claimed.

In the meantime, frustrated by its experience to date with the SR&ED audit process, TELUS had substantially reduced its claims for the period from 1999-2000. However, encouraged by the 2002 settlement, TELUS resumed its efforts to participate in the process beginning with the 2001 taxation year. Unfortunately, TELUS has continued to experience great difficulty with CRA's adversarial audit approach, resulting in onerous costs to resolve claims. TELUS was required to undergo two separate audits of its 2001/02 wireless claims before reaching a still less than acceptable resolution and has only recently resolved its wireline claims for the period from 2001-2004. In order to arrive at these resolutions, the Corporation has been forced to engage external consultants at a cost in excess of $ 3 million in addition to a similarly expensive investment of internal resources including key technology managers whose time is better spent developing the new services and technologies to address customer needs.

With this as a background, TELUS respectfully submits its recommendations for improvement to the existing SR&ED tax incentive program.

1. Reassign Responsibility for Administration of Program, Provide Certainty and Remove the Program from the Income Tax Act

CRA's administration of the SR&ED program is consistent with their background in enforcing compliance with the Income Tax Act in that they similarly employ an adversarial approach in dealing with taxpayer SR&ED claims. Although Canada touts that its program is one of the most generous in the world, CRA's approach effectively neuters the program's goal to of incenting private sector SR&ED.

Because claims are consistently challenged and denied and the cost to defend such claims is exorbitant, claimants can be discouraged from participating in the program. This occurred in 1999 and 2000 when TELUS sharply reduced its participation in reaction to negative audit enforcement conducted by CRA.

The adversarial approach adopted by CRA leads to considerable uncertainty with respect to a taxpayer's ability to realize the SR&ED benefits claimed. This uncertainty means that related Investment Tax Credits ("ITC's") cannot be recognized in the Corporation's financial statements until there is likelihood of eligibility of a claim and ultimate receipt of the incentive. This results in a long time lag (several years) between the conduct of the SR&ED and the accounting recognition of the related ITC's. Since the TELUS business units that perform SR&ED cannot immediately recognize the benefits of their SR&ED activities in their departmental financial results at the time such activities are conducted, they are not motivated to undertake the projects which inherently have higher risk and lower payback. If there was more certainty as to the eligibility of claims to enable ITC's to be recognized on a current basis, these benefits would help make more projects justifiable.

The net result of the lack of certainty in the administration of the SR&ED program is that any ITC's received are more of an after the fact bonus rather than an incentive that is considered at the time an expenditure is made.

We also note that TELUS files its wireless SR&ED claims with Industry Canada to support its commitment to research and development under the terms of its wireless Spectrum licenses. These claims are audited by external auditors to provide independent assurance for Industry Canada that the SRED claims meet the criteria under the license agreements, the identical criteria as for the income tax program. While these audited claims are accepted in full by Industry Canada, CRA has historically accepted only 30-40% of the claims for income tax purposes.

TELUS also has concerns in the use of the Income Tax Act as the delivery mechanism for the SR&ED program. Because this program is located in the Income Tax Act, the implication is that the chief administrators from the Corporation's perspective are its income tax personnel who have no understanding or background in science-related matters. This results in considerable frustration in dealing with CRA since such tax personnel cannot assess whether the Corporation's application for such incentives are too broad or if CRA is being overly conservative. Certainly, such personnel are not trained to provide project descriptions in the language that CRA seems intent on receiving.

TELUS notes that because of its relative size that CRA audits every taxation year of the Corporation and its subsidiaries. Indeed CRA is virtually located at TELUS premises on a permanent basis. Such audits have their own timelines and requirements for responses to queries which are usually negotiated between TELUS and CRA in order to be reasonable for both sides. CRA's separate audits of SR&ED are not coordinated with the regular income tax audits and the demands placed on the Corporation by such reviewers are considerably more severe in terms of demand times for responses which must be quite detailed and well-considered by science experts. This lack of coordination with the regular audit cycle of CRA together with rather inconsiderate and unreasonable demands for information within short timeframes puts considerable strain on the Corporations administration of its income tax affairs. While TELUS wishes to be as cooperative as possible in meeting the requirements of the Government for the information that it needs, CRA should attempt to coordinate their activities to make the process as smooth as possible for both sides.

TELUS recommends that the Government's policy as to how it wishes the SR&ED program to be administered should be revised to enable certainty in the determination of eligibility of SR&ED activities. The different treatment by CRA and Industry Canada is a case in point. Responsibility for the SRED program should be reassigned to a Federal department that is more aligned with an incentive based approach, such as the Industrial Research Assistance Program. This could also reduce duplication of the costs of having two different departments administer research programs. Moreover, consideration should be given to removing the SR&ED program from the Income Tax Act to avoid the implication that SR&ED has something to do with administering income taxes. If on the other hand, the Government of Canada continues to believe that CRA is the best agency to administer this program, there should be more coordination with the regular income tax related audit and the audit of SR&ED claims.

2. Increase Transparency, Timeliness and Fairness Through Improved Disclosure and Consistency of Delivery

In today's financial markets, companies are under increased pressure to accurately measure their financial results and companies within industry segments are under increased scrutiny and comparison to competitors. The integrity of the Canadian markets is dependent upon transparent, fair and timely financial disclosure and the Canadian SR&ED incentive program should have the same characteristics due to the importance of this program on the financial results of claimants. Furthermore, Canadian taxpayers have a right to know how their government is spending tax dollars to invest in incentive programs such as SR&ED.

Currently the program is subject to strict confidentiality rules and complexity that prevent the public from analyzing and comparing the value of incentives received by the companies in which they invest. Also, the long time delays in auditing and appealing claims prevent companies from recording the benefits in an accurate and timely manner. While public companies do their best to address these concerns, non-public companies do not have the same disclosure requirements. This is of particular concern to TELUS as its main competitor, Bell Canada, is about to privatize and will not have the same financial disclosure requirements as TELUS.

TELUS also has a serious concern with the fairness in and consistency with which the SR&ED program is administered. Over the past three years, the Corporation has engaged a number of different external consultants to assist in preparing and defending SR&ED claims. These consultants have advised TELUS that CRA takes a much more adversarial approach in challenging TELUS claims as compared to claims by its competitors, which we understand are being much more readily accepted by CRA. We further have been given to understand that if this is not a particular taxpayer based discrimination, it could be a result of inconsistent treatment of all taxpayers that file in the Prairie Region SR&ED administration located in Calgary. The additional costs of supporting its claims, and the extent to which CRA denies claims, results in TELUS and its shareholders being subjected to unfair discrimination and financial penalty relative to its competitors and other taxpayers whose files are administered in cities other than Calgary. The Government of Canada should not be interfering with the financial markets by subjecting taxpayers to discriminatory treatment.

TELUS would also note that there is inconsistent treatment between large and small claimants. While TELUS appreciates that due to the size of its claims, all such claims must be carefully reviewed, TELUS has received anecdotal evidence from several sources that because small claimants are not regularly audited, claims are generally fully approved without adjustment.

The Government should provide full public disclosure of amounts provided to companies as SR&ED incentives, either through the tax system or otherwise, to allow the public to gain a full understanding of how public money is spent and to consider this information in the financial markets. Furthermore, TELUS recommends that the Calgary SR&ED personnel, practices and procedures should be reviewed from the perspective of improving consistency of treatment for all taxpayers in Canada. Moreover, the Government should treat both large and small SR&ED claimants in a consistent manner.

3. Improve Clarity of SR&ED Requirements

The legislation in the Income Tax Act provides a very general definition of SR&ED so the program is administered through a series of Interpretation Bulletins and other government publications. However, there is still considerable uncertainty as to the definition and requirements of SR&ED and auditors use inconsistent methodologies to evaluate claims.

Commercial enterprises normally engage in experimental development in developing a product or service from inception, through a series of trials to commercial development. The cutoff between SR&ED and commercial development is not well defined and this causes disputes between CRA and claimants. The grey area between what is clearly experimental development and commercialization needs to be addressed. There are significant development, refinement and enhancements required in moving from the pilot stage to a fully commercial project, especially in large, capital intensive projects. A telecommunication product or service which may function in a test lab situation often encounters significantly different technological uncertainties when it is deployed onto the full network. Issues arise such as geographical disparity, distance and capacity limitations, degradation of transmission due to natural or structural impediments (ex: trees and buildings), interference from other forms of broadcast transmissions, etc. It is overly simplistic to assume that the SRED process is complete when a prototype product or service has been developed in a lab setting.

Auditors and technical consultants also use arbitrary and inconsistent means for evaluating SR&ED projects, particularly if those projects are large and complex. CRA has frequently adopted the approach of breaking TELUS projects into smaller components in an effort to deny many of the expenditures, even when those expenditures are integral to the conduct of the SR&ED. This tactic directly contradicts the audit approach described in the CRA literature. More recently, CRA has challenged TELUS to identify and claim only those activities directly associated with "technical nuggets". TELUS is not aware of any CRA literature that discusses or defines "technical nuggets" and we believe this is a further attempt by CRA to unfairly restrict claims to a very small percentage of the overall SR&ED effort.

We have also noted that CRA enforces timelines to accommodate CRA's financial yearend. Often TELUS has been subject to restrictive timelines so CRA can complete their audit and "sign-off" on the file by March 31. We suspect this is to allow auditors to meet certain annual targets and we've been told by auditors that there are other CRA mandated timelines that incent the auditors to close files without proper review. This is unfair to an organization such as TELUS with complex claims that require significant time to support and defend, particularly given the adversarial approach employed by CRA.

There must be an additional investment of time and resources in clearly defining the nature of SR&ED and the audit approach to be used for administering claims in a fair and impartial manner. This information must be clearly communicated to claimants and auditors.

4. Improve Dispute Resolution Process

TELUS claims are administered by the Calgary Taxation Services Office. The relationship has been difficult, in part because of the fact that the auditors are in a different city and because there has been a history of adversarial and difficult audits. TELUS has requested that the administration of its claims be relocated to Edmonton, where the TELUS Taxation department resides. These requests have been denied.

The consultants engaged by TELUS to assist with SR&ED defense have also advised us that the CRA Research and Technology Advisor and the external technical consultants to not have the background to properly review TELUS claims. TELUS claims include projects related to wireline technology, wireless technology, software development, video, data and voice applications, digital TV, broadband and VoIP services. However, the same technical consultants are employed to audit all of these varied claims.

Furthermore, TELUS has been advised that any appeals associated with SR&ED claims will be reviewed by the same personnel in the Calgary TSO who conducted the original audit. This undermines the independence and credibility of the appeals process.

Additional qualified technical resources must be employed to audit SR&ED claims and a fair and independent appeals process should be utilized.

5. Revise the Rules Related to Investment Tax Credits (ITC's)

Consideration should be given to revising the method of providing SR&ED tax incentives. The current program for ITC's and income inclusion has certain deficiencies.

ITC's are required to be included in income in the year after they are utilized to reduced Federal income tax payable. This results in provincial taxation on the ITC income inclusion, reducing the incentive for the taxpayer who performs the SR&ED and benefiting provinces in which the SR&ED may not occur. The system for providing Federal tax credits and income inclusion effectively results in a hidden transfer payment from the Federal government to the provinces.

ITC's expire within 20 years and TELUS has been in the situation of having to reduce discretionary claims to increase taxable income and utilize ITC's due to expire. This creates taxable income for provincial purposes which then requires the increasing of discretionary deductions in the provinces, increasing the complexity of TELUS tax filings. Eventually this will lead to the acceleration of provincial tax liabilities due to the ITC income inclusion.

Many SR&ED performers are in the "start-up" phase of their business cycle and don't immediately benefit from ITC's other than those companies which may qualify for refundable tax credits. The benefit of ITC's may only be realized once the Corporation is taxable so the incentive is not received when it's needed most.

Non-residents receive no net benefit from the ITC system because any reduction in Canadian taxes is offset by the reduction in their foreign tax credit, thereby increasing their local taxes. This restricts the benefit to non-residents and may limit foreign investment in Canadian SR&ED.

An SR&ED incentive program based on non-taxable grants would alleviate many of these deficiencies.

Thank you for considering our submission. You have asked if we would give permission to post our submission on the Department of Finance website. We hereby provide permission to post our submission.

TELUS would be pleased to meet with you at any time to discuss any of TELUS ideas or those put forward in submissions of other parties. In that regard and for purposes of the permission noted above please contact:

Mr. Timothy McGillicuddy
Vice-President, Taxation
10020-100 Street
Edmonton, Alberta T5J 0N5

Yours truly,
TELUS Corporation

Robert G. McFarlane
Executive Vice-President and Chief Financial Officer