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Ernst & Young LLP's Submission in Response to Joint Finance Canada – Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:

Tax Incentives for Scientific Research and Experimental Development

Executive Summary

Ernst & Young LLP (Ernst & Young) is pleased to submit its comments in response to the consultation paper issued jointly by Finance Canada (Finance) and the Canada Revenue Agency (CRA) on Canada's Scientific Research and Experimental Development (SR&ED) tax incentive program.

Ernst & Young is a Quality and People focused organization. With regard to the SR&ED tax credit program, we assist taxpayers in many ways. For example, we may be asked to:

  • Defend a claim prepared by a taxpayer, or a different representative
  • Educate taxpayers with respect to the SR&ED program with a view of assisting them in becoming self sufficient in preparing and defending claims, or
  • Prepare and defend claims on behalf of taxpayers.

In preparing our response we interviewed over 50 corporations to discuss how important the SR&ED program is to them and why, as well as their concerns and suggestions with regard to improving the SR&ED tax credit program. These interviews included companies who are not our clients. We are pleased to report the importance of the program is such that companies were eager to discuss and share their views. We thank these companies for their time and sharing their perspectives to broaden and validate our perspectives. Our submission is based on:

  • Interviews with over 50 corporations to discuss areas where the SR&ED program has been key in supporting their success, and their concerns and suggestions;
  • Observations gathered from the experience of our National Ernst & Young SR&ED team members; and
  • Observations gathered from the experience of many more Partners and Staff at Ernst & Young who deal with taxpayers who perform SR&ED.

From this input process, it is clear that the SR&ED Tax Credit Program is very important to companies to continue their SR&ED, and to continue their SR&ED in Canada. Two priorities of taxpayers are very clear:

1. Consistent administration of the program to provide predictability to allow companies to rely on the program; and

2. Refundability, i.e. the opportunity to benefit from some or all of the tax credits in situations where the claimant does not have any Part I tax payable.

There have been many surveys that have reported taxpayers' views on SR&ED issues. These surveys are reflecting these same priorities. In engaging in detailed interviews with taxpayers and through input from our SR&ED team members and other Partners and staff, we have sought to focus on providing practical solutions to issues of concern to assist Finance and the CRA in their objective to improve the SR&ED program.

Our submission will start with a preamble to set a baseline on the economic reasons why SR&ED tax credits work.

The body of the submission will focus on highlighting the more successful factors of the SR&ED program and suggest practical options to improve areas where the legislation, policy or administration of the program can be reviewed to further benefit the Canadian economy:

1. Consistency and Predictability

  • Recommended actions for improving consistency through administration;
  • Options for improving consistency through legislation and policy: Clarifying the definition of SR&ED to narrow the gap in interpretations between taxpayers and the CRA;

2. Refundability: A Progressive ITC Structure

  • Implement a progressive ITC rate and refundability structure that balances efficiency, simplicity and equity by providing:
  • A greater incentive for all Small and Medium sized Enterprises (SMEs) carrying on SR&ED in Canada; and
  • Some refundability for all taxpayers, providing a minimum incentive for taxpayers who currently perform SR&ED but cannot access any of the benefits; and

3. Other policy and administration issues to consider.

Preamble - Why SR&ED incentives?

Over the past two decades government support of research and development (R&D) activities has become very popular with many developed and less developed countries. As of 2007 more than 35 countries offered some type of R&D incentive or tax credit. The policy rationale for these incentives stems from the idea that increased R&D activities lead to new product and manufacturing innovations and this in turn improves a country's industrial competitiveness leading to economic growth and ultimately a higher standard of living for its citizens.

While it is now commonly accepted that there are economic benefits associated with encouraging R&D activities, it was not always accepted by policy makers that it was possible to induce technological change through policy initiatives that encouraged more R&D activities. This is because in the past, it was generally thought that technological change was exogenously determined and as such impervious to policy initiatives.[1] This view persisted until Paul Romer wrote two articles[2] that eventually convinced the economic community and policy makers that technological change was endogenously determined. As simple as this transformation sounds, it has had a profound impact on economic policy and it formed the basis for the multiple R&D incentives adopted by many governments throughout the world in recent years.

Some of the more notable observations and policy implications that have resulted from the Endogenous Growth models are summarized below[3]:

  • Technological progress and change can be influenced by economic policies in a permanent manner, if they induce greater competition in markets and if the rate of innovation improves – contrary to the Neo-classical models. A key implication of this model is the benefit for countries of governments subsidizing and supporting R&D and technological infrastructure growth.

  • Improvements in human capital and technological progress can lead to increasing return to scale from capital investments. Governments should make it easier for people to invest in themselves and provide incentives for them to join the work force.

  • Private investment in R&D is very important to technological progress and economic development. Human capital investment (in the form of training, additional education, and learning while employed) follows the same lines of reasoning. All forms of private investment related to R&D and human capital development, including investments in machinery and equipment to the extent that they are important to the development of technology and knowledge should be encouraged.

  • Encouraging entrepreneurship can also impact economic growth as a result of new ideas arising to displace older concepts (Schumpeter's growth through creative destruction notions) and also from the commercialization of new ideas and knowledge.

  • Property rights' enforcement and patents can encourage greater innovation and act as an incentive to undertake R&D.

Over and above the argument that R&D influences technological change which in turn impacts economic growth, the rationale for offering fiscal incentives to private corporations undertaking R&D activities is based on the notion that the social benefits[4] from these types of activities are greater than the private benefits. This argument implies that markets fail to price R&D optimally, from a social perspective, and that a tax incentive that reduces the private cost of this activity also reduces the gap between the social and private benefits.

From a policy perspective, several criteria are often used to evaluate tax regimes and incentives. Below is a broad summary of the policy criteria used to evaluate a tax regime and its incentives:

  • Efficiency

  • – the extent to which the tax system distorts the allocation of resources in an economy in the absence of market failures. In a well functioning economy, taxes that distort market prices alter private resource allocation decisions which in turn lead to a sub-optimal level of economic output. To the extent that a tax on corporations corrects a market failure, such as those aimed at encouraging R&D activities, the allocation of resources may actually improve.
  • Simplicity

  • – this criterion addresses the extent to which a tax regime or incentive is easy to administer by the tax authorities and comply with by the private sector.
  • Equity

  • – a tax system, or incentive, is deemed to be equitable if it treats similar taxpayers on the same basis (horizontal equity) and the tax burden increases on the basis of taxpayer's ability to pay (vertical equity).

The improvements we suggest in this submission have considered the desirability to maintain these 3 criteria.

1. Consistency and Predictability

Greater than 50% of the companies we interviewed expressed concerns about the lack of consistency between reviewers or across geographies. At the same time, our interviews and the various surveys reported by many organizations, including the CRA, indicate that many taxpayers are generally satisfied with the SR&ED program.

Fundamentally the tax incentive is a science and technology lead program. The definition of SR&ED is consistent with the Organisation for Economic Co-Operation and Development's (OECD) definition, and is based on the taxpayer seeking a scientific or technological advancement through resolving scientific or technological uncertainties. Applying the definition, particularly determining what constitutes a scientific or technological advancement involves a certain amount of subjectivity. The subjectivity is perceived as being far beyond what is normally experienced in taxation matters.

The CRA has implemented initiatives in the past that had been successful in improving consistency in the SR&ED program. We are recommending some of these initiatives be reinstated and we are also proposing options for improving consistency through changes in the definition of SR&ED supported by a clear communication of the policy intent with respect to the definition of SR&ED and the SR&ED program overall.

Recommended Actions for Improving Consistency through Administration

With the subjectivity of the definition of SR&ED in mind and the relative complexity of some of the other provisions of the Income Tax Act (ITA) with respect to SR&ED, how does the CRA preserve the incentive nature of the SR&ED program and also manage consistency in the CRA's technical reviews across Canada while still preserving fiscal integrity?

The issues discussed in this submission are real; however, we should be cognisant that discussing the issues does not diminish all the good work that is being done by the CRA and the overall very significant importance of the SR&ED program to many taxpayers, including in deciding to locate their SR&ED activities in Canada.

Achieving consistency should not be viewed as a one time fix, but a continuous process. While it is important to always strive for a "perfect" system, we appreciate that the journey toward consistency is much like manufacturing companies working toward 0 defects; there may always be some degree of inconsistency, the key is to continuously measure and reduce it. When inconsistencies are identified, there must be an effective process for redress and an opportunity for both Industry and the CRA to learn from the experience. The present degree of inconsistency experienced by taxpayers is significant and warrants immediate and definitive action.

A very large gap between industry and the CRA existed in the mid to late 90's and the CRA made significant efforts in narrowing the gap, mainly through consultation with industry. The consultation initiatives worked well and the outcome was a better balance between the efforts to claim and the results, and fiscal integrity was preserved. Over the past few years, there have been instances where we have observed a resurgence of some former concerns. The majority of the corporations that we interviewed stated that they have experienced a lack of consistency with the program within the last few years. We believe the stakeholders can re-establish the balance to improve the program.

In an ideal world, to achieve consistency, the CRA would have everyone (approximately 500 staff members consisting of Research and Technology Advisors (RTAs), Research and Technology Managers (RTMs), outside consultants, Financial Reviewers (FRs) and Financial Reviewer Managers (FRMs)) report to a single person who reviews all files, but this is neither practical, nor feasible.. The following list of potential centralised controls may offer some assistance in finding practical solutions, some of which are already in place to varying extents:

  • An independent body that can review files or particular issues within a file on request (similar to the access to head office in the late 1990's and the early years of this decade);
  • A team of independent individuals reviewing field office files on a sampling basis to understand the outcome of files where there was a significant difference of opinion between the CRA and the taxpayer (e.g. more than x% difference between amount claimed and amount assessed, or where the time taken to conduct a review exceeds a year or a certain number of hours, or when contested by a taxpayer including when a notice of objection is filed) as well as to ensure consistency of responses to issues across Canada;
  • More resources focussed on reviewing the planning, progress and completion of files, hands on file management;
  • A facilitated cross-Canada exchange of information between managers (The facilitation would be provided by one (1) or preferably two (2) individuals who are independent, and strong in the intent of the policy to avoid the group drifting away from policy);
  • Follow up on issues that are going to Appeals to learn from the outcome;
  • More training of the CRA's outside consultants in the application of the SR&ED rules; and
  • Joint training for CRA and industry.

It would seem that the solution to consistency lies in very strong hands-on leadership and hands-on management, at a level of detail sufficient to be effective to significantly improve consistency.

We have compiled a list of regular occurrences that support the view that consistency is the primary issue in the delivery of the program and, therefore, definitive action is required:

  • The relatively low success rate of SR&ED for experimentation in a commercial environment in some Coordinating tax Service Offices (CTSOs) compared to others, measured across a significant number of claims in different areas of the country;
  • RTA's assessing files in a manner contrary to CRA published policy;
  • The significant differences in interpretations based on the size of the project (in other words, the dollar value of the claim appears to influence the outcome in some instances);
  • The lack of consistency in what is determined to qualify under the definition of SR&ED when the taxpayer has been paid for a product or service that is connected with the SR&ED in some manner;
  • Variation as to when and how taxpayers are advised of concerns by the CRA, including the use of draft science to communicate concerns that were not raised during an on-site review.

It is difficult for taxpayers to observe inconsistencies between taxpayers.

Industry associations have undertaken many initiatives to bring to light these inconsistencies, and SR&ED service providers are well positioned to observe these inconsistencies. s. In our over 50 interviews, more than half of the taxpayers have either reported inconsistencies in the treatment of their divisions in different provinces and Tax Services Offices (TSOs) or reported significant differences in the application of the SR&ED rules when there is a change to the RTA or FR assigned to their corporation.

The inconsistencies generally fall into two categories: (1) situations where claims or taxpayers are treated differently within the CRA and (2) situations where the CRA's application is not consistent with the law.

1. Inconsistencies within the CRA

  •  Inconsistent treatment of experimental development from region to region, in a manner that is not consistent with published policy, including stated views that experimental production does not exist.
  • Onerous evidentiary requirements *
  • Lack of transparency *
  • Discouraging taxpayers from working with SR&ED service providers*

2. Inconsistencies with the law

  • Work performed by employees is considered SR&ED directly undertaken by the taxpayer, where the same work performed by a service provider for a taxpayer is not considered SR&ED performed on behalf of the taxpayer **
  • Phase IV Clinical Trials **
  • Support on support **
  • Incorrect application of the contract payment rules**

* For a more detailed explanation of the issue, please refer to [Appendix A-1]
** For a more detailed explanation of the issue, please refer to [Appendix A-2]

Tax policy objectives


A very important issue from a tax policy perspective is that the application of the law should be equitable for all taxpayers. For the SR&ED program to truly be an incentive program, the benefit must be predictable for the taxpayer. The lack of consistency in the application of the SR&ED legislation poses a serious threat to that predictability.


We recognize that the number of claims has significantly increased over the years. We also recognise that the CRA must perform reviews across all industries and across all sizes of taxpayers as a part of maintaining fiscal integrity. We suggest that the staffing levels may need to be reviewed to ensure the CRA has the necessary resources to monitor the planning, execution and conclusion of reviews in order to provide equitable treatment for all taxpayers.

We also recommend that the centralised control solutions noted above be reinstated or enhanced as the case may be.

We recommend a return to consulting with Stakeholders.

We recommend that the CRA management engage in active hands-on management of files which are being adjusted, and actively train and set up processes that help sustain consistency.

Finally, we recommend that, at the very beginning of communications with the taxpayer with respect to the risk assessment of a claim or the review of a claim, the CRA present taxpayers with the Taxpayer Bill of Rights, and make clear that the CRA fully endorses the taxpayer's rights. The document, to be reviewed by the CRA with the taxpayer, should require the taxpayer to acknowledge the communication and the provision of a copy of the tax payer's rights.[5]

Options for Improving Consistency through the Legislation and Policy: Clarifying the Definition of SR&ED

The definition of SR&ED needs to be focused on the intent and nature of the work to meet the policy objectives of equity, and to encourage the desired behaviours from taxpayers. The definition also needs to be general enough to provide the CRA with the means to administer the program as an incentive program across industries and fields of science and technology. Finally, it needs to set boundaries to avoid taxpayers claiming beyond what is intended by Parliament.

We believe that the current definition meets these objectives. The definition and, perhaps more importantly, the policy intent of the definition must also be clear to facilitate the management of consistency in the administration of the SR&ED program. The current evidence of inconsistency indicates that this is not clear.ar.

There is generally no significant concern in the preamble and the first three paragraphs of the definition of SR&ED:

"scientific research and experimental development" means systematic investigation or search that is carried out in a field of science or technology by means of experiment or analysis and that is

(a) basic research, namely, work undertaken for the advancement of scientific knowledge without a specific practical application in view,

(b) applied research, namely, work undertaken for the advancement of scientific knowledge with a specific practical application in view, or

(c) experimental development, namely, work undertaken for the purpose of achieving technological advancement for the purpose of creating new, or improving existing, materials, devices, products or processes, including incremental improvements thereto ..."

This part of the definition is consistent with the OECD's definition of SR&ED and that of many countries, and has provided a sound basis for the administration of Canada's SR&ED program for many years.

However, paragraphs (d) to (k) of the definition of SR&ED result in significant variations in interpretation, and to a certain extent, causes difficulties with respect to the meaning of experimental development in paragraph (c).

Paragraphs (a) to (c) of the definition of SR&ED are followed by:

" and, in applying this definition in respect of a taxpayer, includes

(d) work undertaken by or on behalf of the taxpayer with respect to engineering, design, operations research, mathematical analysis, computer programming, data collection, testing, or psychological research, when the work is commensurate with the needs, and directly in support, of work described in paragraph (a), (b), or (c) that is undertaken in Canada by or on behalf of the taxpayer ..."

The he CRA's interpretation of paragraphs (c) and (d) varies significantly from one reviewer to another, and is very often restrictive. For example, if paragraph (d) is interpreted as adding work that is not already described in paragraph (c), this can lead to an interpretation that "experimental development", as the term is used in paragraph (c), is limited to "the experiment". This represents a restrictive view of what constitutes experimental development. The issue can then be compounded by interpreting paragraph (d) very narrowly such that only a restricted amount of work is allowed under that paragraph as well.

Should the experiment include only the effort to carry out the "test"? Should the test include only the measurement of the results of the experiment: the final step where performance of a prototype is tested or where readings are taken from the output of a computer modelling program? Or, should the experiment be interpreted as including:

  • Formulating a concept or theory
  • Developing what will be experimented with (a segment of code, a test fixture or structure, a prototype) – to prove or disprove a concept or theory;
  • planning the test or tests required;
  • setting up the equipment to execute the test;
  • executing the test; and
  • summarizing, analyzing, and reporting the results?

A restrictive interpretation of "experiment" and of "testing", and confusion between a well planned experiment using known analytical methodologies and a "routine test" can make the difference between receiving an incentive for SR&ED work or not. An appropriate interpretation would be to view a), b), and c) widely enough to include the work listed in d); and not use d) to restrict what is included a), b) and c).

We refer you to Appendix B for a similar analysis of paragraphs (e) to (k).

Over the past few years, taxpayers and SR&ED service providers have noted a significant increase in restrictive interpretations by the CRA, although the legislative definition of SR&ED has not changed and neither has CRA published policies. While the increase in restrictive interpretations is not consistent, the relatively recent trend towards more restrictive interpretations appears generally across the board. Approximately one-third of interviewees reported differences in opinion in eligibility with CRA on review, mainly from a science perspective.

Tax policy objectives


The current definition of SR&ED results in a very wide range of interpretations. This diversity of opinion may be caused to some extent by some confusion as to the policy intent of the SR&ED program. The range of interpretations does not serve the policy intent when they are too restrictive or too broad. One would expect that, as long as the work is "commensurate with the need" and "directly in support of" overcoming an uncertainty to achieve an advance, it is eligible. A policy statement to that effect would be sufficient, and very beneficial to taxpayers and the CRA.


The inconsistency in interpretation by the RTAs of the definition of SR&ED as well as in the application policies and guidance documents related to the definition, results in inequity in the administration of the program.



We recommend that the definition of SR&ED be reviewed to clarify Finance's policy with respect to encouraging SR&ED beyond the laboratory and that the clarification be communicated to all stakeholders. Specifically, we recommend that paragraphs (d) to (k) of the definition of SR&ED be reviewed and that the policy intent be clearly and broadly communicated.

2. Refundability: A progressive ITC structure

The SR&ED tax incentives provide Canadian controlled private corporations with enhanced refundable tax credits, generally on up to $2M of annual SR&ED expenditures where certain conditions are met. These incentives are clearly very important for growing companies, and have been repeatedly cited as key to small company success.

Increased ed refundability, for all taxpayers, was the most common change recommended by survey respondents.

While recognising that the ITC structure is effective for small companies, the majority of taxpayers surveyed indicated that the structure does little to encourage companies to do SR&ED in Canada who are not able to recognize the benefits of the ITC's immediately and causes inequities between companies in the same industries and companies across industries.

Limiting enhanced benefits to Canadian Controlled Private Corporations

Corporations must be Canadian controlled private corporations (CCPC's) throughout the taxation year as a first condition to access the enhanced refundable SR&ED tax credits. This creates inefficiencies (by reducing the incentive for corporations to access public funding) and inequities (by not providing access to the same benefits to non CCPCs) in the SR&ED program, and adds to the complexity of the legislation and to the administration of the program. As well, to a certain extent, this application is inconsistent with the overall policy objectives of increasing SR&ED in Canada.

Taxable Income Test and Taxable Capital Test

CCPCs must be within certain thresholds to access enhanced refundable SR&ED tax credits, failing which the $2M expenditure limit on which the enhanced refundable SR&ED tax credits applies will be reduced or eliminated:

  • Every $1 of taxable income for the previous fiscal period that exceeds $400K will reduce the $2M expenditure limit by $10 (Taxable Income Test), and
  • Every $5 of taxable capital that exceeds $10M will reduce the $2M expenditure limit by $2 (Taxable Capital Test).

The Taxable Capital Test creates an inequity by providing less access to industries that typically require more capital. The alternative is to raise financing in stages which creates greater risk. Manufacturing companies are more likely to exceed taxable capital thresholds than engineering service companies, for example. The Taxable Capital Test in combination with the Taxable Income Test also creates inequities between start-ups and existing SMEs with businesses that generate on-going profits.

Finance will have no doubt received many representations requesting an increase in the $2M expenditure limit, since that limit has not been increased since its inception in 1985. We provide for your consideration a different model that can be effective, simple and equitable. Ernst & Young recognises that the government does not have unlimited resources and that changes to the SR&ED program must consider the projected tax expenditure. We encourage you to consider our proposed model from a conceptual point of view and adjust the quantum as necessary to reflect an appropriate tax expenditure that would align with the program objectives of stimulating the Canadian economy through SR&ED, while recognizing that the $2M expenditure limit has been in place since 1985.


We recommend establishing a fixed amount graduated threshold that would be applicable to all taxpayers. For example:

ITC rate Applicable to expenditures Refundable

35% First $2M Fully
30% $2M to $3M Fully
25% $3M to $5M 50%
20% In excess of $5M No

This recommendation is based upon the following principles:

  • Graduated rates would apply on an associated corporation basis for SR&ED carried out in Canada;
  • There is no differentiation between current and capital expenditures for ITC entitlement purposes (for simplicity);
  • Refundability applies to all corporations (no taxable income or size test); and
  • Non-refundable ITCs offset Part I taxes otherwise payable (can also consider offsetting employment related levies)


The above scheme eliminates the Taxable Capital Test for the existing expenditure limit. Therefore, it does not favour service businesses over manufacturing businesses.


The above scheme is horizontally equitable in that it provides the same incentive to all corporations. This would encourage taxpayers to seek more funding for SR&ED by tapping into public markets without losing their refundable credits.

The above scheme is vertically equitable, in that corporations have access to refundable credits, proportionate to their overall operations.

Larger unprofitable corporations (that do not have Part 1 tax owing for many consecutive years) would also be encouraged to perform SR&ED activities to increase their competitiveness.

We believe that non-corporate taxpayers should also gain access to refundable credits in order to further enhance the horizontal equity of the program; however we acknowledge this would add greater complexity.


In our proposed model, the separation of current and capital expenditures beyond determining the conditions for eligibility is removed by having the same entitlement to a refund of ITCs earned on both types of expenditures.

Finally, a fixed graduated threshold structure would be relatively simple to administer. The entire section 127.1 would be eliminated, together with the concept of a qualifying corporation[6]. The model eliminates the convoluted structuring undertaken by some taxpayers to maintain their CCPC status where the refundability of ITCs is essential to continuing operations or raising capital.


Plan B

Alternatively, a less dramatic change in the structure of ITC entitlement would involve increasing the expenditure limit and changing the size test to one that measures CCPCs using a weighted formula that considers various elements, creating a balance across industries. For example, a weighted balance of the number of employees or annual payroll and total assets could reduce inequities currently existing across industries. The structure for these types of weighted formula has worked well in the context of the computation of Manufacturing and Processing credits and in the allocation of income among provinces.

Differentially encourage CCPCs

Notwithstanding our recommendation above, Finance may want to differentially encourage CCPCs to perform SR&ED. We would then recommend that the above scheme be enhanced for CCPCs by allowing them to deduct the incremental SR&ED expenditures[7] incurred in a taxation year against the taxable income of the preceding taxation year. This would encourage CCPCs to retain income in surplus years for reinvestment in SR&ED in subsequent taxation years.

3. Other Policy and Administration Issues to Consider

We believe the above two issues are paramount to the overall success of the SR&ED program. This was clearly articulated in our interviews with taxpayers. We have grouped under this section various other issues and potential solutions for your consideration. These have been raised as we reached out to a variety of companies in many different economic situations and industries. Although they may not have as broad an impact as the above issues, they do affect a number of taxpayers and, in many instances impact the objectives of efficiency, simplicity and equity. In other instances, they represent opportunities to enhance the SR&ED program, focussing on the objectives of:

  • Encouraging SMEs to do more SR&ED in Canada, and
  • Encouraging the cooperation between the public and private sectors.

Lack of recourse

Elevating issues to to CRA Managers

Taxpayers will occasionally ask for issues to be considered by the RTA's or FR's managers (Managers). This generally occurs after a significant amount of time has been spent on the review and a draft report has been issued; and often only when they have been informed by someone outside of CRA that this is an option. A desire to cooperate with the RTA and FR to understand the issues and give the RTA and FR sufficient opportunity to resolve the issues without having to elevate them to the Manager level is to be commended and should be encouraged. However, if there is no progress, or there is a lack of transparency with regard to the issues CRA sees in the claim in the early stages of the review, this can result in raising the issue so late in the process that a mutually agreed outcome becomes less likely.

The longer the file has been subject to review and the more the parties have committed their positions to writing, the more difficult it is to solve the communication issues and appropriately assess the file. We understand the difficulty from a human relations perspective and note that the issue is particularly prominent with respect to matters where a significant degree of judgement is required, for example interpreting the definition of SR&ED and assessing the reasonableness and sufficiency of documentation and other evidence presented to support the eligibility of a SR&ED project. In this example, where the manager is brought to the table after significant interactions have occurred in a review, in order to fully appreciate the difference in position between the RTA and the taxpayer, the CRA Manager would have to review masses of information and be advised as to verbal communications between the taxpayer and the RTA or FR, adding a significant amount of additional time by the CRA and the taxpayer.

We refer back to our recommendation to review staffing levels to ensure that the CRA has sufficient resources for Managers to participate in the planning and the execution of the reviews. We have experienced the benefits of having the Managers attend the first meetings with taxpayers, where the contextual framework is presented and the ground rules for the review are agreed upon. That small investment of time up front makes a significant difference in the efficiency of reviews and the consistency of the approach adopted by the RTA and FR, often resulting in more efficient audits and fewer disputes. For files where there exists, or begins to exist a potential of a significant difference of opinion, we recommend the manager attend.

We also refer to our recommendations to reinstate centralised controls to facilitate resolutions beyond the TSO.

Notice of Objection

Currently, if the CRA reviews an amended tax return which includes a SR&ED claim and takes the position that the entire SR&ED claim is ineligible, the CRA may not issue a reassessment with respect to the disallowed SR&ED claim because there is no change to be made to the original assessment. As a result, because a notice of reassessment has not been issued, the taxpayer is unable to file a notice of objection for that taxation year. Although the taxpayer may be in a position to object in a subsequent taxation year when the taxpayer is denied the ability to claim the disputed ITCs, this may be many years later, making the defence of the claim and the assessment of the objection more difficult for both parties.

We recommend that the legislation be amended to provide for a mechanism to object to disallowed SR&ED claims in the absence of a formal reassessment. Alternatively, we recommend that the CRA be compelled to issue a reassessment in such circumstances, or that some other mechanism be provided to allow for Notices of Objections to be filed.

Minister's discretion

The Minister's discretion, formerly afforded pursuant to subsection 220(2.1) has been revoked with respect to SR&ED. There are many situations where the lack of recourse creates inequities. Here are a few examples:

  • A technical project description is lost between the time it was put in the envelope with the T661 and the tax return sent to the CRA (prior to the filing deadline) and the time the SR&ED division at the CTSO receives the claim (after the filing deadline). The CRA currently does not review the claim, even where it is distinctly possible that the CRA lost the technical descriptions.
  • A taxpayer files a complete T661 including the calculation of qualified expenditures but does not file the Schedule 31 within the 18 months. The full claim is disallowed even though the policy intent of the 18 month rule is that the work and expenditures are identified with the 18 months.

We recommend the reinstatement of the Minister's discretion formerly afforded pursuant to subsection 220(2.1). We also recommend that CRA's administrative policies with respect to the 18 month rule be reviewed.

Fear of reprisal

Many taxpayers have faced situations they considered unjust or inappropriate, but they refused to bring the issues to the attention of CRA's management for fear of reprisal.

This is particularly apparent in smaller SR&ED performers where the SR&ED tax credits represent a significant source of financing for their ongoing SR&ED. The subjectivity inherent in the SR&ED program means that the individual CRA reviewers have significant power over taxpayers in the eyes of many taxpayers, notwithstanding that CRA management does not condone reprisals and would take corrective action if it were aware of unjust or inappropriate activity by its staff.

The following are examples of unjust or inappropriate activities that we have witnessed or been made aware of:

  • Suggestions by RTAs that the taxpayer should voluntarily withdraw a project from a claim, without the RTA providing a rationale. These suggestions are sometimes accompanied by a comment that failure to do so would result in a long review that would likely end up with a conclusion that would be less favourable than the offer on the table;
  • Financial reviewers suggesting a fixed percentage reduction to eligible expenditures with no rationale and stating that, if the company does not agree, there will be a full scale technical and costing review (i.e. reviews that commence with the CRA offering 50% to conclude the file now, rather than considering the merits of the claim); and
  • Threats to impose penalties if a taxpayer continues to file based on an interpretation that differs from that of the CRA.

Although we encourage taxpayers to bring such concerns to the attention of CRA management, we recognise that the taxpayers' fear of reprisal is not irrational, particularly when those taxpayers have brought other issues to the RTA or FR Manager in the past with little or no success (see above discussion on Elevating Issues to CRA Managers) or the taxpayer relies on the SR&ED program for a significant part of its funding.

Legislative issues

We would like to bring to your attention a few areas where we have had frequent observations or request from taxpayers when discussing possible improvements to the SR&ED program. We have summarised them below, but refer you to Appendix C for more information.

  • SR&ED performed outside Canada by Canadian resident employees of Canadian resident corporations is ineligible and the legislation was changed to also make SR&ED performed in Canada by non-taxable suppliers ineligible;
  • ITCs reduce Part I tax, which results in an offsetting adjustment to the foreign (Canadian) tax credit of US corporations, eliminating the incentive for many subsidiaries of US corporations;
  • Foreign government assistance should have the same treatment as contract payments from foreign sources
  • Enhanced tax credits (and GST/HST concessions) for SR&ED performed in collaboration with universities could significantly increase public-private collaboration; and
  • The T661 prescribed form does not accommodate proper reporting of eligible expenditures under the traditional method, creating confusion.

In our survey, a number of taxpayers have also commented that the Federal ITC should not reduce the SR&ED deduction pool and should not otherwise be brought into income.


The SR&ED program is an incentive program that often necessitates an exercise of judgement because the subjective nature of the matters under discussion. We have been involved in many claims where this has proven to be very successful and enabled taxpayers to achieve great things in their businesses and for the Canadian economy. The SR&ED program is a critical consideration in the location of SR&ED activities and the raising of financing by SMEs for the conduct of SR&ED activities.

The issues discussed in this submission should not be viewed without recognizing all the good accomplished by the program and the majority of CRA reviewers who work diligently to do the right thing and to do so consistently. There exists an increasing pattern of inconsistent behaviour and incorrect application of the law and a decreasing number of venues in which the taxpayer may seek redress in an efficient and economic manner.

We have made recommendation for changes to the legislation, and proposed that the Finance Canada issue a clear policy intent with respect to the application of the SR&ED provisions. The intent is to simplify interpretations through policy intent thereby providing greater support for interpretations that would underline the incentive nature of the program, and provide clarification for the administration of the law. We recommend the return of open consultation with stakeholders as history has shown that open communication and transparency are fundamental to the success of the program.

Finally, we have made recommendations in areas where we believe that Finance could expand the incentive program. The underlying principles for these recommendations are efficiency, simplicity and equity. We believe the Canadian economy would benefit from a broader application of enhanced refundable credits for all corporations regardless of size or structure. The removal of size tests and the CCPC requirement would encourage SMEs to perform more SR&ED, and would be efficient, simple, and equitable.

Appendix A-1 Inconsistencies in the administration of the SR&ED program Procedural issues. [Return]

Evidence requirements

In the past, Finance and the CRA have made significant efforts to ensure that the SR&ED program operates as an incentive program. The scope and depth of an SR&ED claim review should take into consideration risk factors and the evidence required to support a claim should be reasonable and consistent. This is important for fiscal integrity.

Some taxpayers have had difficult claim reviews, with poor results and are of the view that the time required and cost of preparing and defending claims are greater than the benefits they will receive so they have ceased claiming. Although this is the exception, there are too many taxpayers for which the efforts required to claim SR&ED are considerably more than one would expect. This can be caused by the taxpayer not being well organised, but too often it is because of onerous evidence requirements imposed during an audit. Referring back to Question 2 of the Consultation Paper issued by Finance and the CRA, this is an impediment to performing SR&ED, as taxpayers have limited resources; and often focusing more time on claim preparation or defence is taking resources away from conducting SR&ED and running the business.

Although this subject is covered generically in the section "Consistency" above, we believe it is important to highlight some of the more frequent occurrences raised in what appears to be incorrect or disproportionate evidence requirement in the hopes that raising these occurrences will help the CRA identify root causes and work with stakeholders to improve consistent process and outcomes. Examples include:

  • Denial of a claim because the taxpayer does not have a time sheet system, and a perceived inability to consider other reasonable allocation methods and forms of evidence to support eligible effort;
  • The concept of reasonableness for determining if expenditures are attributable to SR&ED is often replaced with a requirement to demonstrate with 100% certainty;
  • The amount of evidence requested is disproportionately high for some reviewers. For example there are cases where the first communication from CRA is a letter requesting copies of all time sheets, all invoices, cheques (copies of front and back) or other similar information requirements (including for multi-million dollar claims);
  • Documentary evidence specifically requested is not what is typically generated in the business environment;
  • Difficulty in working with documents which contain both SR&ED information and business information leading to conclusions that the taxpayer has claimed too broadly;
  • Lack of acceptability of verbal evidence;
  • Denial of payments for SR&ED performed on behalf of the taxpayer if no written contract exists, or if the contract is in the form of a purchase order;
  • Perceived pre-judging of the merits of the claim with the assumption that the taxpayer has claimed the entire business project not the SR&ED project; and
  • Insistence that only contemporaneous documentation is acceptable evidence.

For a taxpayer who is not well versed in the program and not represented by someone who is conversant in the SR&ED program, this can cause a major inequity both in the resolution of the claim and in the resources the taxpayer must apply to the claim process.

Lack of transparency

The current lack of consultation with industry combined with inconsistencies is leading to a sense of lack of transparency. Stakeholders' sense, or are given hints that there exist:

  • Unpublished interpretations or policy changes; and
  • Published CRA policy or guidance documents that either the CRA in general or specific reviewers consider to no longer be valid.

If the consultative committees were to be reinstated, or if taxpayers had access to head office, they could raise these issues on a timely basis and resolve them, or be directed to where they can learn more about the change. This sense of lack of transparency is heightened when:

  • The CRA does not disclose concerns to a taxpayer until a science report has been drafted. This delay in disclosing concerns may occur even if the taxpayer has asked if CRA has concerns throughout the review; and when
  • The CRA refuses to discuss issues with taxpayer until a report is drafted.

It is understandable that it is difficult for the RTA or the FR to raise an issue that could lead to disallowing ITCs to a taxpayer. However, by not bringing the issue to an open discussion, taxpayers are being denied a fair opportunity to address the issue by bringing relevant facts into consideration. Not communicating issues as they arise leads to a higher level of concern with regard to the issue, a longer review process and a reduction of trust.

Discouraging taxpayers from working with SR&ED consultants

We understand the CRA has experienced cases where they feel that the representative is creating a barrier between the CRA and the taxpayer. We agree that the CRA should have the opportunity to speak directly with the technical people involved in the work done when they are still available. Indeed, this is a best practice in reducing review times.

The SR&ED program has its complexities. The CRA frequently faces situations where the taxpayer has not differentiated between Research and Development and SR&ED. Many taxpayers have developed internal teams to prepare and defend SR&ED claims. The team members invest considerable time keeping current on the law and interpretations and often implement rigorous processes to identify, qualify and claim SR&ED. Not all taxpayers are in a position to invest the time and allocate the resources to fully comprehend the requirements of the SR&ED program and to keep up to date. As a result, these taxpayers may choose to rely on the use of external SR&ED specialists.

In many other areas of taxation, the CRA welcomes the participation of taxation specialists hired by the taxpayer (external representative), particularly where the taxpayer does not have sufficient knowledge of the legislation and interpretations relating to the issue under review. In fact, we believe SR&ED is the sole area of the Income Tax Act where the involvement of external advisors is actively discouraged by any CRA reviewers. By contrast, the CRA's assessing practices on transfer pricing issues, another area of the Income Tax Act that requires considerable judgement, is to fully accept and indeed expect input from a taxpayer's advisor. This is viewed not only as being fair to the taxpayer, but often expedites the resolution of issues and is consistent with CRAs Taxpayer Bill of Rights.

Unfortunately, there continues to be a significant number of situations across Canada where the CRA specifically recommends to taxpayers not to involve SR&ED specialists. These messages take various forms, from subtle to overt. Specific instances include:

  • refusing to speak with SR&ED advisors engaged by the taxpayer as the taxpayer's representative in a review meeting;
  • stating that the CRA does not want to work with the taxpayer's representative and recommending as a next step a settlement discussion with the taxpayer alone since involving the taxpayer's representative will make the process longer and more likely to create issues with the file;
  • Telling taxpayers that tax practitioners provide "no value added";
  • Not corresponding directly with the representative even when the taxpayer has specifically asked the CRA to do so; and
  • Notwithstanding the Guidelines to Resolving Taxpayers Concerns, management basically stands by the decision of reviewers regardless of the facts of the case.

For taxpayers who do not have sufficient knowledge of the SR&ED program, this represents a serious inequity. Some taxpayers take various steps to obtain support from their SR&ED specialists without having them present at meetings with the CRA for fear they will treated unfavourably by the CRA if there is an external advisor at the table.

Appendix A-2 [Return]

Inconsistencies in the administration of the SR&ED program Interpretation issues

Work performed by employees is considered SR&ED directly undertaken by the taxpayer, where the same work performed by a service provider for a taxpayer not considered SR&ED performed on behalf of the taxpayer

We have seen variations of what constitutes SR&ED based on who is performing the work. For example, under the proxy method, if a taxpayer is conducting SR&ED involving the development of a new tool in the automotive industry and the SR&ED requires an employee to polish a new tool to a specific "finish" so that it can be tested, CRA usually agrees that the employee is performing experimental development. However, if the taxpayer chooses to contract the polishing to an outside party, CRA no longer sees the act of polishing as "SR&ED". Various reasons have been given for this position including the rationale that the "contract" is not for "SR&ED" specifically and polishing is not one of the 8 types of support work denoted in paragraph (d). CRA has also stated that the work of the contractor could be included if the traditional method of claiming was used. In our view, work that is SR&ED will remain as SR&ED regardless of who is doing the work, how they are being paid and the claiming method elected.

Phase IV Clinical Trials

Work undertaken in Canada for Phase IV clinical trials can be eligible SR&ED work as defined in subsection 248(1). However, many CRA reviewers automatically take the position that all work undertaken in a Phase IV trial is not SR&ED. Rather than assuming this work is ineligible by its label, it is an important part in terms of equity to approach these projects as any other project and understand how the work performed does or does not seek to advance scientific knowledge and meet the definition of SR&ED. The automatic assumption that there is no scientific uncertainty in these trials is incorrect as the trials do fail frequently enough to demonstrate uncertainty exists. The fact that Health Canada requires these trials in many cases should also be treated as an indication that there is scientific uncertainty.

Support on support

Regulation 2900(2)(c) provides for directly related and incremental expenditures to be considered "directly attributable". The CRA has taken a position for directly related as follows:

The work performed by particular employee(s) or department(s) must connect with (i.e. "related to") and be done without an intervening step or intermediary between the employee/department (i.e. "directly") and,

  • the SR&ED work; or
  • the SR&ED staff; or
  • the machinery/equipment used by staff to perform SR&ED.

Examples of activities or expenditures denied under the "support on support" banner include:

  • Information technology (IT) support for a person directly engaged in SR&ED is allowed, but IT support for a person supporting the employee (support employee) directly engaged in SR&ED is not allowed. If the support person does his/her own IT support, the IT support is allowed.
  • Fringe benefits attached to the salary of a support person are considered support on support, on the basis that they are not directly related to SR&ED because the support person's salary stands between the fringe benefits and the person doing the SR&ED. For example, what is particularly offensive to taxpayers about this position is the fact that legally required wage levies on eligible salaries are considered ineligible on the basis that "they are not directly related".

In our view, the requirement of the intervening step or intermediary goes beyond what is intended or needed by 2900(2)(c) which is already a three-fold test: (i) the prosecution of SR&ED, (ii) directly related, and (iii) would not have been incurred if such prosecution had not occurred. It does not seem reasonable that the manner in which a company organizes its work (a business decision) should make a difference to whether or not the work is SR&ED. To add a fourth test "support on support" is unnecessary and onerous requirement that only creates administrative complexities.

Contract Payments

There is significant confusion regarding the interaction of sections 37 and 127 with respect to expenditures for SR&ED undertaken on behalf of the taxpayer and contract payments.

For the purposes of subsection 37(1) when two Canadian taxpayers enter into an agreement to have SR&ED performed in Canada and one taxpayer is paying the other taxpayer to perform the SR&ED then both taxpayers would have SR&ED expenditures. The performer can claim the salaries and other costs to do the SR&ED and the payer can claim the payment to have the SR&ED performed on its behalf. As section 37 does not provide for a reduction of eligible SR&ED expenditures by the amount of a contract payment, both taxpayers are entitled to a deduction under subsection 37(1). Contrary to statements made by some CRA reviewers, there are no requirements in the legislation with respect to ownership of intellectual property or taking on the economic risks.

However, one of the cornerstones of the SR&ED program is that there is to be no double dipping of ITCs and thus the contract payment provision was created in section 127. For the purpose of this discussion, the key point of the contract payment definition is whether the SR&ED was performed on behalf of a person entitled to a subparagraph 37(1)(a)(i) or (i.1) deduction. For whatever reason this concept of simply looking at whether the payer is entitled to a 37(1) deduction in order to ensure that there is no double dipping on SR&ED tax credits seems not to be considered by many taxpayers, practitioners, and CRA reviewers.

We believe that the CRA needs to review its assessing policy in this area. For example, many CRA reviewers seem to be primarily concerned about intellectual property ownership and the fact that funds were exchanged between two entities. We believe the correct approach would be first to determine the taxpayer's entitlement under subsection 37(1). The second step is to determine if there is a contract payment, the test being that the payer is entitled to a subsection 37(1) deduction.

From a practical point of view, a performer may not have all the information necessary to determine if a payer is entitled to a subsection 37(1) deduction or vice versa. One solution may be to amend the legislation to recognize an agreement between the parties stipulating who will be claiming SR&ED tax credits, and that such agreement be honoured by the CRA providing that this would not be a mechanism to transfer tax credits and would always be consistent with the substance of the transaction.

Appendix B - Definition of SR&ED - Analysis of paragraphs (e) to (k) [Return]

For greater certainty, exclusionary, a purpose test, or combinations thereof

The starting point in determining if particular work constitutes SR&ED is to determine if the work meets the requirements of the preamble and meets the definition of either (a), (b) or (c) or (d). We must then look further in the definition of SR&ED which reads as follows:

"... but does not include work with respect to

e) market research or sales promotion,

f) quality control or routine testing of materials, devices, products or processes,

g) research in the social sciences or the humanities,

h) prospecting, exploring or drilling for, or producing, minerals, petroleum or natural gas,

i) the commercial production of a new or improved material, device or product or the commercial use of a new or improved process,

j) style changes, or

k) routine data collection."

Many differences of interpretation arise from paragraphs (e) to (k) of the definition of SR&ED in subsection 248(1) of the Income Tax Act. It is difficult to understand if these paragraphs are "for greater certainty" or meant to specifically exclude work that would otherwise meet the definition of SR&ED either by its very nature or as a result of a purpose test, or combinations thereof.

For example, work which is market research or sales promotion as noted in (e) would not meet the requirements of the preamble or of paragraphs (a),(b), (c) or (d) because it would not seek a scientific or technological advance. Thus, paragraph (e) is for greater certainty, so that it is clear that market research is not SR&ED.

Similarly, "the commercial production of a new or improved material, device, or product, or the commercial use of a new or improved process" as described in paragraph (i) would not meet the requirements of the preamble or of paragraphs (a),(b), (c) or (d). Thus, paragraph (i) is for greater certainty, so that it is clear that such commercial activities are not SR&ED.

We believe that paragraphs (h) and (i) should also be interpreted as a purpose test. We believe the better view in interpreting the incentive is to encourage taxpayers to perform SR&ED including SR&ED in commercial settings. Achieving the economic benefits for Canada often requires taxpayers to follow through from laboratory experimentation to commercial setting experimentation. If the purpose of the production is for experimentation and it meets the requirements of the preamble and paragraphs (a),(b), (c) or (d), it is SR&ED (and not commercial production).

If the experimental development happens to create a product that is sold or can serve some other non-SR&ED purpose, the ITCs related to the property acquired are to be recaptured.

As a third example, we believe routine data collection as noted in paragraph (k) refers to the purpose of the data collection and not the manner in which the data are collected. The collection of data for SR&ED purposes, albeit the process of collecting the data may be routine, represents eligible work and is, in fact, specifically covered in paragraph (c) as a step in the process of experimentation (experimental development ) and also covered in paragraph (d) as "data collection". We do not interpret "data collection" in paragraph (d) as meaning data collected in an unusual manner (a process that is non-routine), but rather meaning data collected for SR&ED purposes. It is our understanding that taxpayers do not generally experience difficulties in reaching agreement with the CRA on the eligibility of data collection work.

As a final example, we believe that although there may be research in the social sciences or the humanities that could meet the requirements of the preamble and meets the definition of either (a), (b) or (c) or (d), paragraph (g) specifically excludes that work.

Interpreting paragraphs (e) through (k) with a view that the paragraph is "for greater certainty" is different than viewing them as "exclusionary" paragraphs. Using an exclusionary approach, work could be determined to be SR&ED because it fits under one of (a) through (d) but if one finds that it could also fit into paragraph (e) through (k), it is then excluded and it no longer can be viewed as meeting the definition of SR&ED. An example of this approach would be work that clearly met the definition of experimental development in paragraph (c) would be excluded if the experiment results in a salable product. CRA has taken the position that work can be both experimental development and commercial production and in the cases the exclusion applies and the work is ineligible. It is our view that the same work cannot be both experimental development and commercial production. Moreover, this is contrary to Application Policy 2002-02R2.

More than one third of companies surveyed expressed having experienced significant differences of opinion with CRA reviewers recently, mainly with science reviewers. Many CRA reviewers are interpreting the definition of SR&ED with the "exclusionary" approach mentioned above, while many assess from the perspective of "for greater certainty". These differences are prevalent enough to point to a fundamental difference of opinion overall. This is further supplemented by differences in interpretation from certain offices and even between different reviewers within the same office. Below are examples of inconsistent, yet recurring situations.

  • SR&ED performed on prospecting, exploring or drilling equipment using equipment and facilities that are in commercial use currently, or that may be in commercial use in the future, although recognised as eligible work under paragraphs (c) and (d) by the RTA is ruled as "excluded" because of paragraph (h), regardless of whether it is SR&ED performed in search of a technological advancement on the equipment or the process of prospecting, exploring or drilling. I t should be noted when RTA's take this position they are taking a position that is contrary to CRA's Application Policy 95-2.
  • After removing as many uncertainties as possible in a pilot plant, the work performed in continuing the experimentation to achieve success at a commercial scale by removing the remaining technological uncertainties. This scenario is often determined by the CRA to not meet the definition of SR&ED because the work involves producing a part or material on equipment that is hoped will eventually be used for commercial purposes, or because the work includes implementing a process that is intended to eventually be used for commercial purposes if successful. CRA is often only allowing the cost to perform the SR&ED which is incremental to the cost that would be incurred when the SR&ED is over and commercial production is underway. This is a model similar to "carve-out", and is applied by the CRA instead of allowing the work as SR&ED and applying recapture if and when the property is sold or converted to commercial use. Examples of this interpretation exist, even when the commercial scale experimentation failed in whole or in part. There is also often a very fundamental misunderstanding of the very real technological uncertainties in scaling up from a pilot plant to commercial production, and a tendency to deny the risks being taken. The denial is clear when opinions are voiced such as "The taxpayer would never have tried this at this scale had they not expected it to be successful".

Appendix C - Other legislative issues

SR&ED performed outside Canada

We believe the legislation should be amended to allow as an eligible expenditure under subsection 37(1) SR&ED performed by Canadian residents employees while they are outside Canada. This would also reduce a significant administrative burden for taxpayers and the CRA in keeping track on a daily basis of time spent inside Canada and outside Canada for a number of employees. It would also reduce the propensity of Canadian companies to hire/contract non-residents to perform the same work. This, in our view, would be a suitable balance to the current policy on taxable suppliers.

Taxable Supplier

Prior to the introduction of "taxable supplier" into the SR&ED legislation, it did not matter whether the SR&ED was done in Canada by Canadians or done in Canada by non-Canadians. In both cases investment tax credits were earned. Now and for about the last 10 years, expenditures for SR&ED paid or payable to, or for the benefit of a person or partnership that is not a taxable supplier does not earn ITCs.

Companies that have SR&ED done in Canada by non taxable suppliers are doing so for a reason and that reason generally will be because they are the best people to do the work or perhaps no Canadian resident taxpayer has the ability to do the work. Non taxable suppliers often transfer very valuable knowledge to Canadian companies when performing SR&ED in Canada.

To deny the tax credits for SR&ED done in Canada by non-taxable suppliers could be considered an impediment to Canadian SR&ED performers, particularly small and medium sized innovative companies, and could result in these companies not finding and utilizing the best available people to perform aspects of their SR&ED, particularly when the expenditure is sizeable for the taxpayer.

US foreign tax Credit

In certain situations involving foreign controlled Canadian corporations performing SR&ED in Canada, the net impact of claiming a SR&ED ITC in Canada is neutralized by a decrease in the foreign tax credit earned by the foreign parent. This will, unfortunately, also neutralize one of the policy intents of the SR&ED program which is to attract/ increase the level of foreign investment in SR&ED performed in Canada. Ernst & Young supports some of the previously suggested initiatives to resolve this inequity, namely:

  • The creation of an alternative refundable wage credit, possibly at a lower rate, where the taxpayer could choose between the wage credit or to carry the non refundable SR&ED tax credit forward or,
  • The option to apply SR&ED ITCs against payroll taxes, as opposed to Federal Part I Tax.

Government assistance

The definition of government assistance has been in place for over 20 years and CRA's administration with respect to the forgivable loans component of this definition has basically remained unchanged. Generally speaking, CRA has always taken the position that forgivable loans are loans that are contingently payable. There was a time when it was the norm that government assistance for SR&ED to be repayable conditionally upon the taxpayer meeting certain revenue expectations based on the success of the SR&ED. Now, in many cases, the structure of these agreements between the government and taxpayers has changed such that, for example, the funds are repayable based on the results of a currently successful business and not on the success of the SR&ED. In these cases, there is little doubt that the funds will be repaid. We recommend that the government reconsider its position with respect to government assistance.

It should be noted that in situations where companies would have been entitled to a section 127.1 refund for the year in which the expenditure was incurred this issue is more than a timing difference as refunds will not be generated in the years the funds are repaid. Also, in the case of some of the provinces, the repayment of the funds results in no provincial SR&ED assistance.

As a last note, we suggest that CRA's position that government assistance also includes assistance provided by foreign governments be reviewed. This seems to be inconsistent with the fact that payments from foreigners are not considered to be contract payments.

Enhanced, fully refundable ITC for SR&ED performed in collaboration with Universities

In order to better leverage Canada's Public Sector R&D by increasing collaborations with the private sector, we would like to propose an enriched, fully refundable credit for University and Public Institute Research.

Acknowledging that there is less of a profit element in university research contracts than in the private sector, the Federal Government could implement a program similar to the ones found in the provinces of Québec and Ontario who each have an enhanced credit for universities and other public research institutes.


On the GST / HST side, it has been argued that, with only partial Input Tax Credits, Institutional research is unfavourably treated compared to business research when applying the GST HST rules A relatively simple legislative change could be to allow SR&ED work performed within public research organizations to benefit from the same GST / HST treatment as those performed in the private sector.

T661 and traditional method expenditures

Among other things, the T661 is used to report and calculate SR&ED expenditures. However, there appears to be an anomaly in the T661 in that there is no line item for Regulation 2900(2)(b) salaries where an employee directly undertakes, supervises or supports the prosecution of SR&ED. Form T661 has only a line item specific to salaries for employees who are directly engaged in SR&ED. Given that 2900(2)(b) salaries are broader than directly engaged salaries we suggest that the CRA clarify how to report the former category of salaries.


1. The assumption that technological change was exogenously determined was a core assumption used by Neo-classical growth theories.  [Return]

2. The two articles that launched the New Growth Theory were titled "Increasing Returns and Long-Run Growth" (Journal of Political Economy, 1986) and "Endogenous Technological Change" (Journal of Political Economy, 1990). [Return]

3. See Bradford DeLong, "Endogenous Growth: Economic Theory and Faster Growth", Mimeograph, April 29, 1996. [Return]

4. Examples of social benefits include knowledge spillovers and the creation of second and third tier services and manufacturing activities that support technological progress. The net benefit of a R&D tax incentive ultimately depends on the relative magnitude of the social benefit in comparison to the costs associated with the incentive. [Return]

5. This may also be an ideal time to raise an RC59 to reduce delays in the review process. [Return]

6. We suggest dealing with excluded corporations in section 127. [Return]

7. Measured as the increase in a year over the average SR&ED expenditures of the three previous fiscal years. [Return]