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Canada's Life and Health Insurers' Submission in Response to Joint Finance Canada – Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:
We have prepared this paper in response to the request for submissions issued by the Honourable Jim Flaherty, Minister of Finance, and the Honourable Gordon O'Connor, Minister of National Revenue on how to make the scientific research and experimental development (SR&ED) incentive program more effective for Canadian business and to allow it to play an even greater role in fostering a more competitive and prosperous economy. We believe that the SR&ED program is an important tool of the federal government to promote R&D in Canada.
Life and health insurance companies, and more generally the financial services sector as a whole, have been and continue to be leaders in the development of computer software to provide innovative products and services to our clients in a competitive marketplace. Financial institutions have consistently made enormous investments in technology development as it is an integral part of our business operations. This sizable expenditure represents a significant segment of the Canadian economy. Through these development efforts, we have significantly advanced technology and fostered innovation. Of equal importance is that these efforts create rewarding careers for highly skilled professionals, which allows companies to retain valuable talent within Canada.
Importance of Technological Development to the Financial Services Sector
In today's global market place, Canadian financial institutions must compete globally to be successful. At the same time, we recognize the strategic advantages of remaining in Canada, advantages that are made available through programs such as the SR&ED credit. This program becomes even more critical as other regions of the world compete for the same technology expenditures and the same human resource talent. The SR&ED credit is a significant and often powerful incentive for financial institutions to retain their technology development in Canada when there are many offshore alternatives that provide very competent service. The financial incentive of the SR&ED credit plays a very important role in an extremely competitive financial services market place where cost leadership is not only a profit motivation, but a survival imperative.
Our submission focuses on three areas:
- Increasing access to the benefits for all companies
- Modifying the current definition of SR&ED
- Reducing the compliance burden and ensuring consistent administration.
The current two tier system provides refundable credits at the rate of 35% for Canadian controlled private corporations and non-refundable credits at the rate of 20% to all other corporations. One of the stated objectives for the SR&ED program is to provide incentives which as much as possible are of immediate benefit. We believe that the current system with its restrictive ownership limits; low SR&ED expenditure limit ($2,000,000); taxable income and taxable capital limits needs to be radically revised in order for the objectives of the program to succeed.
We recommend creating a new three tier system:
- We propose that the government eliminate the current ownership restrictions; the taxable income and taxable capital limits; and raise the expenditure limit to $10,000,000. This would have the effect of making high rate credits (35%) refundable to all corporations without the current ownership restrictions on the first $10 million of SR&ED spending per annum.
- We believe that the SR&ED work is no less valuable to the economy if it is undertaken by non-CCPC as compared to a CCPC and that the other restrictions add complexity to the system and cause companies to take actions that they would not otherwise have taken to stay within these limits in order to access the refundable credits. Our proposal will allow companies to take sound business decisions and not ones motivated by retaining the refundable credits so necessary to their cash flow.
- Further we propose that to the extent that corporations incur SR&ED expenditures in excess of $10 million per annum, credits will be earned at 20%. However, if the credits are not used to offset taxes payable, the additional credits will be refundable within limits. The limits could either be a dollar amount such as in France where up to ‚¬16 million of R&D credits are refundable by the government if the taxpayer has not utilized its credits within 3 years. Alternately, the limit, which we prefer, would be to allow the SR&ED credits to offset against another pre-tax levy such as the employer's portion of employment insurance premiums.
- Currently, companies in a loss position and certain of those with foreign parents with foreign tax credit systems are unable to get immediate benefit from the credits. Hence, the credits are either ignored or discounted completely in planning a company's R&D investment. Increasing refundability will eliminate these issues for loss making companies and for Canadian subsidiaries of U.S. parents (since in the U.S. refundable credits do not reduce the quantum of Canadian tax credited on the distribution of earnings to its U.S. parent).
- Low rate (20%) non-refundable credits would continue to be earned for SR&ED expenditures over and above the refundable credit limits.
The new three tier structure will eliminate some of the current inequities in the SR&ED program and will stimulate additional R&D investment in Canada.
Modifying the Definition
The bulk of SR&ED undertaken by life and health insurers is in the field of computer software. There is extensive guidance issued by the Canada Revenue Agency in this area. This guidance focuses on eligibility in the field of computer software as being based on the search for a technological advancement and the attempt to resolve technological uncertainties.
CRA's Software Guidance states:
"Projects aimed at developing the initial release of saleable software which is "leading edge" in some technological way are often largely eligible. To develop software at the leading edge of today's technologies generally requires the developer to come up with new constructs, such as new architectures, algorithms or database management techniques (i.e., make Technological Advancements), and there are then specific uncertainties as to the viability of these (i.e., Technological Uncertainty). If the software's competitive edge stems from advance in an area other than technology, such as business management, or improvements in financial management techniques, the project is unlikely to be eligible. Almost any software developed for sale is developed systematically and the uncertainties are systematically resolved (i.e., Technical Content).
Nevertheless, since some saleable products are simply the adaptation of established software or known developmental techniques to new situations the taxpayer must specifically identify the Technological Advancement and the Technological Uncertainties to successfully make a claim. He must have some evidence that shows that the development systematically approached problem identification, solution evaluation and testing. He should clearly state at what point in time the project was complete i.e. when the Technological Uncertainties were resolved and a Technological Advancement was consistently demonstrable or when the project was abandoned. Simply claiming that he was "developing new saleable software" does not validate his claim. Similarly, new or novel functions or features that the software provides to end-users do not alone establish eligibility, because novel features and functions can be developed to provide a commercial advancement without attempting a Technological Advancement or encountering Technological Uncertainties."
We submit that this interpretation favours high-tech companies which are developing products for sale. We submit the above should not be the only criteria for determining what SR&ED is and what is not. An alternate definition could be one similar to the one used in the United States which focuses on the following criteria:
- Is the work technological in nature and:
- Is the application intended to be useful in the development of a new or improved business component of the taxpayer and;
- Do substantially all of the activities undertaken constitute elements of the process of experimentation?
We believe that taxpayers should be encouraged to develop new and innovative functionality, products and services through the SR&ED program. The development of new and innovative functionality, products and services has as much value, if not more, to society than the types of work currently allowed as eligible SR&ED.
We submit that by changing the focus of the SR&ED program, taxpayers undertaking computer software development will be on an equal footing whether they are on the forefront of technological advancement or they are developing innovative products and services for their customers, which in turn improves Canadian productivity, and ensures the success of Canadian businesses, which in turn maintains jobs in Canada.
Reducing Compliance Burden & Ensuring Consistent Administration
The current administration of the SR&ED program by CRA has resulted in a significant increase in the cost of compliance for financial institutions. For example, increased requests (demands) for more detailed supporting documentation including specific SR&ED documentation has required a significant investment of time especially when the SR&ED claims had been filed in a previous year. CRA must understand that industry does not generate specific SR&ED documents and that CRA should rely on documents that are created as part of company's normal business practice. Publicly available documents on the CRA website that describe the SR&ED program, which companies rely on for SR&ED submission purposes are not being followed by certain CRA reviewers. Companies are being told that these no longer apply and if this is the case, it should be communicated to the public and the documents should be removed from the website. The lack of consistency and predictability in assessing the SR&ED submissions across the country has resulted in companies withdrawing from the program (again) as the cost of compliance is too high. As we noted earlier, these incentives are key for financial institutions retaining highly skilled information technology work and resources in Canada. If these administrative problems in the delivery are not corrected, Canada will potentially lose this work to offshore organizations.
Increasing immediate access to the SR&ED program tax incentives, modifying the definition of SR&ED, and reducing the compliance burden and ensuring consistent administration will stimulate further R&D investment in Canada with all of the attendant positive spill over effects to the economy.