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PARTEQ Innovations Submission in Response to Joint Finance Canada Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:

November 28, 2007

Ms. Nancy Horsman and Mr. Peter C. Armstrong
Joint Finance Canada – Canada Revenue Agency SR&ED Consultations
140 O'Connor Street
Ottawa, Ontario K1A 0G5

Dear Ms. Horsman and Mr. Armstrong:

On behalf of PARTEQ Innovations, the technology transfer office for Queen's University, I am pleased to provide the enclosed submission for the public consultation process on the SR&ED program being undertaken by the Department of Finance and the Canada Revenue Agency.

Over the 20 years PARTEQ Innovations has been commercializing the intellectual property owned by Queen's University, our 40 spin-off companies have raised over $703 million in investments and created more than 500 jobs in Canada. The SR&ED program has been an essential source of non-dilutive financing that augmented private investments and helped to bring Canadian university research to the international market.

While our spin-off companies, investors, and Queen's University have significantly benefited from the SR&ED programs, there are a several changes that could be made to the SR&ED program to further encourage investment in Canada's research and development companies.

Thank you for allowing us an opportunity to participate in your public consultation session in Toronto and to submit our opinions for a stronger SR&ED program that will benefit all Canadians.

We are granting you permission to post our submission on the Department of Finance website.



Paul Vickers

A) How do the SR&ED tax incentives affect the performance of R&D in Canada, and how can they contribute to increasing private sector investment in R&D?

The SR&ED tax incentives are an essential component in helping to successfully advance early-stage university research from the labs to the marketplace. Almost every one of the forty spin-off companies PARTEQ Innovations has formed over the past twenty years has utilized the SR&ED programs to finance research and development in intellectual property licensed from PARTEQ Innovations and Queen's University.

Some of our notable successes with advancing university research with the assistance of the SR&ED programs include:

Neurochem Inc., a publicly traded pharmaceutical company with product candidates in clinical development for amyloid-related diseases and disorders of the central nervous system.

Performance Plants Inc., a plant biotechnology company focused on the modification of plant metabolism to enhance crop protection and increase yields.

Cytochroma Inc., an applied genomics and drug discovery company with applications in the treatment of cancer, bone disorders and skin diseases.

Datec Coating Corporation, an advanced materials company specializing in the development and application of a unique ceramic coating process for heating elements in domestic appliances and for non-stick surfaces and electrical insulation.

The SR&ED programs help to keep our spin-off companies in Canada when they attract foreign investment. Without the SR&ED tax incentives, foreign investors would have insisted in moving a number of companies, and many jobs, to foreign jurisdictions.

Investing in university spin-off companies is inherently risky. The SR&ED programs encourage investors, particularly angel investors, to invest in these risky ventures as their investment will leverage these programs and provide the company with an incremental 40% to 65% of non-dilutive and non-repayable cash flow on their investment.

Abolishing, or reducing, the enhanced tax credit rates will negatively impact the ability of early-stage spin-off companies to raise capital. Along with the loss of investment, the companies will reduce their hiring of highly skilled professionals and delay the launch of their product. The risk of the company failing to reach successful commercialization is significantly increased if there are negative amendments to the SR&ED programs.

B) Are there features of the SR&ED tax incentives that impede the growth of small and medium sized innovative Canadian companies, and how?

With a limited supply of Canadian venture capital, many of our spin-off companies must look to US venture capital to fund their research and development. This usually results in the US investors having control of the spin-off company, and as such, the spin-off company loses its Canadian Controlled Private Corporation (CCPC) status and access to the enhanced ITC rates. One of two events inevitably happens: The spin-off company spends $50,000 to $100,000 in professional fees to implement a complex legal structure that allows for US foreign investment and retain the enhanced ITC rates; or the spin-off company is moved to the United States.

As there are legitimate ways of having foreign shareholders and retaining the enhanced ITC rate, the SR&ED legislation should be amended to allow for this to be easily achieved without spending an excessive amount on legal and accounting fees. As long as the research and development activity is being under taken in Canada (a current requirement of the SR&ED legislation), the ownership composition should be irrelevant.

Tying the enhanced ITC rate threshold to the CCPC status is not enticing foreign investment in Canada, and is encouraging foreign investors in Canadian companies to move the spin-off company to another jurisdiction. If the objective of the enhanced ITC rate is to provide an enhanced benefit to small and medium sized businesses, a different threshold should be considered, such as number of employees or size of the asset base. With many US states and other countries providing their own R&D incentive programs, the base ITC rate is not as a compelling reason to stay in Canada as it was 20 years ago.

C) How could more private sector R&D be leveraged?

There are many times that our spin-off companies need to access the expertise of non-Canadian consultants because the required service is not available in Canada, such as certified labs, clinical testing, and best-in-class experts. Unfortunately, non-Canadian consultants are not eligible for SR&ED tax credits. In today's global economy, this restriction should be revisited, otherwise, Canada is at risk of seeing these companies move to countries that provide the required services. Furthermore, Canadian companies should not be penalized for seeking the foreign services they require to become a Canadian success story.

To encourage public-private R&D collaborations, the Federal Government should consider implementing a program similar to the Ontario-Business Research Institute Tax Credit (OBRITC). The OBRITC program provides a 20% refundable tax credit (incremental to the 10% Ontario Innovation Tax Credit) on eligible contracts with eligible research institutions. Enhancing the OBRITC program with a Federal incentive will encourage more companies to partner with our leading research institutions. When implementing this program, care should be taken to ensure spin-off companies who are partly owned by the research institution are eligible to participate in the Federal incentive.

The current $2 million expenditure limit for refundable tax credits has not changed since the formation of the program 20 years ago and has not kept pace with the increasing cost of carrying out R&D. Small CCPCs earn an insignificant 8% refundable tax credit on expenditures over $2 million (versus 35% on expenditures below $2 million). As many of our early-stage companies require several years to commence profitable, and hence taxable, operations, the non-refundable ITC component is largely irrelevant when deciding to carry out the R&D in Canada or another jurisdiction. To reflect current economic conditions of conducting R&D in Canada, the expenditure limit should be increased to $10 million.

The start-up phase of spin-off companies usually involves the purchase of capital assets to be utilized in the performance of R&D. Under the current legislation, tax credits earned on capital expenditures are 40% refundable, compared to 100% refundable for current expenditures. To encourage small and medium size companies to invest in R&D assets, the refundable rate should be changed to 100% for capital expenditures below the expenditure limit.

It is counterintuitive for the Federal SR&ED tax incentives to be reduced by the provincial incentive for R&D. The Federal and Provincial governments should be working together to encourage private investment in Canada's R&D companies, and not be penalizing the good intentions of a provincial program at the federal level. By not reducing the federal incentive by the provincial incentive, Provincial governments will be more likely to increase their incentive programs.

To ensure Canadian companies reap the financial benefit of their R&D efforts, patent protection is essential. Otherwise, foreign competitors will exploit to their financial benefit Canada's technology advancement. As patent protection is a necessary expenditure to protect the company's R&D assets, patent protection in all jurisdictions should be included as an eligible expenditure for SR&ED purposes.

D) Given the improvements already implemented or under study, how could administration of the SR&ED tax incentives be further improved and their complexity reduced?

Overall, we are pleased with the administration of the SR&ED program. SR&ED auditors are responsive to our operating and business environment, and where possible, assist us with increasing our claims.

We encourage Canada Revenue Agency not to centralize the auditing process at large tax centres or increase the administrative filing burden on claimants.