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PC Private Sector Submission in Response to Joint Finance Canada – Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:
Improving the Scientific Research and Experimental Development Tax Incentives
We are responding to the government of Canada's consultations on Improving Scientific Research and Experimental Development (SR&ED) Tax Incentives as citizens who share a strong commitment to the SR&ED Tax Credit Program's integrity and its future success. Formerly, we were the private sector members of Canada Revenue Agency's ("CRA") "Partnership Committee" on SR&ED. Although the SR&ED Partnership Committee was discontinued in 2006 as a cost cutting measure, the private sector members have continued to meet on our own time and at our own expense to exchange information and points of view.
It is important to note that this response does not necessarily represent the views of companies or other organizations to which the individuals belong. Rather, it represents the views of a dedicated group of individual concerned citizens who have been intimately involved in improving the delivery of the SR&ED tax credit program over the course of many years. We are drawn from a wide range of industries and the professional community of advisors through to program claimants and we are deeply concerned about the current administration's impact on the future of this important program. Therefore, we are pleased to have this opportunity to share our views with the government of Canada and with other Canadians.
Our responses to the consultation questions are as follows:
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?
We believe that the SR&ED Tax Credit Program has been shown to be Canada's most important R&D incentive for small, medium and large businesses all across Canada. We also believe that it has been and continues to be a highly successful program that delivers on its objectives both financially and in numerous other ways that are often difficult to measure and not always reflected in the measures defined in the government's consultation paper.
We are of the view that the consultation paper significantly underestimates the financial returns of the SR&ED tax credit program. We note that the parameters and proxies used in the determination are deliberately conservative. Despite this, the results of the assessment continue to show that the program is justified financially on its own merits.
However, in our view this basic assessment is only a starting point. It is one thing to try to measure the increase in R&D resulting from incentives, but it is quite another to try to measure the decline in R&D that might occur without the incentives. Preserving and encouraging the level of R&D performed by Canadian companies is every bit as worthy as providing incentives to encourage companies to conduct new R&D.
Clearly, overall economic impact is an important benefit of the program too. Yet, the increased success of companies that is derived through the innovations that are commercialized from R&D that was made possible by tax credits cannot be directly measured and linked to the R&D tax credits in any way that we know. None-the-less, we are aware of many examples where this has happened. In this respect, it is important to recognize that it is this economic end result of R&D that is the true objective of the incentive program, not just the level of R&D itself.
The tax credits are also extremely important to large multinational companies, both those based in Canada and those based elsewhere with operations in Canada. It is a well known fact that many large companies compete internally for the privilege of conducting R&D in the many individual countries in which they operate. This R&D incentive provides an advantage to the respective business units and to the economies of the countries that win this work. In this respect, the SR&ED tax credits are a powerful tool for those individuals who work to bring this R&D to Canada. There are countless success stories that highlight this clear benefit.
Regardless of how it is measured, we strongly endorse the federal government's stated support of continuing this investment in Canadian research and development. In particular, we fully endorse the need to increase basic and applied research, as well as experimental development especially in science and technology, as an essential component of Canada's future economic well-being, and we believe that SR&ED Tax Credits are one of the most important and most effective ways to do that.
B) Are there features of the SR&ED tax incentives that impede the growth of small and medium sized innovative Canadian companies, and how?
There are many features of the current program which impede the success and growth of Canadian SME's. But it is important to note that a large number of these also impede the success of large companies too.
Industry concerns about red tape, complexity, consistency, frequent policy changes, failure to communicate policy changes internally and externally, and lack of certainty are well known and have been raised by many groups over many years. Small and medium sized companies are particularly challenged to describe their activities in the context of SR&ED eligibility criteria and the translation from business context to technology context is an issue. Lack of consistency in the administration of the program itself also leads to inconsistent results in claims and makes it difficult, if not impossible, for companies to depend on the SR&ED tax credit as part of their growth plans.
We expect that other submissions will describe a great many issues in this area in much greater detail. However, we are aware of some specific indicators of new emerging issues which indicate that a serious review of the program administration and operation is timely. These include:
- Publicly available policy documents, upon which taxpayers depend for guidance, are not being followed by all CRA reviewers. CRA SR&ED program staff state that some or all of these policy documents no longer apply or will soon be cancelled. This trend has significantly increased the cost of compliance and has resulted in taxpayers leaving the SR&ED program. Some reviewers have a poor understanding of national policy issues.
- Concerns that changes to policies are being made behind closed doors as opposed to the open, transparent and consultative method that had been in place (many of the currently existing policy documents were developed with a broad consultation between both the CRA and industry).
- Significant differences in assessing practices from one Tax Services Office to another which leads to a lack of trust in the administration of the program in general.
- Growing demand for ever more documentation and also more SR&ED specific documentation.
- Internal and external training for CRA RTAs and financial reviewers is becoming insufficient which has a very direct impact on consistency and the increased cost of compliance.
- Use of science/technical consultants, who have not received the same training courses (i.e., internal CRA RTA training) as CRA's own RTAs and are therefore more likely to render an inconsistent opinion. This is exacerbated in some cases, where the untrained consultants are used to train CRAs' RTAs.
- Use of regional tax and other conferences to announce SR&ED administration policy changes and not communicate these changes to the rest of the country.
- Refusal to grant claimants the right to a second technical opinion.
Last but not least, we believe that changes in the CRA headquarters SR&ED Directorate's willingness to work with the private sector have effectively hobbled any ability to make the kind of ongoing continuous improvements to the program's delivery that are so essential in the globally competitive world in which Canada competes, and this makes it very difficult to respond to the rapid changes that all Canadian businesses (small and large) face.
C) How could more private sector R&D be leveraged?
Regulatory changes to leverage more private sector R&D were beyond the scope of our primary mandate as members of the Partnership Committee which was focused on improving the delivery of the program under existing regulations. None-the-less, our familiarity with the program policies and objectives, and our many discussions with users of the program have provided us with some insights into possible improvements for consideration.
1. Allow as eligible the Canadian costs of qualifying SR&ED performed outside Canada by Canadians working as part of an overall SR&ED project in Canada.
2. Include various aspects of patenting intellectual property and participating in standards setting as eligible activity where the goal is to entrench SR&ED supported IPR in international standards.
3. Improve the definition of eligibility for SR&ED activities that are conducted as part of a business's commercial activities. This is the source of considerable disagreement among reviewers in the field – especially when the activities are process related.
4. Increase the annual $2.0 million SR&ED expenditure limit for qualifying corporations.
5. Many companies have expressed an interest in extending the refundable SR&ED program to public companies meeting the current income and capital tests. Recognizing the implications from a financial exposure perspective, some have suggested that companies not eligible for refundables be permitted to apply their credits to employer-related taxes and charges other than income tax such as EI, health levies, etc.
6. Consider allowing companies who are engaged in a contract with another company to formally designate which party has the right to claim the R&D performed under the contract.
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?
There are some obvious and easy ways to improve the administration of the program, and we believe that improving the administration will inherently reduce its complexity and the related cost of compliance. We are hearing about the problems identified in question b) above and a plethora of others with ever more increasing frequency and we are very concerned that the administration of the SR&ED Program is returning to a period of inconsistency and lack of transparency similar to that of the 1990s. The administration of the SR&ED program is working increasingly against the incentive philosophy which is at the core of the program. The program administration is building disincentives to its use for those to whom the program is targeted. History is on the verge of repeating itself.
A decade ago, this vital SR&ED tax credit program was in jeopardy with serious and wide-spread industry concerns about the delivery of the SR&ED Program. In response, the Federal Government hosted a Minister's Conference in 1998 where industry and government jointly developed an action plan to:
- resolve outstanding problems,
- develop new processes,
- restructure the administration,
- build an effective "client focused" culture in the agency, and
- put a continuous improvement process in place to ensure the program's ongoing future success.
The foundation of this action plan was a private/public partnership focused on joint improvement of the delivery of a science and technology based incentive program. This partnership has been exceptionally successful. The delivery of the SR&ED Tax Credit program was restructured and revitalized. The vast majority of CRA field staff embraced the concept of partnership at all levels and, having been empowered to deliver an important client oriented incentive program, have been doing an outstanding job. The results have been recognized by all parties concerned and pre-98 complaints virtually disappeared. We believe that the client survey that has just been completed reflects the success of these past efforts.
Unfortunately as outlined in our response to question "b)" above, we are concerned today that the light of the SR&ED Program does not shine as brightly as it did only a few years ago.
In our view, some senior Canada Revenue Agency executives have remained resistant to the concept of partnering with the private sector and have taken deliberate steps to dismantle the partnership and its influence on the delivery of the program. Without any broad consultation with stakeholders, CRA has taken the position that this is their program alone and that they will run and deliver it in accordance with other existing tax audit models. They seemunwilling to allow this incentive program its intended place as a key driver in our efforts to make our country a global leader in innovation, to improve Canadian society and help move Canada to the forefront of innovative nations. Over the course of the last two years the Executive Management of the Canada Revenue Agency has systematically disassembled the structure that was put in place by the partnership. The key technical staff has been methodically removed and the program has been re-aligned to be consistent with the agency's culturally inherent audit mentality. This is the same audit mentality that was the basic recognized problem during the pre-1998 problem period.
During this process, CRA executives clearly stated that CRA has no vested interest in the success of the program itself and has no responsibility to follow policy directions given by political leaders. Even the use of the word "client" has been replaced by the word "taxpayer" in order to preclude any obligation to look after the best interests of program participants. Our experience has shown that continuous improvement has required integrated field and stakeholder engagement. CRA's rejection of any partnership with the private sector makes it next to impossible to ensure that the program can continue to respond with agility to the changing needs of Canadian Business, or to ensure that the program does not increasingly fall short of its real potential to build Canada's future competitivity.
Most recently, a full scale effort has also been undertaken by CRA to reverse many of the improvements that were made over the course of the last decade. Ostensibly, these steps were takenin reaction to recommendations of the recent Gomery report. However, very few of these new directions closely resemble Gomery's recommendations. The new direction seems more likely to entrench the very concerns expressed by Gomery – namely a significant lack of transparency and an unwillingness to work more closely with the private sector. We are deeply concerned that this new direction works against the need to improve the SR&ED Tax Credit Program, and that it will have significant negative consequences to Canada's future economic health and prosperity. In our opinion, Gomery was only a convenient excuse for CRA to return to the culture of audit and enforcement that is culturally inherent in an agency whose primary mandate is tax collection. If the program is to be an effective incentive to industry to increase "innovation and R&D" and achieve the program's objectives, it must operate in a manner consistent with this intent.
For all the many reasons above, we have come to believe that SR&ED tax credits can only reach and maintain optimum effectiveness if the program is delivered by a stand-alone organization that understands and values the incentive character of such a program and who makes it an integral part of their primary mission to work with the program's clients to help them achieve the desired outcomes. This can and has been done in other countries.
None-the-less, there are several opportunities to improve the administration regardless of the authority that delivers it. For example:
1. Hold another Minister's Conference to build a consensus on a path forward and re-open regular on- going consultation with industry in some form. This might not be a re-incarnation of the Strategic Steering Committee or the Partnership Committee, but regular ongoing overview with the private sector is critically important to continuous improvement and the overall success of the program. The process of developing and reviewing policies must be transparent. Companies need to know which existing policies still stand, which are being reviewed, and which are being discontinued. As this is being written, CRA cannot even decide if experimental production exists or not. Claims by some companies are being accepted and some are being rejected.
2. Given that the SR&ED Investment Tax Credit Program is science based, we believe that the Headquarters function should be led by a technical management team and technical leader with significant experience in science & technology and its application.
3. Re-instigate the NTSS structure with a responsibility for consistency.
4. Re-instigate joint training of CRA / Industry (which could include pre-training CRA before joint training).
5. Deliver on the government's commitment to provide an industry ombudsman for CRA.
6. To maintain a more "even keel", we would recommend that Finance, the "owner" of this program, be an active participant in the ongoing consultation process that is created.
In conclusion, we believe that the SR&ED Program is Canada's leading vehicle for supporting industrial R&D, and we applaud the government's efforts to open a new dialog with stakeholders of the SR&ED tax credit program. We are confident that these stakeholders have a strong mutual interest in working together with government to ensure its effective delivery. At risk is nothing less than Canada's position in a competitive world economy, since frustration on the part of claimants can easily lead to loss of public confidence in the SR&ED Program.
Therefore, it is our sincere hope that this consultation process will provide an opportunity to put us all back on a path toward rebuilding and success of the program to the benefit of Canada. In this respect, we trust that our views will be useful in the process of delivering on the objectives of this consultation process, and we hope that our blunt approach to dealing with the issues that we have raised will be accepted in the spirit in which they were provided – namely the best interests of Canada and Canadians.