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Forest Products Association of Canada's Submission in Response to Joint Finance Canada Canada Revenue Agency Consultation Improving the Scientific Research and Experimental Development Tax Incentives:

SR&ED Review
FPAC Submission

November 2007

Executive Summary

The Scientific Research and Experimental Development (SR&ED) is a valuable program that creates meaningful incentives for private industry to invest in R&D and experimental development. In the forest products industry, it supports industry contributions to FPInnovations, which conducts commercially oriented research on behalf of the forest products industry. It also supports research conducted directly by companies to develop new products and processes.

The major flaw in the SR&ED program as it currently exists is the lack of refundability. Non-refundable credits, provided to most claimants, are of no immediate benefit to companies during unprofitable periods. For industries like forest products, which is in the midst of a period of structural and cyclical economic pressure, the need to innovate is, arguably, even greater. For companies that cannot take advantage of the credit, the incentive provided by the SR&ED is diminished, which has the perverse impact of reducing the incentive for those companies who need it the most. FPAC therefore recommends expanding refundability to all claimants, subject to an appropriate limit, as a key reform to strengthen the program and enhance Canada's innovative performance. This can be implemented in cost effect manner, while also allowing for the use of accumulated unutilized credits.

Canada's forest products industry is suffering through an unprecedented prolonged downturn brought on largely by a rapid appreciation of the Canadian dollar, compounded by specific market factors. As a result, companies have experienced extreme pressures on cash flow and investment. Their capacity to maintain R&D activities have been tested to their limit and research and development (R&D) programs are in jeopardy. Reduced R&D activities will have a long term impact on future productivity and competitiveness, and put at risk the industry's core innovative capacity in Canada.

The administration of the program is also of concern to the forest industry. Our members are experiencing considerable inconsistency in claim reviews from year to year and from one claim to another. The pulp and paper sector worked with CRA for 3 years to jointly develop a sector specific guidance document. While this process provided some benefits, the implementation of the guidance document has been inconsistent. It is recommended that CRA take action to improve program administration and to bring the administration consistently in line with the agreed upon principles outlined in the pulp and paper guidance document.


Canada's forest products industry is facing both structural and cyclical challenges. On the structural side, intense global competition from new competitors in South America and Asia, changing demand patterns in North American paper markets as a result of the proliferation of electronic communications technology and a capital stock that requires urgent renewal are creating intense pressure for restructuring and renewal. On the cyclical side, the dramatic slowdown in the U.S. housing market has put pressure on the solid wood industry. Both cyclical and structural factors are exacerbated by the rapid rise in the Canadian dollar.

The appreciation of the Canadian dollar has been the single most important factor leading to rationalization in the industry. The higher dollar has a direct downward impact on margins with consequential pressures on cash flow and capital investment. Major input costs for Canadian forest products producers, by contrast, are priced in Canadian dollars and do not adjust rapidly to exchange rate fluctuations. For some inputs, like energy, fibre and transportation, prices are rising which compounds the impact of a higher dollar. Aside from the obvious impact on companies' operating cost structures and profitability, their capacity to maintain R&D activities is put in jeopardy, putting future productivity and competitiveness at risk.

In this context, the review of the SR&ED program is very timely. FPAC recommends changes both to program policy and administration.

Policy Issues: The Case for Refundability

While Canada has a long history of global leadership in innovation in the forest sector, there is evidence to suggest that the industry is falling behind its leading competitors in R&D. The traditionally fragmented industry structure, dictated by federal and provincial policies, has imposed a comparative disadvantage on the Canadian industry. Larger companies, more common in competing jurisdictions, are better able to manage the risks and capture the benefits of product and process innovations.

In addition, the emergence of countries like Finland as leading global competitors and innovators in the global forest and paper industry has been attributed not just to the emergence of global-scale forest products companies within the country, but also to the competitive strength of its equipment supply sector and broader forest products industry cluster. By contrast, Canada's traditional status as a major supplier of machinery and equipment to the global industry has eroded substantially, particularly in the case of the pulp and paper sector.

In order to capitalize on emerging growth opportunities for Canada in the global forest products industry, the industry must be at the forefront in the development and early deployment of new technological innovations of the bio-economy of the 21st century, such as bioenergy, nanotechnology, and biorefining. Accelerating its R&D activities is an obvious critical element to its success. R&D activities very frequently involve use of the production equipment, which represents considerable cost and risk to individual mills and companies. The SR&ED program plays an important role in mitigating this risk, and assisting companies to advance an innovative agenda.

There is a major flaw in the current SR&ED tax credit program that seriously limits its potential effectiveness. On the surface the program looks generous. But a more fundamental review uncovers a serious shortcoming for a broad array of claimants. For most companies, credits are non-refundable, which carries no immediate benefit when companies need it most – during unprofitable periods, such as in sustained market downturns, or when earnings significantly lag R&D investments. This is particularly ineffective for cyclical industries, such as forest products, where companies maintain R&D efforts during unprofitable periods by borrowing against future profits. The result is that the program does not live up to is objective of providing "incentives that are, as much as possible, of immediate benefit".[1] To address this issue, FPAC recommends making SR&ED credits refundable for all claimants, subject to an appropriate limit, and examine ways in which companies could be provided accelerated access to accumulated (past) credits.

How could Refundability be implemented?

Expanding refundability, compared to the current model, largely represents a time shift in when SR&ED credits are utilized.[2] Currently, there are a portion of credits earned but not claimed due to the claimant being in a tax loss position. These credits are either applied to previous tax years (up to 3 years back) or carried forward to claim in future years (up to 20 years). While the intent is admirable, these carry back and carry forward provisions provide minimal flexibility for claimants in cyclical industries. During unprofitable periods, claimants can use up the carry back provision but that will provide immediate benefit for only the initial period of a downturn. In a prolonged downturn (i.e. more than 3 years) the carry back provision is no longer available to claimants. Then they must rely on the carry forward provision which provides no immediate benefit but only allows claimants to maintain a pool of credits. As credits are accumulated, along with other tax credits during unprofitable periods, the impact of incremental credits diminishes and the SR&ED activities of these companies are under increased risk.

From a cost perspective, implementing refundability would shift the credit utilization from future years to the current year, representing a temporary incremental cost to the Treasury in the initial few years. Already up to one-third of claims in any given year accrue from activities conducted in previous years, ad this portion of the annual tax expenditure would presumably be eliminated over time. There may be some concern about providing 100% refundability; however, there are options to limit how refundability is provided. This would mitigate the initial time shift cost of refundability but still provide immediate benefit to a broad array of claimants who are in a tax loss position. For claimants in a tax payable position there would be no effect of refundability on the Treasury since these claimants are already utilizing the credits earned in the current year.

FPAC is prepared to discuss with Finance Canada options for targeting refundability for maximum immediate benefit to claimants. The following principles should guide consideration of limiting refundability:

  • use mechanisms as broad as practical so that all claimants have equal opportunity to earn refundable credits;
  • ensure incentive level from refundable credits is sufficient to provide meaningful support and does not unduly penalize claimants wanting refundability; and
  • avoid mechanisms that favour one cost component over another (e.g. labour vs capital).

Providing accelerated access to accumulated pool of credits

Some claimants may experience unprofitable periods such that they exhaust their carry back provision and accumulate unutilized SR&ED credits in a pool being carried forward to future profitable periods. These claimants are likely in cyclical industries or those in early stages of product or technology development. This is currently the case for numerous companies in the forest products industry. In fact, some companies have unutilized credits dating back to 2002 or 2001. Clearly, the current policy of non-refundability is failing these claimants. Every year that losses continue, claimants are under increasing pressure to cut costs, including R&D. Protecting R&D activities from cost reductions is not infinitely possible.

There is a better way of providing flexibility of utilizing credits than a 20 year carryforward. To the extent that a claimant has SR&ED eligible expenditures beyond a refundable limit and thus earns non-refundable credits, those credits could be eligible for refundability after a waiting period. This waiting period would be most appropriately set at 3 years to allow the carryback provision to 'insulate' claimants from short periods of unprofitability. Unprofitable periods of more than 3 years are much harder to endure and maintain R&D expenditures. In these situations, making accumulated credits refundable after 3 years accelerates the benefit claimants can receive from the incentive program. Any remaining accumulated credits would continue to be carried forward.

This approach applied to the existing pool of accumulated credits would enable claimants to access their oldest credits first, some of which might be under the 10 year carryforward rule and will soon be expiring. Moreover, it would provide immediate benefits if there is a lag between a refundability announcement and effect on prospective claims (due to the 18-month application window).

An optional component of a 'lagged' refundability provision could be to limit refundability of pooled credits from each carry forward year to the amount of current eligible expenditures. For example, if claimant A's most recent approved claim earns $10 million in credits, it would be eligible for a refund of up to $10 million in credits from each year of eligible carryforward credits (i.e. those older than 3 years) in its pool of accumulated credits. This linkage to current R&D expenditures would provide further incentive for companies to maintain R&D activities and limit the near-term exposure to the Treasury.

Administrative Issues

The forest products industry has concerns about the consistency of administration of the SR&ED program, relative to the sector specific implementation guidelines that have been developed jointly by industry and CRA

These guidance documents, jointly developed by CRA and industry, serve to help the industry conduct and prepare claims, and assist CRA officials in reviewing claims. When these documents were developed, it was expected that they would result in greater consistency of claims from the sectors and of reviews by CRA was expected to accrue. A prime example is the development of the Pulp and Paper Sector Guidance Document, released in September 2004. The Pulp and Paper industry worked closely with the CRA to develop this is document over a 3 year period. Among the issues that it addressed was the critical issue of experimental production in a commercial environment – a very common practice in the pulp and paper sector but one poorly understood within the context of CRA application policies.

Unfortunately, the Pulp and Paper Sector Guidance Document has had mixed results. It has led to a better understanding of eligibility and expenditure treatment within the forest industry such that some companies who previously did not participate are since applying for credits.[3] Moreover, its principles are being referenced by other sectors. However, its use by CRA officials is inconsistent across field offices and some reviews are contrary to the Guidance Document itself. An example is the determination of experimental production in a shop floor project. The Pulp and Paper Sector Guidance Document and the Application Policy 2002-02R2 clearly indicate that sale of product is possible with experimental production. However, some claims are being challenged by CRA on the basis of sale of product equals commercial production. This is contrary to stated policy and guidance. But to pursue a second review and the appeal process, if necessary, is very costly and time consuming for claimants.

FPAC recommends that the administration of the program be reviewed to ensure that it is consistent across the country, that it is consistent with the jointly developed guidance document, that CRA has appropriate technical expertise to assess claims and that there is a transparent process in place to resolve disputes.

Additional administrative issues are highlighted in the attached appendix.


The forest industry, along with the rest of the Canadian manufacturing sector, is under the most severe competitive pressure that it has faced in many decades. The rapid rise of the dollar and the emergence of strong global competitors make innovation and investment even more critical. As an exporting nation, Canada must take aggressive steps to promote the competitiveness of its exporters. The SR&ED program is a key building block of Canada's innovation system. It is essential that during this period of intense competitive pressure, this program provide real incentives for SR&ED in sectors which are not currently profitable.

FPAC therefore recommends that refundable tax credits be provided to all claimants. As well, refundability should be extended to the pool of accumulated unutilized credits so claimants can accelerate their access to non-refundable credits. We firmly believe the federal government has the fiscal capacity to adopt these recommendations.

Our members also have concerns with the the administration of the SR&ED program. Claim reviews are inconsistent from year to year and across field offices. We recommend immediate action to address these administrative concerns.

A more effective SR&ED program would not only encourage and sustain private sector spending on R&D but enable Canada to improve its R&D and innovation performance. Certainly, doing so is critical to the renewal and transformation of Canada's forest products industry, and we look forward to the results of the current review.


Administrative Irritants

There is considerable frustration in the industry with respect to the administration of the SR&ED program. The protracted nature of today's reviews, their costs, both in dollars and professional time, and the associated uncertainties about credits, can impact materially on the cash flow of both large and small firms even when credits are eventually approved. These concerns make it harder for companies to dedicate resources to the claim and review processes.

There appears to be considerable inconsistency in how claims are reviewed. For example, one claim from an FPAC member company was rejected due to perceived ineligibility because it was deemed to not meet the scientific challenge requirements of Section 248 (1). Subsequently, this project was abandoned by the claimant because it could never resolve the technical challenges to which the project was developed to address.

Most SR&ED conducted by the industry is associated with incremental improvement of established technology associated with the development of both new and improved products and processes. In the industry, the measure of success for SR&ED is not publications, but, rather the overall technological advancement as it is measured in the improvement of products and processes. Often many small, incremental advancements must be made to produce any truly significant advancement that achieves market advantage – the overall goal of experimental development in the industry. It is the higher level advancement that is most easily recognized in experimental development projects rather than the numerous small advances associated with the numerous individual technological barriers that must be overcome to achieve these improvements.

Specifically, we have concerns with the following policies and practices:

  • requiring documentation which is inconsistent with the ability of the claimant to document claims in a cost effective way;
  • moving to interpretative guidelines which are more appropriate to pure sciences or the applied extensions of academic research rather than with the experimental development on improving products and processes which dominates the SR&ED conducted by businesses;
  • promoting unproductive audit practices which raise the compliance costs far beyond those which are reasonable and necessary to demonstrate accountability;
  • demanding levels of documentation and proof of an advancement more onerous than those which companies are subject to in other countries which places the industry and Canadians as a whole at a competitive disadvantage;
  • in many problematic audits, projects are being broken down into individual subprojects and then eligibility is assessed based on the science auditor's ability to recognize advancements at the subproject level;
  • companies with subsidiaries in different regions reported that different approaches and positions are being applied to their claims. A concern of these companies is the difficulties this raises in setting up and managing any standardized company-wide reporting systems to track their SR&ED and the inherent uncertainty about credits and the ultimate reporting initiatives of these subsidiaries, to not report SR&ED activities at all;
  • the abolishment of National Technology Sector Specialists has removed what was an effective reference point in resolving detailed issues when CRA reviewed claims. The result is less opportunity for informal resolution of issues prior to more formal objection and appeal processes. Overall, the program is being administered more with an audit and compliance mindset than a cooperative approach to an incentive program; and
  • CRA's new training procedures accompanied by the restrictively positioned guides and academic concepts of how SR&ED challenges arise are not helping auditors understand how to scope out SR&ED in business settings. Concerns that new guides are not helping the situation and that CRA's consultative processes are now being driven more to raise the barriers and control expenditures than by the need to develop objective, legislative based, useful assistance for claimants.

FPAC recommends:

  • that the Department of Finance reconfirm the objectives of the incentive program and launch an interdepartmental working group with CRA to ensure that the program is being administered in a manner consistent with the objectives and intent of the program, and the Act, regulations, application policies and guidance documents;
  • the re-establishment of the National Technology Sector Specialists role with sufficient authority to determine eligibility of claims;
  • clarification of the definition of SR&ED so that if conditions outlined in 248(1) a-d are met, associated activities are not considered "commercial activities";
  • clarification of the definition of SR&ED costs to establish that costs are those that can be reasonably allocated to SR&ED projects from normal business records;
  • ability to consolidate SR&ED claims and file with a single taxation office. In so doing, more efficient use of resources and cost for both parties, alleviating multiple audit reviews at various locations;
  • a amendment to the legislation to permit, on an elective basis, non- related parties to a contract, to formally designate which of the parties to a contract has the right to claim the SR&ED associated with that contract; and
  • develop rapid, effective and transparent ways to resolve issues and disputes.

Members of FPAC

AbitibiBowater Inc.

Alberta-Pacific Forest Industries Inc.

Canfor Corporation

Canfor Pulp Limited Partnership

Cariboo Pulp and Paper Company

Cascades Inc.

Catalyst Paper Corporation

F.F. Soucy

Howe Sound Pulp and Paper Limited Partnership

Kruger Inc.

Louisiana-Pacific Canada Ltd.

Mercer International

Mill & Timber Products Ltd.

Papier Masson

SFK Pulp

Stora Enso Port Hawkesbury Limited

Tembec Inc.

Tolko Industries Ltd.

UPM-Kymmene Miramichi, Inc.

West Fraser Timber Co. Ltd.

Weyerhaeuser Company Limited


1. The Federal System of Income Tax Incentives for Scientific Research and Experimental Development:  Evaluation Report.  Department of Finance Canada and Revenue Canada.  December 1997 [Return]

2. The true incremental cost of refundability is based on refunding credits that are earned but would otherwise never be utilized.  To the extent this occurs, it is a failure of the current policy since the support is never actually received. [Return]

3. The publicly reported R&D expenditures for the industry were previously understated since not all companies participated in the SR&ED program or completed the Statistics Canada survey.  More recent figures remain understated but are closer to what the industry believes is a more accurate number. [Return]