Reform the SR&ED tax credit, don’t narrow eligibility

Many innovative, technology-intensive companies have benefited from the Scientific Research and Experimental Development (SR&ED) tax credit. These are the types of businesses – often entrepreneurial start-ups – that Canada should be nurturing. They can represent the future promise of our economy.

It is widely expected that the coming federal budget will include major changes in SR&ED.  In the wake of the Jenkins Panel report on innovation and the soon to be released Taxpayers’ Ombudsman report on problems with SR&ED, which I believe will have to address illegitimate SR&ED claims, many companies involved in research and development have become concerned about its future.

In the best-case scenario, companies decide to take a risk and invest in research and development as a result of the incentive offered by SR&ED. Then, recipients re-invest the tax credit into growing their businesses. They hire more of the workforce that we need to compete in the new economy.

But the evidence is that too many of the claims for this credit, especially amongst the smaller claims, are illegitimate. Sometimes the claims are filed long after the fact, often at the suggestion of a claims processor who is trolling for possible claims, and working on a contingency fee. Even if the tax credit is plowed back into a legitimate business, it does not function as an incentive to take risks and invest in innovation and commercialization.

Here is an extract from the Globe and Mail of January 31, 2012:

Nearly 25,000 companies across Canada use the tax break, which for small companies means instant cash rebates for R&D they’ve already conducted. A recent Globe and Mail investigation found widespread abuse, including bogus claims and large consultant fees paid from credits.

Companies that use the program have long complained that the program is too bureaucratic, unpredictable and bears no relation to how company’s actually conduct R&D. The result is often no money for legitimate work, and quite often credits for companies doing routine product development.

Many of those complaints are likely to be included in a long delayed report on the SR&ED program by the federal Taxpayers’ Ombudsman, Paul Dube, which is expected to be made public as early as next week.

This is not the first time that a tax-credit program, begun with noble intentions, has proved vulnerable to abuse. The solution is not to abandon the SR&ED credit, but to reform it. When properly structured and implemented, this credit is a valuable tool for Canadian competitiveness and economic growth. It’s tragic that access to this tool may now be at risk of being reduced.

We need to reform SR&ED so that it is a true incentive, genuinely encouraging companies to take a risk and invest in research and development. We need to discourage the trolling for possible SR&ED claim revenue, long after the fact. We need to make it easier to decide on the scientific eligibility of a project.

While it is true that many of the Jenkins Panel’s 228 industry submissions criticized the administration of the SR&ED program, very few of those submissions recommended fixing the problem by limiting claims to labour costs as the Jenkins panel itself concluded.
That’s because many companies which legitimately benefit from SR&ED tax credits are in capital intensive businesses with large upfront investments in equipment.  Limiting SR&ED to labour costs would dramatically increase the costs of research for them.

So, in contrast to a recommendation of the Jenkins report, the Liberal Party cannot support restricting SR&ED to labour costs.

This raises the question:  How do we make SR&ED more efficient and reduce the number of illegitimate claims without significantly narrowing the scope for eligibility?

Two changes would improve the efficiency of the claims process for SR&ED credits, and may require few additional resources.

1) Require companies to notify the Canada Revenue Agency within three months of the start of a project that will eventually lead to a SR&ED application.  This statement would include a brief description of the technical obstacle to be overcome, and the company’s objective and initial plan of attack. The CRA would immediately and automatically acknowledge receipt of the notification, not as a pre-approval but simply to set an agreed-upon start date for which a future SR&ED claim could be made.  Companies could quickly file amended statements should their research lead them in an entirely different direction.

This modest, proactive documentation would be designed to facilitate the determination of scientific eligibility, which is a large part of the work to process SR&ED claims. Filing it would help ensure that SR&ED acts as an incentive, and limit the amount of retrospective SR&ED trolling by consultants.

2) The time it takes before beginning to process SR&ED claims must be reduced.  Currently a firm has up to 18 months to apply and the CRA may take up to a year to audit their claim.  Amid growing, research-intensive companies, people tend to move around and knowledge of a research endeavour, as well as documentation, is often lost with the passage of time. The experience of those who process SR&ED claims is that resolving disputes after some time is usually more difficult and leads to extra costs for the company and extra man-hours for CRA employees, which means wasted tax dollars.  Allowing a maximum of six months to file a claim after fiscal year end (the same deadline for income tax returns) would help avoid this problem.

These changes, while not meant to be comprehensive, could substantially reduce abuse without limiting the scope of a valuable program.

 

Ted is the Science and Technology critic for the Liberal Party

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[…] to Ted Hsu (Liberal Critic for Science and Technology), there are too many illegitimate SR&ED claims.  He […]

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