Labouring over R&D

OBJ Staff
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Changes to SR&ED tax credit program expected in federal budget

Companies engaged in research and development and operating at a loss could see their financial situation worsen under recently proposed changes to a "flagship" government assistance scheme that are expected to appear in the upcoming federal budget.

KPMG's Geoffrey MacDonald.

by Greg Markey and Peter Kovessy

The Scientific Research and Experimental Development program, which has existed in one form or another since the 1960s, is worth approximately $3.5 billion in tax credits annually. Commonly known as SR&ED, the program was put under the microscope by OpenText Corp. chairman Tom Jenkins, who prepared a detailed review of federal support for research and development.

One of the main recommendations of the Jenkins report is to phase out the "refundable" part of the tax credit program, meaning only those companies that actually turn a profit and pay taxes would receive SR&ED benefits.

Some say shutting out unprofitable firms is counterproductive.

"Giving (tax credits) to profitable companies defeats the purpose of the SR&ED program," says Elizabeth Lance, CEO of the Ingenuity Group, which helps companies apply for federal and provincial tax credits.

"Having a (refundable) tax credit like this reduces the risk of being an innovator and an entrepreneur."

Geoffrey MacDonald, an Ottawa-based partner at accounting and consulting firm KPMG, calls the proposed changes "puzzling."

"It will hinder (innovation)," he says. "There will be lots of companies in this region that, all of a sudden, (will see) their SR&ED credits will dry up."

The program is the single largest source of federal support for commercial research and development. For a Canadian-controlled private corporation, the program generally provides a tax credit worth 35 per cent on the first $3 million of eligible R&D labour, equipment and overhead costs. The tax credit is worth 20 per cent for expenditures above that.

In recent years, SR&ED has been criticized by its supporters and detractors alike. Some argue that the program lacks focus, and that rather than investing in strategic sectors, the money is spread too thinly across too many companies in too many sectors to make a meaningful difference. Critics also say a disproportionate amount of the financial benefits are accrued by consultants and advisers, rather than being allocated for actual R&D.

Part of the problem, some say, is that Canada Revenue Agency officials are inconsistent in their rulings on what expenses are eligible.

The Jenkins report says the program must become more "predictable," but also more cost-effective. It recommends decreasing spending on SR&ED and directing the savings to other initiatives that are more focused.

Along with phasing out the refundability provisions, the Jenkins report recommends restricting SR&ED to labour expenses. (See sidebar)

Prime Minister Stephen Harper has signalled that he plans to implement some of the recommendations of the Jenkins report in the spring budget.

Speaking late last month at the World Economic Forum in Davos, Switzerland, Mr. Harper reiterated the need to overhaul how the government approaches R&D.

"We believe that Canada's less-than-optimal results for those investments is a significant problem for our country."

SR&ED shakeup

The Jenkins report made several recommendations on how the federal government can strengthen its programs to support innovative businesses and promote commercially oriented R&D. The SR&ED recommendations focused on simplifying the program by basing the tax credit for small and medium-sized businesses on labour-related costs and directing the savings into direct support initiatives.

Simpler compliance and administration

The tax credit benefiting small and medium-sized Canadian-controlled private corporations should be based on labour-related costs in order to reduce compliance and administration costs. Because the credit would be calculated on a smaller cost base than at present, its rate would be increased.

More predictable qualification

Improve the Canada Revenue Agency's preclaim project review service to provide firms with preapproval of their

eligibility for the credit.

More cost-effective

Reduce the amount of SR&ED tax credit assistance by introducing incentives that encourage the growth and profitability of small and medium-sized enterprises while decreasing the refundable portion of the credit over time. Redeploy the savings to fund new and/or enhanced support for innovation by SMEs.

More accountable

Provide data on the performance of the SR&ED tax credit on a regular basis to permit evaluation of its cost-effectiveness in stimulating R&D, innovation and productivity growth.

Phased implementation and consultation

Adopt the proposed changes through a phased-in approach to give the business sector time to plan and adjust smoothly.

Organizations: OpenText, Ingenuity Group, Canada Revenue Agency KPMG World Economic Forum

Geographic location: Ottawa, Davos, Switzerland Canada

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