CATA renews call for major changes to SR&ED program in upcoming Budget

Key issue is universal refundability

The calls for change to Canada’s premier R&D tax incentive program are growing louder in the run up to the federal Budget expected later this month. The most recent pitch for universally accessible investment tax credits (ITCs) comes from the Canadian Advanced Technology Alliance (CATA), and builds upon similar proposals by the Information Technology Association of Canada (ITAC) and the Ottawa Centre for Research and Innovation (OCRI).

CATA argues in its latest Action Report that the scientific research and experimental development (SR&ED) program must be simplified and made available to the thousands of large and small innovative firms that cannot access the credits for a variety of reasons. With the high-tech downturn putting severe pressures on company cash flow, universal refundability is seen as a critical survival tool.

Currently, SR&ED tax credits are refundable only in certain circumstances, leaving many firms with unused tax credits while attempting to return to profitability. Approximately 70% of the value of ITCs claimed each year fall into the non-refundable category. Unless the recommended changes are adopted CATA asserts that the ambitious goals set out in federal government’s Innovation Strategy are unattainable.

The program’s problems point to an even more fundamental issue of policy. CATA says that ITCs were originally made non-refundable in the majority of instances to encourage large firms to increase sales and profitability. With the shift to developing and sustaining a knowledge-based economy, CATA argues that “the government’s philosophy may need to be revisited and possibly revised”.

“In the long run, the government needs to re-think the policy base of those credits so that they reflect the nature of the knowledge economy,” says Dr Russ Roberts, CATA’s senior policy director. “The design of the SR&ED program is out of sync with today’s directions for economic growth. In the past the government was concerned with spinoffs to the economy through manufacturing and sales. But knowledge jobs themselves are now the spin-off. We need to maintain them in Canada and nurture them. That changes the policy perspective.”

Roberts says discussions with the Department of Finance indicate that officials have a good awareness of the issues, a recognition of the complexities of the legislation and the burden they place on investors. He’s confident that there is enough interest in a solution that changes are pending, but on the critical issue of refundability the perspective of Finance is difficult to predict.

“I can’t get a read on their stand or their directions on universal refundability or some mechanism that achieves the same thing,” he says. “It could apply to other taxes but the point is to broaden as far as possible the opportunity to use up unused credits if you don’t go for refundability.”

TOO MANY EXCLUDED

Under the current legislation, SR&ED offers two levels of credits — 20% for large private or public corporations and 35% for most small Canadian-controlled private corporations. There are many exceptions to the latter, however, resulting in ITCs being denied to firms at a time when the investment climate is bleak.

One particularly bizarre situation is created by the SR&ED definition of arm’s length. If two completely unrelated firms are connected by virtue of receiving venture capital from the same source, they are forced to share the expenditure limits on the ITCs. The problem arises because the definition does not distinguish this scenario with companies that have wholly owned subsidiaries which are attempting to access the program.

Another untenable situation is caused when a venture capital corporation requires that a Canadian firm relocate its head office to another country as a condition of receiving funding. Although the workforce and all R&D activity remain in Canada, refundability is denied as they are considered to be a foreign corporations. The same result occurs with reverse takeovers, when Canadians firms exchange shares with a foreign shell corporation to obtain a public listing.

The above scenarios are typical of small or early-stage firms, but problems also arise for firms further along in their evolution and mature corporations seeking bridge financing during market downturns.

US multinationals conducting R&D in Canada face their own unique set of problems with the SR&ED program, since the value of the credits they receive in this country increases their income tax liability at home. ITAC has urged the government to consider allowing these companies to claim the tax credit against levies or non-income taxes. But CATA’s Roberts says the issue is due to US legislation and will continue until US treatment of Canadian tax credits changes.

“The tax back issue will occur until it is dealt with through various treaty mechanisms,” he says.

SUPPORT FOR CHANGE BROADLY BASED

On the broader issue of changes to SR&ED, CATA, ITAC and other organizations agree on the overriding issue of simplifying the credits and introducing universal refundability. Without fundamental changes to the system, they say an increasing number of eligible firms will not take advantage of the program, undercutting the national R&D effort and making the Innovation Strategy’s targets impossible to achieve.

“Too many companies are falling through the cracks in part because of the sheer complexity of today’s system. This is further exemplified by the number of eligible companies that simply cease claiming SR&ED credits. This problem has to be rectified,” states the CATA report.

In addition to changes to the SR&ED program, CATA continues to advocate the abolition of federal capital tax and the introduction of a streamlined service for all R&D assistance. For the latter, Roberts says the concept of a one-stop shop for SR&ED, the Industrial Research Assistance Program and Technology Partnerships Canada remains part of its advocacy program.

“It’s still on the table and it’s still a concern of the CATA board of directors,” he says. “It’s interesting to watch the reaction.”

R$