International comparison of R&D tax credits reinforces need for SR&ED flexibility

The Information Technology Association of Canada (ITAC) continues to build on its five-year campaign to modify the investment tax credits used for industrial R&D. It has sponsored a comparative international study of R&D tax incentive regimes and hopes to use its findings to urge the federal government to make its flagship R&D tax credit program refundable to all firms regardless of size or profitability.

Called extended access, such treatment would allow firms in loss positions to use their tax credits, rather than wait until profitability and deduct their value from taxes owed. The study — entitled Extending Access to R&D Tax Credits: An International Comparative Analysis — argues that the increasingly frequent use of R&D tax credits in the industrialized world is challenging Canada’s leadership position for industrial R&D tax treatment.

Even more challenging are those countries — Norway, France, Netherlands — that provide extended access to all firms. Other countries offer limited extended access, including Canada, which only offers it to Canadian-controlled private corporations (CPCCs) under a certain size.

A close examination of the 13 countries included in the study reveal that Canada remains one of the most generous — if not the most generous — jurisdictions when it comes to using the tax system to support industrial R&D. The report notes that the scientific research and experimental development (SR&ED) tax credit incentive is Canada’s largest federal industrial R&D program. Each year the government forgoes between $1.4 billion and $1.6 billion in tax revenue, accounting for approximately 25% of overall government support.

When combined with provincial incentive programs that top up and enhance the federal program, Canada is hard to beat. Adding to the attractiveness of the Canadian regime is the absence of caps on the use of the tax credits. But there are suggestions that other nations are increasing using the tax system as part of an overall innovation and industrial productivity strategy.

“We don’t say Canada doesn’t look good. It is very, very generous in terms of its international standing,” says report author Dr Jacek Warda. “But we have to keep an eye open and seek new innovative solutions … Some countries have more flexible rules especially for larger companies.”

For ITAC, increased flexibility of the SR&ED program requires the introduction of new mechanisms that wouldn’t necessarily increase its cost as measured in foregone tax revenue. Providing extended access to large companies would avoid the recent dilemma faced by those firms caught in the technology downturn, unable to use the credits they had earned due to red ink on the bottom line.

Allowing R&D tax credits to be deducted from labour-related corporate taxes is another option. Not only would it apply to all firms regardless of size, it would also prove useful for foreign-controlled corporations. Currently, the SR&ED program is of limited use to US-based firms, since any benefit they gain is offset by their tax treatment in their country of origin. However, a recent ruling by the Internal Revenue Service that refundable tax credits do not reduce foreign tax paid may help alleviate the problem.

The report found that six of the 13 countries surveyed provide some level of accessibility to tax credits for firms when they are not profitable. Several countries appear to have more flexibility in refunding the tax credits, however. France provides a full refund of the tax credit for new start-ups in which private individuals own at least 50% of the capital. For larger firms, all other firms are eligible but they must carry forward unused tax credits for three years before using them. In the Netherlands, refunds are offered through labour-related tax deductions paid for by the employer regardless of firm size. The mechanism is an explicit manifestation of the desire to provide an immediate link between actual expenses and the receipt of the deduction.

Norway also uses reductions in labour-related taxes with a twist. The firm must first reduce corporate income tax by the credit earned. Once again, firm size is not a factor, nor is country of origin of its status as a public or private corporation.

It should be noted that several countries that rank among the world’s most R&D intensive were not included in the report. Germany, Finland and Sweden were not included and none use tax credits as a mechanism for stimulating industrial R&D.

NO REVIEW OF SR&ED IN NEAR TERM

Despite the chorus of calls for reform of the SR&ED program, Finance Canada is apparently not actively reviewing it with a view to making fundamental changes. There is ongoing dialogue between Finance staff and a so-called partnership committee comprised by SR&ED users. But government officials say the time is not right for introducing any major changes.

“If there is a review, Finance would be playing it very close to their vest. They’re keeping it very quiet,” says the official. “If you look at the government’s finances and the pressures on them, there won’t be any expansions at this time. R&D at the moment will remain where it is.”

In addition to ITAC, the report was sponsored by Ernst & Young, IBM Canada, PricewaterhouseCoopers and Research in Motion. It follows a series of S&T and R&D-related reports ITAC has released this fall. They include Investing in Prosperity, ITAC’s pre-Budget submission to the Commons Standing Committee on Finance, and Can the Private Sector Get Canada into the Top Five Innovative Economies of the World by 2010?, prepared by Dr Douglas Barber and Research Infosource Inc. All reports can be found at www.itac.ca.

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