Innovation Canada: A Call to Action

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Innovation Canada: A Call to ActionRecommendation 2Simplify the SR&ED program bybasing the tax credit for SMEs onlabour-related costs. Redeploy fundsfrom the tax credit to a morecomplete set of direct supportinitiatives to help SMEs grow intolarger, competitive firms.The Vision of the PanelThe SR&ED tax credit is the flagship of federalsupport for innovation, allowing almost 24 000firms across all economic sectors and regions ofthe country to make individual, market-drivendecisions about the industrial R&D they need inorder to compete and succeed. It is essential forthis highly valued program to be made simpler,more predictable and more cost effective inpromoting innovation through business R&Dspending. Much more information on the costsand benefits of the SR&ED program needs to beprovided on a regular basis to enable futureprogram adjustments and to ensure that theprogram continues to contribute cost effectivelyto business innovation in Canada.Getting ThereTo realize this vision, the Panel makes thefollowing recommendations.2.1 Simpler compliance and administration —The tax credit benefiting small and mediumsizedCanadian-controlled privatecorporations (CCPCs) should be based onlabour-related costs in order to reducecompliance and administration costs.Because the credit would be calculated on asmaller cost base than at present, its ratewould be increased. Over time, thegovernment should also consider extendingthis new labour-based approach to all firms,provided it is able to concurrently providecompensatory assistance to offset thenegative impacts of this approach on largefirms with high non-labour R&D costs.2.2 More predictable qualification —Improve the Canada Revenue Agency’spreclaim project review service to providefirms with pre-approval of their eligibilityfor the credit.2.3 More cost effective — Reduce theamount of SR&ED tax credit assistance byintroducing incentives that encourage thegrowth and profitability of small andmedium-sized enterprises (SMEs) whiledecreasing the refundable portion of thecredit over time. Redeploy the savings tofund new and/or enhanced support forinnovation by SMEs, as proposed in thePanel’s other recommendations.2.4 More accountable — Provide data on theperformance of the SR&ED tax credit on aregular basis to permit evaluation of itscost-effectiveness in stimulating R&D,innovation and productivity growth.2.5 Phased implementation andconsultation — Adopt the proposedchanges through a phased-in approach togive the business sector time to plan andadjust smoothly. There should be earlyconsultations with the provinces on theproposed changes, given that they maywant to consider adopting the same baseas the federal government.Simpler Compliance and AdministrationThe base for the SR&ED tax credit currentlycomprises — in addition to the direct labourcost of researchers — overhead expenses,materials, capital equipment expenses, contractsand payments to third parties such as postsecondaryinstitutions. This Canadian definitionof the tax credit base is broader than that inmost other countries. Four developed countries(the US, Japan, Australia and Singapore) exclude6-10
Program Mix and Designcapital costs from the base. The US alsoexcludes overhead expenses, while the credit inthe Netherlands is based on wage costs only.The calculation of non-labour costs can becomplex, particularly for expenditures on capitaland materials. This complexity imposes costs onR&D performers by increasing their complianceeffort and, particularly for SMEs, leads toincreased reliance on third-party consultants toprepare R&D claims. Recall that compliancecosts for the SR&ED program are currentlyestimated to average approximately 14 percentof the value of credits earned by small firms and5 percent for large firms.The program could be greatly simplified bymoving to a program cost base comprised of(i) direct labour costs, (ii) the labour componentof contracts (assumed to be 50 percent, the sameas for in-house R&D) and (iii) payments to thirdparties (such as post-secondary institutions),much of which are labour based. Moving to alabour cost base will reduce compliance costs byeliminating all of the calculations related tocapital, materials and overheads.Since high compliance costs mainly affect SMEsand since switching to a labour cost base wouldadversely affect large firms in industries wherematerial inputs and equipment are a largefraction of the cost of doing research, it isrecommended that this new labour-basedapproach immediately apply only to the taxcredits for the CCPCs. Thereafter, thegovernment should consult with the businesscommunity and the provinces on the possibilityof applying the approach to all firms. Suchuniversal application should be pursued on thecondition that initiatives are developed toaddress the potentially negative impacts of alabour-based approach on large firms withcapital-intensive R&D activity.More Predictable QualificationThe CRA does not review all filed claims, butinstead uses a risk management approach,reviewing some claims for both their financialcontent and scientific aspects (that is, whetherthe R&D expenditures are eligible for the taxcredit). Businesses must be able to demonstratethat their projects meet the SR&ED eligibilitycriteria, and must identify the particular costsassociated with the eligible project. Businessestherefore face “eligibility risk” should theproject not qualify as SR&ED in the view of CRA,or should the costs allocated to the eligibleSR&ED project be determined by CRA to be lessthan originally expected.Box 6.4 Claiming Overhead Expenses through theSR&ED ProgramFirms claiming the SR&ED tax credit currently have the option of claiming overhead expenses(administrative and financial support, utilities, etc.) either directly or through the proxymethod. Under the proxy method, firms forgo claiming their actual overhead costs, butinstead gross up their wage costs by 65 percent. Almost all firms choose the proxy method,but the reasons for this are unclear to the Panel. For example, for some firms, the reducedcompliance costs in using the proxy method may justify its use, even when the actualoverhead is greater than 65 percent of wage costs. In other cases, firms may find theiroverhead costs are less than 65 percent and so the proxy method provides a net benefit.The Panel believes that the proxy method is justified, but it is unclear what the appropriaterate should be. Therefore, the Panel advises the government to undertake a study of thetrue overhead costs borne by firms for their eligible R&D activities and to establish the proxyrate that best reflects these costs.6-11
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Page 77 and 78: Program Effectivenessfull spectrum
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Page 111 and 112: Filling the Gapscompetitive levels,
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Page 115 and 116: Filling the GapsThe budgetary impli
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Page 131 and 132: ConclusionChapterConclusion9We are
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