Innovation Canada: A Call to Action

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