Innovation Canada: A Call to Action

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Innovation Canada: A Call to ActionBox 6.2 Key Parameters of the SR&ED Tax Incentive ProgramNature and PurposeThe SR&ED program seeks to encourage Canadian businesses of all sizes and in all sectors toconduct R&D in Canada that will lead to new, improved or technologically advancedproducts or processes. The program offers two types of incentives:Income tax deductions — All allowable SR&ED expenditures, including capital, may bededucted from taxable income in the year incurred at the taxpayer’s discretion; unuseddeductions may be carried forward indefinitely. R&D spending is generally considered tobe an investment — that is, the spending is undertaken in one period with theexpectation of generating revenues in future periods — so allowing immediatedeductibility of capital and current expenditures provides a significant benefit to firms.Investment tax credits — Earned as a percentage of qualified SR&ED expenditures,investment tax credits can be used to reduce the amount of income taxes otherwisepayable. They can be carried back up to three years and forward up to 20 years to reduceincome taxes otherwise payable in those years. Credits earned in a year but not used arepartially or fully refundable (that is, redeemed for cash) for smaller businesses.EligibilityParticipants: corporations, proprietorships (individuals), partnerships and trustsCosts: Salaries and wages, overhead expenses, materials, capital equipment expenses,contracts and payments to third parties such as post-secondary institutionsProjects: experimental development, basic and applied research, and support work (suchas engineering design and operations research) carried out for the purpose of achievingtechnological advancement or advancing scientific knowledge.AdministrationAdministration is the responsibility of the Canada Revenue Agency (CRA), while governinglegislation (Income Tax Act) is the responsibility of the Department of Finance. Firms file aSR&ED claim for their eligible expenditures incurred. The CRA reviews the claim, and aims toprocess 90 percent of refundable claims within 120 days of receipt and 90 percent of nonrefundableclaims within 365 days of receipt. The CRA offers a preclaim advisory service tohelp businesses identify the eligibility of projects. It is available at no cost before claims arefiled. As noted on the CRA website, the preclaim service is “neither an advanced income taxruling nor a pre-approval of a SR&ED claim. A final determination on any SR&ED claim mustbe based on the actual work done and can only be made after the claim is filed.”growth in the number of small CCPCs in 2007may have been due to an increase of thetaxable income threshold that allows a companyto qualify for the enhanced credit. Due to theirhigher credit rate and refundability, small CCPCsclaimed about 40 percent of total credits whileperforming about 30 percent of qualifyingR&D in 2007.The SR&ED program, unlike grant programs, isnot subject to assessment of the quality of anyparticular business project. Businesses that donot qualify for a refundable credit nevertheless6-6
Program Mix and DesignFigure 6.3 Tax Expenditures, by Type of CorporationValue of Credit ($ million)Number of Corporations (units)2004 2005 2006 2007 2004 2005 2006 2007SmallCCPCs 1 043 1 119 1 128 1 298 15 482 16 917 17 712 19 806Largefirms 1 944 1 448 1 471 1 822 2 452 2 448 2 728 2 599Others a 137 170 208 136 1 259 1 510 1 920 1 310Total 3 123 2 737 2 807 3 256 19 193 20 875 22 360 23 724aIncludes CCPCs in expenditure limit phase-out range and small non-CCPCs.Source: Department of Finance.face “tax risk” in that they must have sufficienttax payable in order to fully benefit from thecredit. This has the significant advantage of“targeting success” — that is, the (nonrefundable)benefit is available only tocompanies that are sufficiently profitable —while making the credit less open ended than itinitially appears. Although businesses can carryunused credits to future years, delayed usereduces the value of the benefit. With thealmost 50-percent reduction in the federalstatutory corporate tax rate since 2000,businesses now find it more difficult to fullyutilize the SR&ED tax credit generated in acurrent year against federal tax otherwisepayable, putting further downward pressure onthe average expected effective tax credit rate. Incontrast, the criterion for “targeting success”does not apply to the small CCPCs that receivea fully refundable tax credit.Net Public BenefitIn 2007, the Department of Finance conducteda thorough benefit–cost analysis of the SR&EDprogram (Parsons and Phillips 2007). Itconcluded that the public benefit of theprogram — the part due to the incrementalR&D investment stimulated by the SR&EDsubsidy and the estimated social return on thatincremental investment (i.e., extra outputgenerated in the economy as a whole) —exceeded its full costs. These costs include notonly administrative and compliance costs, butalso the cost to the economy of having to raiseadditional tax revenues to finance the credit.This type of benefit–cost analysis relies on keyparameter estimates — particularly of theextra R&D performed per dollar of tax creditprovided and of the social rate of return onbusiness R&D expenditure — which are subjectto considerable estimation error. Thesemeasurement problems, together with thedifficulty of applying the methodology to otherinnovation support programs — for example, tobusiness network and internship programs —have led the Panel to conclude that thecalculation of net public benefit is notsufficiently precise at this time to permit abenefit–cost ranking of the government’sbusiness R&D support programs, nor to finetunethe mix between SR&ED and the portfolioof direct expenditures.The estimation of net public benefit ofinnovation programs is nevertheless an excellentgoal and should be included, as it is developedand refined, within the suite of programevaluation tools, as referred to in Chapter 5 onprogram effectiveness. What can be said, in anyevent, is that the net public benefit of a supportprogram declines as administration andcompliance costs increase, and as the subsidy6-7
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The Context of the ReviewChapterThe
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