In the weeks leading up to the March 29 federal budget, the Scientific Research and Experimental Development (SR&ED) tax credit program was the subject of many debates concerning its validity as a tool to encourage innovation in Canada. Prime Minister Stephen Harper said in January 2012 that he believed Canada had received less than optimal results for its investment in SR&ED and the government would soon act to address this problem.
Why did government support for research and development become one of the main topics of debate before the budget? In 2010, the federal government announced a comprehensive review of the support it provided to companies that perform R&D in Canada. Following this announcement, the Jenkins Panel carried out its analysis of the state of innovation in Canada and delivered its report in late October 2011. Changes to the SR&ED program were certainly called for as part of the report’s recommendation that the government change the balance of R&D spending to provide more direct funding through targeted grants and incentives, and less in the form of indirect spending through tax incentives.
One only needs to Google the words “Jenkins Report” to realize the impact this document had, and the public debate that it created. Over the next several months leading up to the budget, the media, taxpayers, consultants, associations and many others weighed in with their views on what was wrong with innovation in Canada.
Limiting ourselves to the panel’s recommendations for the SR&ED program, the changes centred around simplifying the program and providing incentives for commercialization and profitability for claimants. The panel’s first recommendation was to simplify the program by having claims for small- and medium-sized enterprises be based upon labour costs only. Second, the panel called for a reduction of the refundable portion of SR&ED claims so that a part of the benefit would be driven by company profitability.
So what happened? Would the finance minister implement the panel’s recommendations on budget day? In two words: sort of.
Claims made under the SR&ED program will be pared back in coming years, but the proposed changes did not strictly follow the panel’s report:
Reduction of general tax credit rate — The general SR&ED investment tax credit rate will be reduced to 15 per cent (from 20 per cent), effective January 1, 2014. The good news is that for qualifying Canadian-controlled private corporations earning refundable federal credits at 35 per cent, this rate has not changed.
Capital expenditures —Capital expenditures will be removed from the base of eligible expenditures for amounts incurred in 2014 and subsequent years. All other expenditures such as salary and wages, materials, overhead expenses and contract payments remain eligible.
Proxy overhead calculation —The prescribed proxy amount will be reduced to 55 per cent (from 65 per cent) of direct labour costs in a phased-in approach with costs incurred in 2013 having a rate of 60 per cent applied, and 2014 having a rate of 55 per cent.
Arm’s-length contract payments — Only 80 per cent of the contract payments will be used for purposes of calculating the SR&ED tax credits effective January 1, 2013.
• The budget also announced that the government will spend $6 million over the next two years on changes to the administration of the program that will:
• Determine the feasibility of a pre-approval process
• Enhance the existing online self-assessment eligibility tool
• Work with industry representatives to address emerging issues
• Improve the Notice of Objection process to allow for a second review of scientific eligibility determination.
The good news is that the program still offers significant benefits. The bad news is that some companies will see their claims reduced by close to 30 per cent. This assumes that the provincial government will follow suit, a fair assumption given the harmonized tax system in which we now live. Smaller Canadian-controlled corporations will be affected as well, but the reduction in their claims could be as little as 6 per cent.
But all is not doom and gloom. The funds taken from the SR&ED program, some $1.3 billion over the next five years, are being redirected to grant programs such as the Industrial Research Assistance Program, the BDC and other research-oriented programs.
Will we see more changes? Tough to say with certainty but it’s possible. These changes are significant and the government will want to review the impact on innovation and likely make adjustments.
In closing, your claims will probably be reduced, that much is a given. The good news is that the SR&ED program remains substantially intact and will reward companies such as yours for performing qualifying work. You may also be eligible for grants and incentives under new programs or existing ones that are better funded as a result of the budget.