It’s the distortions in the small business tax environment created by Finance, the consultation methodologies being used by Finance, and the CRA’s administration of the tax system that are really huge and fixable issues – issues ignored by the Prime Minister and by his Minister of Finance.
Even if Canada’s much touted Supercluster investments are reasonably successful at creating value added technologies, the Government is doing little to nothing to see that the businesses in these clusters have a real incentive to grow and commercialize their innovations here in Canada and the resulting IP (Intellectual Property) to the full benefit of Canadians.
For that matter, they have not addressed the issue that small Canadian business does not have an even and constant playing field in which to grow and commercialize its innovations to their fullest economic potential here in Canada, rather than in the U.S. and elsewhere.
Key issues raised by tax experts
Often, provisions in the Income Tax Act conflict with other provisions of the Act, and/or are simply confusing as to meaning and intent.
The costs to business of the tax lawyers and accountants needed to straighten out entitlements is a real concern of business. They should also be a concern to the Prime Minister as well.
The Government says that it is working toward a fairer tax system. If this is the case, the Government must insist and ensure that its officials understand and correct legislative flaws and/or apply transparent policies in ways that lead to consistent and predictable determinations of entitlement for the small business community. Large businesses have the resources and leverage to cope, if they wish. Smaller businesses do not.
The $3 billion Scientific Research and Experimental Development Tax Incentive Program (SR&ED)
Not only have leading lawyers and accountants raised SR&ED concerns over the years with Finance and CRA officials about unstable interpretations of eligibility for the incentive by CRA officials due to the lack of legislative clarity, but problems are being highlighted in the evolving jurisprudence. The result is that a program that could be one of the best in the world is often despairingly criticized by our members and other user groups.
For a detailed update on the SR&ED program, see “Scientific Research and Experimental Development (SR&ED) Tax Incentive Program, CATA Update on SR&ED, July 2017” at https://drive.google.com/file/d/0B__wzrAC_E12MkJOZjJzTDlVRmc/view.
See also the Canadian Federation of Independent Business (CFIB), “Small business key to making Canada the innovation nation”, https://www.cfib-fcei.ca/en/media/small-business-key-making-canada-innovation-nation.
Years ago, it was pointed out by a Department of Justice lawyer that subsection 37(4) of the Income Tax Act states:
No deduction may be made under this section in respect of an expenditure made to acquire rights in, or arising out of, scientific research and experimental development.
An extreme interpretation of this provision would exclude a significant amount of SR&ED. Of course, we did not go there when I was the Senior Science Advisor, as that was not the Government’s intent for the program in 1986.
Yet, today, we hear that some in the CRA are pushing the edges of the most restrictive possible interpretations of the legislation. For example, it was brought to our attention that the 2015 edition of the Frascati Manual, OECD (2015): “Guidelines for Collecting and Reporting Data on Research and Experimental Development”, http://www.conicyt.cl/wp-content/uploads/2014/07/Manual-Frascati-2015.pdf, contains the following examples of R&D in computer and information sciences:
❖ Basic research: Research on the properties of general algorithms for handling large amounts of real-time data.
❖ Applied research: Research to find ways to reduce the amount of spam by understanding the whole structure or business model of spam, what spammers do, and their motivations in spamming.
❖ Experimental development: A start-up company takes code developed by researchers and develops the business case for the resulting software product for improved on-line marketing.
It was noted that:
Based on what we have been seeing, the examples of AR and ED provided would both be considered ineligible [for SR&ED] by CRA’s current administration.
The argument would be in both cases that the advancement in knowledge made is in the business domain and not technological, despite the fact that it is the translation of this business domain know-how to a workable software architecture that presents an uncertainty.
Today the CRA would narrow the discussion of SR&ED eligibility down to the definition provided in Frascati for “Basic Research” only. The CRA would not have been doing this in the past, because historical CRA public policies were consistent with all 3 of the Frascati examples above of what is eligible for the SR&ED incentive.
Minister Morneau has heard countless comments about the inappropriate impacts of his small business tax proposals and how they need to be postponed, carefully reviewed, and revised.
The objective should be to ensure equitability: to understand their costs, including social costs, and to mitigate their unintended impacts.
The commentary has gone so far as to say that some of the provisions simply become make-work projects for the CRA and the practitioners. In our opinion, this confrontation was unnecessary, as the community has repeatedly called for a clear analysis of the impacts of the proposals and opportunity for an informed and transparent discussion of potential solutions.
Both the Standing Senate Committee on National Finance, and the Coalition for Small Business Tax Fairness have called for a comprehensive review of Canada’s tax system:
It’s time for the Government to move forward expeditiously on the Senate’s recommendations and develop a more equitable and effective tax framework. A framework that removes disincentives to growth in Canada; one that rewards firms willing to innovate, commercialize, export, and grow here. And, a framework that retains Canada’s competitive position with the U.S. and other nations.
Prime Minister Trudeau, we believe that you should take control of this issue and have your officials proactively seek tax fairness and a more effective system, and that your Government implements the independent review envisaged by the Standing Senate Committee on Finance. The current situation is an unnecessary drag on the efficiency of the Canadian economy.
We believe that the SR&ED program and its administration should be included as a component of the review recommended by the Standing Senate Committee. Specifically, the review should determine why, after decades of commentary about its administration, there are still serious issues such as:
The community supports the concept of the SR&ED program – but not in its current configuration.
Currently, the credibility of Canada’s self-assessment tax system is being pushed to the edge, as highlighted in the Report of the Standing Senate Committee on National Finance. The commentary we are seeing on the SR&ED program continues to be disturbing. The implications are serious. Canada needs an effective and stable tax system supported by Canadians and a credible SR&ED tax credit.
A review of the SR&ED program was announced in the last budget. We have only recently been able to determine who is in charge of this review. It’s the Department of Finance. Finance officials have told us that they will NOT consult and will NOT seek external input from the community. From what Finance officials say, it will NOT be an independent review but rather an internal review led by government officials. This raises the issues of objectivity and transparency.
The excuse is that extensive consultations were done for purposes of the 2011 Jenkins Panel. However, the report of the Jenkins Panel did NOT address the administrative concerns about the SR&ED program raised by the community other than to acknowledge the significance. Nor did the Panel’s report address the continuing changes in the CRA’s practices. See http://rd-review.ca/eic/site/033.nsf/eng/h_00287.html.
It is very important for the Government to consult transparently with the SR&ED community about the current state of the SR&ED program so that relevant analyses can be done and effective decisions made. We believe that these results should be made public.
CATA believes that the review of the SR&ED program must be independent to be credible and influential. We do not believe that the current approach will achieve this.
Dr. Russ Roberts serves as CATA’s Sr. VP, Advocacy, Tax & Finance, drawing on more than 30 years of public policy expertise as he advances thought leadership for innovation and competitive success in Canada.