February 1, 2018

Canadian Industry Questions Government Review of R&D Tax Subsidies: Peter Menyasz, Canadian Correspondent at Bloomberg BNA

Snapshot

  • Industry worried R&D funding to be cut further to offset budget deficits
  • Further cuts could cause exodus in research to other jurisdictions

By Peter Menyasz

It’s been nearly 10 months since Canada’s federal government announced a review of its mainstay tax incentive for innovation, but officials can’t say how the review is progressing, what its goals are, or how long it will take.

Lack of clarity on the future of the Scientific Research & Experimental Development (SR&ED) Investment Tax Credit, worth C$2.7 billion ($2.2 billion) to businesses in 2016, has inudstries like automobile manufacturing worried about a further shift to targeted incentives that could spark a research exodus to other countries.

The government launched the review in March 2017 as part of a broader probe of innovation policy announced in its 2017 budget, but has said nothing since, says John Reid, president of the Canadian Advanced Technology Alliance (CATA).

The business group was “caught by surprise” when Finance Department officials seemed unsure whether they had a mandate to review the credit, and Canada Revenue Agency officials were in the dark on what was happening, Reid told Bloomberg Tax.

“I don’t think anyone is in charge,” he said.

The universally available tax credit program has been slashed from more than C$4 billion ($3.2 billion) in 2008 in favor of grants that let government decide who gets R&D support, and business leaders worry the review will accelerate that trend, he said.

CATA, in a July 2017 report, highlighted the Finance Department’s projection that SR&ED tax credits in 2017 would total C$1.8 billion ($1.5 billion), a 24 percent decrease from the department’s previous forecast for the year. That follows on a C$4.2 billion ($3.4 billion) decline in SR&ED tax credits over the 2009-2010 to 2014-2015 period, the group said.

Large Companies Disadvantaged

Sal Vivona, director of R&D taxation with auto parts giant Magna International Inc., says a continued shift to grants and low-interest loans favors small and medium-sized firms at the expense of large corporations.

It’s hard for companies like Magna to justify doing R&D domestically when they can get better tax support abroad, Vivona told Bloomberg Tax. Some companies are already moving R&D abroad, in part due to the prospects of the North American Free Trade Agreement collapsing under U.S. government opposition, he said.

“If NAFTA disappears, our costs are going to go through the roof,” he said. “We’re going to go south. We’re going to go to other countries. We already have.”

Most R&D performed by small firms is commissioned by large companies, but the government only allows the “doer” to claim the credit, Vivona said. That also makes it more attractive for large firms to move R&D abroad, particularly after Canada in 2012 cut the non-refundable credit for large business to 15 percent from 20 percent, he said. Small and medium-sized businesses are eligible for a refundable 35 percent credit.

It’s particularly an issue in the auto industry, where large-parts manufacturers like Magna are responsible for much of the innovation work, but also affects other sectors like pharmaceuticals and aerospace, he said.

The Canada Revenue Agency’s efforts to limit SR&ED tax credit approvals also hurts, Vivona said. The government was “gung-ho” when the credit was launched in 1984, but as budgets have become strained, the agency has increasingly audited and challenged claims, he said.

The pharmaceutical sector doesn’t have a unified position on the tax credit, with some firms still using it but others finding it too complicated and bureaucratic, an industry source told Bloomberg Tax.

Government Vague on Progress

The government’s promised review of business innovation programs is intended to simplify them, better align them with client needs, and make them easier to access, Department of Finance spokesman Jack Aubry said Jan. 16.

The program review is led by the Treasury Board secretariat, while the Department of Finance conducts a parallel internal review of the SR&ED tax incentive to ensure it remains “effective and efficient,” Aubry told Bloomberg Tax in an email.

“The department is not in a position to indicate when the government intends to announce the outcome of the internal review,” he said.

CATA stressed, in a Jan. 10 brief, that the government must provide a clear and transparent explanation of the review, including which departments and agencies are responsible, the individuals involved, the process, and key elements of the SR&ED program on which it needs industry input.

The brief suggested setting measurable targets for proposed changes to tax instruments and obtaining independent third-party analysis of options for improvements to existing policies and the impacts of changes to the tax environment on Canada’s competitiveness. It also called for creation of a new, independent administrator to take over operation of the program from the Canada Revenue Agency.

And it proposed creation of a new labor-based digital innovation refundable tax credit for smaller businesses and a new “innovation box” incentive to support commercialization and export of successes funded by the SR&ED tax credit and the proposed digital innovation credit.

The Canada Revenue Agency says it supports simplifying the SR&ED rules, but it’s disturbing that the review’s goals aren’t clear, says Russ Roberts, the lobby group’s vice-president of tax and advocacy.

“Are they going to try to balance the budget off this?” Roberts, who helped develop the credit while working for the tax agency, told Bloomberg Tax. Countries like France and the U.K. are much better than Canada at using tax incentives to leverage investment and reward commercialization of research, he said.

Tax Credit Effective, Academic Says

The SR&ED tax credit is among the few effective government supports for innovation, but providing across-the-board subsidies isn’t necessarily a good idea, says John Lester, a former Department of Finance official and now on the faculty of the University of Calgary’s School of Public Policy, which released a report this month on business subsidies.

“Not every small business is going to be the next Blackberry or OpenText,” Lester told Bloomberg Tax.

The government could scale back support for small businesses and replace it with grants, but that risks missing out on potential success stories, he said. Patent boxes may be an option, ensuring that income from intellectual property relates to production within Canada, or the government could use funds currently allocated to SR&ED to lower taxes on intellectual property income, he said.

To contact the reporter on this story: Peter Menyasz in Ottawa at correspondents@bloomberglaw.com

To contact the editor responsible for this story: Penny Sukhraj at psukhraj@bloombergtax.com

For More Information

The EY analysis of pharmaceutical industry R&D spending is at http://innovativemedicines.ca/wp-content/uploads/2017/10/20171030_EY-REPORT_IMC_FINAL.pdf.

The study on Canadian business subsidies is available at https://www.policyschool.ca/wp-content/uploads/2018/01/Business-Subsidies-in-Canada-Lester.pdf.

Reproduced with permission from Daily Tax Report. International, 15 TMIN (January 23, 2018). Copyright 2018 by The Bureau of National Affairs, Inc. (800-372-1033) <http://www.bna.com>

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