Canada’s SR&ED program under scrutiny
R&D tax update, 19 July 2011 (11-3)
Canada’s research and development (R&D) landscape has been under intense scrutiny for several months. Recent reports issued by the Organisation for Economic Co-operation and Development and the Science, Technology and Innovation Council have suggested weaker performance in R&D and innovation by Canadian companies, compared globally, despite the generous Scientific Research & Experimental Development (SR&ED) tax incentive program. The SR&ED program is currently being reviewed as well. The Canada Revenue Agency (CRA) is undertaking a SR&ED Policy Review Project to “consolidate and clarify” the guidance material available to SR&ED claimants. In addition, the independent expert panel headed by Thomas Jenkins, Executive Chairman of OpenText, has been enlisted to assess the federal government’s R&D efforts. Furthermore, the Taxpayers’ Ombudsman has issued a report on the appeals process for SR&ED claims, and is reviewing the systemic issues in the SR&ED program.
Deloitte considers innovation and productivity as being central to Canada’s ability to maintain a relative position of leadership in the world. Recent media criticisms of the SR&ED program could lead to overreaction. We support endeavors to improve the program and make it a more effective tool for industrial innovation. Deloitte urges policy makers to apply caution when proposing changes and to seriously consider industry’s view. Surveys indicate that Canada was able to attract and maintain foreign industrial investment at least partly thanks to the SR&ED program. Industry innovation is mobile and even where Canada’s attraction comes, for example, from its resource base, the fact is that the related innovation investment can now be made anywhere in the world where a similar resource base exists.
In the coming weeks, Deloitte will issue several R&D Tax Updates with insights on topics relevant to the R&D discussion, including the SR&ED Policy Review Project, global R&D tax incentives, and tax policies to improve Canada’s innovation and productivity.
In this issue, we provide an overview of Phase 3 of the SR&ED Policy Review Project, which is currently posted on the CRA’s website for comments and scheduled to be removed August 4, 2011.
New policy papers
As described in our May 11, 2011 newsletter, the material developed under this project is scheduled to replace all current SR&ED guidance documents, effective July 1, 2012. Most of the papers will cover financial topics, four are to be on joint financial/scientific topics, and one is categorized as “scientific”. The current phase of the Project includes the single technical paper, Policy on the Eligibility of Work for SR&ED Investment Tax Credits, along with five papers on financial topics.
The Eligibility paper is to replace the more than 20 SR&ED publications that were created between 1994 and 2005, many of them developed by joint CRA/industry working groups. At only 12 pages, plus glossary and appendices, it is inevitably a much higher level document, and therefore subject to interpretation; the financial papers provide detailed instructions and examples, which is not the case in this paper. For instance, it mentions the importance of deciding whether work is to be claimed as scientific research or as experimental development, but gives no guidance as to what criteria to use. References are not included, although there is a list of source material at the end. For explicit advice on what to do in particular circumstances, claimants will need to turn to other sources such as the Guide to Form T661 and the Guide for Claimants.
The Eligibility paper does include some new recommendations. Scientific or technological advancement and uncertainty have traditionally been the primary consideration when a SR&ED claim is reviewed. As set out in section 2.1.1, the first factor to be considered will now be “technical content”. To satisfy this criterion, the claimed work must have followed the scientific method – starting with defining the inherent uncertainty, then formulating hypotheses, followed by planning and carrying out the testing of the hypotheses, and finally developing conclusions. For each of these stages, contemporaneous documentary evidence is required, since as stated in the paper, “documentation is inherent to the scientific method”. Only after it has been determined that the work meets the technical content criterion does advancement become a factor.
It’s clear that SR&ED program users need to be prepared for a more formal approach to claim review. Although, as always, individual CRA reviewers may choose to interpret evidence requirements more liberally, this and other recent CRA publications provide full justification for work that otherwise meets the criteria for SR&ED to be disallowed on the grounds of inadequate documentation. To avoid the risk of losing credits, potential claimants need to set up comprehensive detailed record keeping for any work they may wish to claim.
This paper, Policy on the Eligibility of Work for SR&ED Investment Tax Credits, is currently posted on the CRA website for comments, and is scheduled to be removed on August 4, 2011. The other Phase 3 papers currently available on the CRA website are:
- Assistance and Contracts Payment Policy
- Contract Expenditures for SR&ED Performed on Behalf of a Claimant Policy
- SR&ED Overhead and Other Expenditures Policy
- Traditional and Proxy Methods Policy
- Prescribed Proxy Amount
They focus on two main areas; work performed under contract, and the details and comparison of the alternate methods of claiming overhead costs, the “traditional” and “proxy” methods. Like the other papers on financial topics in this Project, these are detailed and supported by examples as necessary, and are clearly intended to cover every eventuality. They include cross-references to related documents in the series, and references to relevant legislation.
The SR&ED Policy Review Project will certainly impact SR&ED claim-and-review processes going forward. A number of changes, whether intentional or not, may be introduced in the recent initiatives undertaken by the CRA. These changes could significantly impact the value of tax credits that industry can claim. It is therefore essential to review and monitor the papers being released and make recommendations as deemed appropriate.
Deloitte professionals are available to discuss these matters with you.
This publication is produced by Deloitte & Touche LLP as an information service to clients and friends of the firm, and is not intended to substitute for competent professional advice. No action should be initiated without consulting your professional advisors. Your use of this document is at your own risk.