Deloitte's submission to the Expert Panel Conducting the Review of Federal Support to Research and Development
February 18, 2011
Mr. Thomas Jenkins, Chair
The Expert Panel Conducting the Review
of Federal Support to Research and Development
c/o 1200-270 Albert Street,
Ottawa, Ontario, K1A 5G8
Deloitte is pleased to make this submission to The Expert Panel Conducting the Review of Federal Support to Research and Development. The government is reviewing the federal support for business R&D to see how this support could be enhanced to ensure that federal investment in R&D is effective and delivers maximum results.
In this submission, we will focus on the issues raised in question 10 of the Expert Panel Consultation paper focusing on the SR&ED program. We have extensive knowledge and experience with the SR&ED program through our interaction with many of our clients who utilize the program, our involvement with previous consultations including the CRA-Industry joint initiatives starting in 1997, as well as published research on the relevant legislation and administrative policies. In 2008, we were commissioned by Montreal International and the Toronto Region Research Alliance to undertake a survey to examine R&D issues and the role that the SR&ED program plays in fostering research spending by large firms. We believe that this study is important in understanding the rationale for R&D investment by large firms. It is attached as Appendix 1.
As the nation’s largest tax practice, Deloitte is committed to helping shape the tax policy that will create a globally competitive and innovation-friendly economy. This commitment is made real through direct communication with key government committees, policy makers, our clients and the public at large. Our Future of Tax website is our vehicle for engaging Canadians in a discussion on the role of tax policy in influencing the future of Canada..
As a part of our commitment, we have made previous submissions to the government on the SR&ED program including:
- “Tax Incentives for Scientific Research and Experimental Development”;
- Letter of October 22, 2010 presenting tax policy recommendations to the Minister of Finance in anticipation of Budget 2011; and
- Submission to the CICA Tax Policy Committee.
These papers are attached as Appendices 2-4 inclusive.
The SR&ED Program
The Role of Government in Stimulating R&D
The government has recognized the importance of Science and Technology to the Canadian economy and the role that the government has to play in ensuring a competitive marketplace and fostering an investment climate that encourages private sector investment in R&D in its 2007 publication entitled “Mobilizing Science and Technology to Canada’s Advantage”.
In a global economy, countries are competing for investment and incentives are necessary for Canada to remain attractive to foreign investors. Global investors demand progressive strategies, including R&D incentives, to invest in Canada. Canada has many attractive features including a strong economy, a good standard of living, a highly educated workforce and low income tax rates. However there are other factors where we are less competitive and which may lead investors to locate in more attractive jurisdictions. Our high labour rates and our high dollar make us an expensive place to do business. Government incentives that reduce the cost of performing R&D in Canada are important in maintaining a competitive profile. Canada was once a leader in the implementation of R&D incentive programs; however, more than 30 countries now have substantial tax incentive programs related to R&D and most countries have some form of R&D support.
Business requires government support to invest in the technologies that will build our future. It is crucial that the R&D incentives that are currently available in Canada be maintained and improved in order that industry continues to invest in R&D and drive innovation.
Our Response to your Consultation Questions on the SR&ED Program
1. Does the current structure of the SR&ED credit encourage incremental investment in R&D? Does it free up capital to invest in other aspects of innovation activities to the firm? Does this vary by size of ownership, sector or nationality of firm?
We believe that the current SR&ED Program is effective in encouraging incremental R&D investment. This is based on the following:
- As set out in the Expert Panel Consultation Paper, numerous studies and analyses have evaluated the positive impact of direct and indirect government support for R&D including the federal government’s own analysis.
- The results of the survey of large performers conducted for Montreal International and the Toronto Region Research Alliance and attached as an Appendix 1.
- Our years of experience with our clients who are claiming under the program, many of whom spend every dollar received under the program on incremental R&D spending
The SR&ED program allows all taxpayers to access the program and to choose where to invest their R&D dollars. This universality of access is one of the key characteristics of the SR&ED program. Furthermore, it is the undertaking of SR&ED that matters. Success or failure of the work undertaken is not a criterion. This allows companies the freedom to take risks on new unproven technologies and encourages innovation. Both of these features recommend the SR&ED program over direct grants and incentives that are targeted to specific industries or technologies and require applicants to demonstrate economic benefits.
However, we don’t believe that the program is effective for all large companies performing R&D. For example, the benefits of the program are eroded for Canadian subsidiaries of U.S. companies by the U.S. foreign tax credit legislation. In this case, the benefits of the program only represent a timing difference to the Canadian company as they are clawed back when dividends are paid to their U.S. parent. This is a major issue as Statistics Canada reports that 26 per cent of corporate profits and 30 per cent of revenues in Canada were earned by foreign companies in 2007.
In addition, as the incentives are treated as reduction of tax for accounting purposes rather than a reduction of the costs to which they relate, the benefits of the program are invisible to the R&D performer. Some, but not all, companies reallocate the R&D incentives to the R&D performer for budget purposes.
What is the impact of these issues on the effectiveness of the program in stimulating additional R&D investment? The survey conducted by Deloitte for Montreal International and the Toronto Research Alliance found that 58% of the large companies interviewed factor the SR&ED incentives in making their investment decisions. It should be noted that the survey was significant in that it covered 43 companies in Ontario and Quebec in the advanced manufacturing, information communication technology and pharmaceutical sectors. The companies surveyed are estimated to be responsible for 25% of all R&D expenditures in Canada and 15% of all R&D personnel in Canada. The employment number includes only direct employment and the percentage would be higher if subcontractors to these entities were included. Seventeen of the companies interviewed are ranked in the top 50 Global companies by R&D investment.
We believe that the SR&ED program can be more effective and the percentage of companies using the SR&ED incentives to stimulate additional R&D investment can be increased by introducing full of partial refundability of SR&ED investment tax credits earned. While the SR&ED program offers tax credits at a generous rate, “for Canada to stay competitive and maintain and create quality employment opportunities for an educated work force, it is essential that we enhance the economic impact of our SR&ED incentives. We recommend that the investment tax credit become partially refundable as it is in many countries and in certain provinces of Canada. Currently, only Canadian-controlled private corporations (whose income does not exceed the specified limit) may claim a refundable credit. Expanding the refundable credit to all businesses would appropriately reward the risks inherent in carrying out SR&ED in Canada. This would send a strong message to foreign companies seeking appropriate sites for new investment opportunities.
Refundability enhances predictability regarding timing of the benefits particularly for companies that are not currently paying tax. This will have positive impact on investment decisions as investors can clearly see the matching of risk and reward. This is particularly relevant to US-based multi-national enterprises for which the interplay of the Canadian and US tax regimes makes a non-refundable credit less relevant. From an accounting perspective, a refundable credit is preferable as it is considered an increase in EBIT (reduction in cost). In terms of the delivering the refunds, different models may be considered. For example, refunds could be withheld pending review and assessment. Alternatively, refunds could be issued after a certain time period has elapsed and the tax credits have not been used to reduce taxes payable” (similar to the rules in France.). Another model would deliver the refunds through payroll tax offsets. For a more detailed analysis of our comments on the effectiveness of the program and our recommendation on refundability, see the paper entitled “Innovation and the SR&ED Program” attached as Appendix 5.
2. What are the strengths and weaknesses of the refundable portion of the SR&ED tax credit for Canadian-controlled private corporations and to what extent does it encourage growth and commercial success of the program?
We believe that the current program is effective in encouraging growth in the corporations that can access the enhanced rate of investment tax credits and refunds. We applaud the federal government for increasing access to the program in the 2008 Budget. However, we would note the one of the stated goals for the program is to assist small business to perform SR&ED. Although small companies are innovative, the support for commercialization that drives productivity often comes from larger companies. We therefore recommend that the enhanced rate, refundable tax credits be available to all corporations, not just Canadian-controlled small business. In addition, many companies must balance their business growth objectives with the limits on taxable income and taxable capital that are necessary to retain their eligibility for the high rate refundable incentives. Our recommendations would eliminate the need to make business decisions that are driven by the tax rules.
3. Bearing in mind the improvements being made by the Canada Revenue Agency, are there additional opportunities for change to simply the administration of the SR&ED tax credit and to facilitate the application process?
For our views on the administration of the SR&ED program, please see our paper to the Canadian Tax Foundation included as Appendix 5. We do note that there is a forthcoming report of the Office of the Taxpayer’s Ombudsman on the administration which should be considered in your deliberations.
We believe that Canada requires an innovation-friendly economy and that the tax regime is a powerful instrument for bringing this about. Innovation requires entrepreneurs, competitive R&D incentives, a willingness to invest in emerging companies and other measures to support development of the world-class businesses that will drive Canada’s economic growth.
The Canadian economy has fared well relative to many other industrialized nations. One factor in the past has been the strength of the Canadian resource industry. However it becomes crucial for our future economic development to rely more on our ability to create knowledge and to enhance productivity through innovation. This will benefit all sectors and enable Canada to become a net exporter of related technologies. The wealth created through technical innovation will ensure that future generations will compete globally.
In this submission we confirm our support for enhancements to the SR&ED program to encourage foreign and domestic investment in R&D, and improvements in delivery of incentives to provide certainty to investors.
The outcome of these consultations has the potential to radically improve Canada’s SR&ED tax incentive program. We recommend that action be taken now to reshape the SR&ED program to provide more effective tax incentives to R&D performers. This will stimulate additional R&D in this country creating the proven spill over effects to the economy.
Yours very truly,
Partner and Global Managing Director
Global R&D and Government Incentives
Deloitte & Touche LLP
Please read our full submission.
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