The SR & ED Research and Development Tax Credit Program: A Technical Consultant's Experience and Perspective
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The 2012 Federal Budget introduces a number of changes to government participation in the Canadian marketplace. One of those includes support to Canadian manufacturing for investments in research and development through the Scientific Research and Experimental Development (SR & ED) Program. This article provides a consultant perspective on the analysis and public commentary that preceded the new Program formulation as defined by the 2012 Budget. While the program has changed in scope and design, the following comments serve to support the value of the SR & ED program and the contribution to it by industry consultants.
For those not familiar with the program, SR & ED has assisted Canadian businesses since 1986 in reducing risks associated with developing and improving technological processes, products, devices or materials. Under the SR & ED program both the Federal and the Provincial governments provide substantial cash credits to Canadian companies to assist them in recovering expenditures incurred during experimental and developmental projects. The intent is to stimulate companies to expand their knowledge, products and services. In 2010 (the latest estimates available), Canadian businesses received over 3.5 billion dollars in SR & ED credits from federal budget with provincial contributions adding funds on top of that.
More recently, the Harper Government appointed an independent panel to examine the costs and benefits of research and development support from Federal and Provincial governments over the past decade. The study made several criticisms of the Scientific Research and Experimental Development (SR & ED) program delivered by the Canada Revenue Agency (CRA) in partnership with various provincial jurisdictions.
This criticism was amplified by media pundits including Barrie McKenna of the Globe and Mail who bemoaned the cost of the program versus the demonstrated benefits. In particular, McKenna chose to conclude that most companies would undertake necessary innovation without government incentives. Further he suggested that the program created a "cottage industry of SRED Consultants" with the implied conclusion that they contribute little to the innovation process. Another review Panel chaired by Tom Jenkins from the software company Open Text took a more weighted approach. While supporting the concept of government incentive initiatives, his Panel offered recommendations for changes to the structure of current programs and reductions in the scope of SR & ED credits.
Given the importance of a competitive SME sector in our economy, one would hope that the current changes to SR & ED will capture the view point of all stakeholders before throwing out the proverbial baby with the bathwater. One particular and important perspective is the collective experience and lessons learned of the consulting sector. One can assume that with or without government innovation programs, a consultant sector will inevitably continue to provide expertise to companies in their dealings with government taxes.
MPG Consultants reflect a technical perspective with nearly a decade of experience with the SR & ED program in Eastern and Western Canada. Our clients come from a broad range of industries with the bulk of them being in manufacturing and machine building. In addition, the scope of our clients ranges from the small three to four employee ‘mom and pop’ operations through to corporations with over 150 employees. That experience leads us to a number of insights relative to the overall benefit of the program as well as to how clients can best benefit from the SR & ED program.
By any standards, our experience suggests a number of positive impacts of the research and development support offered through the CRA programs. On a day-to-day basis, we see the challenges faced by our clients in ensuring both the profitability and competitiveness of their individual operations. The recent government review has chosen to highlight a priority for supporting single-focus "breakthrough" technologies with more generous and less controlled targeted grants. We would not diminish the importance of breakthrough technologies. However, the government study and media analysis, unfortunately, all too often dismiss the importance of small incremental improvements to manufacturing and production process – such improvements reflect the ‘muscle and bone’ of SME successes in our country. Machine builders or anodizing plants rarely deliver break-through technologies. However, their very survival as businesses is dependent on intense searches and testing of effective solutions which they would not likely undertake without the SR & ED program. Such solutions do require risk and do require experimentation to ensure the success of manufacturing lines.
The impact of the SR & ED program is further enhanced when we consider its contribution to the survival of Canadian manufacturing in the international marketplace. The cannibalistic thought that we do not need all industries in Canada, let the unfit industries die out and focus on break-through avenues, is strategically dangerous. Let us not forget the fate of the rare earth industry which was centered in the United States twenty years ago. With the absolute demise of rare earth production in North America the electronics industry has been left at the mercy of Chinese suppliers for rare earth materials supply at prices several fold higher in an already recession-stressed economy.
The Jenkins’ panel report came out at a time of radical changes by CRA to the SR & ED claim review process. Over the last two years the technical report format was substantially streamlined to allow computer screening and keyword analysis. In the same period CRA hired a cohort of new technical auditors (by tradition, called Research and Technology Advisors (RTAs) which enabled increased frequency of site audits in some regions by up to 50%. During the audits, RTAs imposed increased demand for detailed engineering and financial documentation that would ensure rejection of claims that might have readily received approval in previous years. The rationale for greater stringency in the review process is quite direct and driven by the need for improved program effectiveness and program value for dollar. In the financial crisis of 2008-2009 SR & ED claims from industry increased by 30-40% with anecdotal experience suggesting that many businesses were managing to survive thanks only to the assistance of the SR & ED money. At the same time, the capacity of Federal Government resources was increasingly challenged by these new demands upon the SR & ED program.
The Jenkins’ panel report and anti-SR & ED media campaign evoked grim expectations about the future of the program and rather intense background discussions involving SR & ED consultants and big accounting firms in early 2012. The Federal Budget of March 29, 2012 confirmed continuation of the Program with some minor modifications. These changes mostly impact big businesses and include:
1. Removal of the capital allowance from the expenditure base (for capital expenditures incurred after 2014)
2. Reduction of the proxy used to calculate overhead costs from 65 percent to 55 percent (to be fully introduced as of January 1, 2014)
3. Reduction of contract payment eligibility to 80 percent of the payment (effective January 1, 2013)
4. Reduction in the general investment tax credit rate for big businesses from 20 percent to 15 percent (effective January 1, 2014).
The revised program still allows SME’s to earn substantial credits for salaries spent on experimentation – depending on the province estimated at 64% in Alberta, 69 % in Saskatchewan and 74 % in Manitoba.
The underlying conclusion from our experience and the new SR & ED Program is that Government remains committed to its support of research and development investments by industry. Moreover, it underscores the need by AMC members to appreciate the benefits of the Program and the value of ensuring obtaining full benefit of the SR & ED Program. In many cases, that process can be very profitably assisted by specialist consultants.
Some important lessons and pointers from the past and optimum benefits for companies claiming tax credits:
· SR & ED is for everyone – not just academic bench research. In fact, statistics show that experimental development claims where manufacturers present their work on improving mechanisms, devices and perfecting their manufacturing process constitute bulk of credits received by SME
· The Program requires special knowledge of CRA mandated rules, regulations and most important -practices.
· As with all tax program processes, the support service provided by consultants ensure optimum benefit to companies and/or defense before government agencies and adjudication entities (e.g. tax courts)
· Time spent by a innovation manager or floor manufacturing supervisor on government technical and financial submissions is time directly taken away from company problem solving and innovation
· Awareness of the SR&ED program is generally good – however, many companies are not completely familiar with the program and, more important, dismissive of it based on the popular misconception that it is simply is not worth the time
· As engineering professionals, our mandate is not only to report to CRA but to critically review, analyze and advise clients on the best courses of experimentation
· The very process of tracking innovation (e.g. time tracking) for SR & ED program which was developed over years is itself a benefit to overall administrative management of the client’s company Back to AMC Connection
   
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