Do concerns regarding the effectiveness of Canada’s SR+ED Program stem from an incomplete understanding of the state of innovation in Canada?
by Rob Farrow, CPA, CGA President, Sutton Levinson Inc. (from a document presented to the CRA November 6, 2013)
As recently as September 9th of this year the Conference Board warned that “Canada’s economy is on a ‘path to mediocrity’ as innovation lags”. At about the same time the Startup Genome was reaching a much different conclusion. Their dataset was heavily skewed towards early stage startups. The report was co-authored by a number of entrepreneurs, included contributions from Steve Blank (Stanford University) and Ron Berman (UC Berkeley), and was supported by Telefónica Digital – a global business division of Telefónica S.A.
I have included a copy of that report with our submission.
At Sutton Levinson Inc (“SLI”) I believe that I speak for my colleagues when I say that we are committed to helping early stage companies grow. For that reason we believe strongly in the value of the SR&ED program.
According to STARTUP GENOME study, Toronto, Vancouver and Waterloo are 8th, 9th, and 16th respectively in terms of their importance as global technology hubs. If this is true – and we expect that it is – it may be in large part due to our generous tax incentives. While the US dominates with 6 recognized technology hubs, Canada is clearly performing well with 3 in the top 20.
In our view the greatest challenge facing early stage technology companies is clearly access to capital for commercialization:
Excerpts from STARTUP ECOSYSTEM REPORT 2012:
- “If Toronto does not improve its funding climate, entrepreneurs may relocate to the nearby
Startup Ecosystems of NYC and Boston where funding prospects are much better.”
- “Toronto’s startup ecosystem is self-sufficient. However, policy makers can help closing the funding gap by attracting late-stage venture funds through tax breaks and incentives, and investor-friendly policies.”
- “The funding climate for startups in Vancouver is insufficient, with startups receiving 80% less funding than startups in SV. They receive 72% less in Stage 2 (Validation) and 97% in stage 4 (Scale). The late stage funding market basically doesn’t exist for Vancouver startups.”
Perhaps the Startup Genome’s perspective is different because they are closer to the action and focused more on start-ups than the Conference Board of Canada. Quite frankly at SLI our focus is also on start-ups and early stage companies. We recognize their funding challenges and have developed connections locally within the investment community. Companies at this stage lack resources and experience. As a result, in some ways they actually need more sophisticated help than their later stage counterparts.
In any event we think it is important to recognize our successes and we believe that Canada’s SR&ED incentive program continues to be a success. The emergence of Toronto, Vancouver and Waterloo as global technology hubs certainly owes a debt to the SR&ED program.
In recent years there has been a great deal of discussion about Canada’s inability to leverage our
investment in R&D incentives to improve productivity. We believe that it is the lack of venture capital for commercialization that is the real culprit. However there are certainly some ‘intellectuals’ who have an almost religious aversion to government incentives of any kind.
CONCERNS WITH THE EFFECTIVENESS OF THE SR&ED PROGRAM
Concerns in Ottawa around the effectiveness of the SR&ED program culminated with the Jenkins Report that made the same mistake that the Conference Board made in September of this year:
- “The federal government recognizes that, despite its high level of federal R&D support, Canada continues to lag other countries in business R&D spending, rates of commercialization of new products and services, and productivity growth”
As a result we are taking a look at how the SR&ED program is being delivered. At SLI we note with some concern that the latest revision of Form T661 collects detailed information about the fee arrangement between claim preparation services and taxpayers.
We applaud the agency’s efforts to target unscrupulous service providers and to improve the quality of claims. We understand that the agency has concerns over contingent fee arrangements. It is, however, claimants themselves that dictate the structure of our engagement terms. Start-ups most often demand contingent arrangements for 3 reasons:
1. Cash flow – start-ups with little cash can fund the claim preparation fee using the tax credits received and delay payment until a refund is received
2. ‘Insurance’ that claims are well-prepared (at least partly because of the existence of unscrupulous or incompetent practitioners)
3. Perceived inconsistency in the determination of technical eligibility by the CRA (understandable given the rapid pace of technological change, the fact that determinations are inherently subjective and that unsuccessful claimants invariably blame the reviewer)
While we understand that the Canada Revenue Agency (“CRA”) may have concerns that service providers are receiving too large a proportion of the tax benefits that were meant as an incentive to SR&ED performers, we must point out that data being collected relates only to the fee and ignores the nature of the service being performed.
We don’t believe that all service providers offer equivalent services
The majority of our clients are start-ups or early stage and are unaware of the documentary requirements of the SR&ED program. While they almost invariably have contemporaneous documentation, they typically have not considered how to implement an activity-based costing
system that ties stand-alone systems to financial accounting records. Implementing such systems and
training our clients in their use, is a significant part of the work that we perform on their behalf.
In the case of start-ups, they may often require remedial bookkeeping when their records are clearly inadequate. In at least one instance we had to properly segregate payments to contractors and employees that had been intermingled by the bookkeeper. In the course of doing that work, we became aware of a significant error on the cut-off for the prior year, which their accountant failed to notice in the preceding year.
During our first year of operation, there are also numerous tax issues that we’ve had to address including:
1. Public company filing as a CCPC (a client we didn’t accept)
2. Company trying to claim EPSPs as SR&ED-eligible – when in fact they weren’t even EPSP- eligible
3. Issues around the valuation of VCC shares going into RRSPs
4. Taxation of and accounting for assistance of various types
5. Reconciliations of Income per financial statements with income for tax purposes
These are examples of the issues that have arisen with clients who are professionally represented. However, many early stage companies choose to use non-designated accountants and bookkeepers as a cost-savings. In addition, we have noticed a number of professional colleagues who represent clients without registering in public practice, presumably to avoid regulatory oversight.
We note that accounting regulatory bodies restrict their members from providing assurance services, unless they can demonstrate the required experience. However there is no corresponding restriction on members who have a background in assurance, who seek to provide taxation services.
In many cases practitioners’ expertise is primarily related to the eligibility of the technology. For many of them a review of the underlying accounting and related tax issues is simply outside of their area of expertise.
On average between 40% and 50% of hours spent by SLI relate to tax and accounting issues. Further, about 10% of our time spent results from our internal technical review process. Taken together we believe that we offer a robust process to our clients. Clearly this is not the case with many practitioners who provide primarily technical writing services.
For the reasons outlined, we trust that the CRA will not place too much reliance on statistics generated from these new forms, or at least understand the limitations of what is being measured.