Flawed R&D scheme costs taxpayers billions. Really?
Whenever I have had intimate knowledge of a particular subject, I am always amazed at how distorted and unsubstantiated a newspaper article can make of the situation, especially in the business community. I have been practicing in the area of R&D tax credits since 1982 and have some knowledge about the Canadian R&D tax credit system and other systems around the world.
I would like to take some time to dissect the article written by Barrie McKenna in the Globe and Mail on March 11, 2011.
“ A flood of questionable tax claims pushed by an exploding cottage industry of consultants is threatening Canada’s signature research and development incentive”
Ok, he is a journalist so he has to use words like flood and exploding. However, when we read into the article, Mr. Brideau of CRA is quoted as saying “It is important to note… that the vast majority of claims are compliant with filing requirements.” So what is the issue? If CRA thinks the vast majority of claims are acceptable then why is this being called into question? I will deal with abuse of the system below.
“But another CRA source said as many as two-thirds of SR&ED claims- often worth millions apiece-are merely accepted “ as filed”, with minimal vetting.” “ The program is prone to abuse because the risk of getting caught is low.” “
I think it is fair to say that CRA cannot audit every claim that is made. From a government viewpoint, auditing one third is very high. However, the most important fact to keep in mind is that your chance of being audited within any given 3-5 year period is greater than 90%. There are bad guys in every field of business and government, but knowing you are eventually going to get audited is very high deterrent.
“Erin Filliter… insisted the government is aggressively pursuing cases of potential fraud and laying charges…”
And so they should. Again no area of business or government is immune to fraud.
“The federal government has known about the gaping holes in the program for more than a decade. Numerous studies, including a 2000 Auditor-General’s report, warned of rampant problems with SR&ED…”. “ What’s worse, there’s no evidence generous tax incentives are leveraging any more R&D than would occur anyway. The Department of Finance concluded …. just $20M to $55M a year worth of net “real income for the country”
By auditor general standards, the SR&ED program came out with higher marks than most government agencies. If you go back and read the report, you will see that the recommendations are for CRA to reduce inconsistency, process claims faster and assess their risk management practices. There was no comment that funds were being wasted or abuse was occurring.
In addition, there have been econometric studies done on R&D tax credit program, and virtually all have concluded a positive net economic benefit.
The Finance document he refers to is from 1997 when the total amount of credits approved was much less than today. The statistic he failed to present from that report is that every federal credit generates $1.38 in incremental R&D spending per dollar of forgone revenue.
But why don’t we look at something more recent like the Sept 2007 Finance publication from Parsons and Phillips (an evaluation of the Federal Tax Credit for SR&ED)? Their conclusion was that the SR&ED tax credit generates positive net economic benefits under a reasonable range of assumptions.
Anecdotally our firm has noticed that companies taking part in and receiving tax credits under the SRED program will take on technically riskier projects than they otherwise would and the most common comment we receive from claimants upon receipt of their Investment Tax Credits is: “now we can hire more engineers”.
“Unlike most other developed countries, Canada chooses to pump cash into business R&D indirectly, through tax breaks, rather than directly through grants, investments or government purchases.”
Wow, to name just a few, the US, UK, Japan, France, Australia and China all have R&D tax credit programs. Tax credits are seen as fair, objective and having a low cost to administer. Grants put the decision as to which company gets funding into the hands of the government. This creates programs that are political in nature, rules that are shrouded in secrecy and provides very little certainty to businesses that they will receive funding. Just look at IRAP. Overwhelmingly, businesses want a tax credit is lieu of a grant.
“Like the SRTC, the great lure of the current system is that the credits are payable as cash refunds.”
The SR&ED program is nothing like the SRTC program, which lasted less than 2 years and was closed down in 1984 for abuse. The 2 main features of the current SR&D program which prevent abuse are: that a company must spend the money and carry out an eligible SR&ED project before receiving any kind of tax saving or credit; secondly, that CRA carries out a very high number of audits ensuring that every company is scrutinized at least once over a 3-5 year period. Many companies do not receive the tax credits until an audit takes place. Neither of these features were in place under the SRTC program.
“The result is that CRA is rubber stamping large volumes of smaller claims that look legitimate because more thorough reviews are too costly and time consuming. Meanwhile, many larger claims are being arbitrarily scaled back or rejected”
I have no idea where he gets this information. We have seen no evidence, based on the thousands of claims we have seen, that CRA is accepting a smaller claim over a larger claim. In fact we have seen the opposite; an increasing number of our clients are undergoing detailed reviews of claims made for less than $25K in total ITCs.
“ But a third or more of that cash being wasted and paid to consultants as a result of hazy rules on what’s legitimate R&D…”
This is really irresponsible. Let’s break it down. Let’s assume his figures are correct that the government hands out $4.7B of tax credits each year and over 20,000 companies apply for these credits. The statistics are that 8% of the companies that claim, or 1,600 companies receive 80% of the credits or $3.8B. So roughly $0.9B goes to the remaining 18,400 companies. Do you really think the large companies are paying consultants 30% of the $3.8B they receive? Again, as someone who has been working in this area for over 25 years, most large companies prepare the claim themselves and have the internal resources to do so. I would be surprised if 5% was going out to consultants on these large claims.
For the remaining group, there remains a high percentage of companies claiming the credits themselves without the aid of consultants. Further, with the competition in this “cottage” industry, the fees are down around 10-20% with fee caps on larger claims.
“ …decidedly low-tech and routine manufacturing, such as baking gluten free cake, making injection-moulded auto parts…”
Now he’s got the auto industry mad. Wow, Husky and all the other innovative companies in Canada that are striving to produce world class injection moulding systems and products should not get SR&ED credits? This is probably the worst thing he could say. It is this type of thinking and behaviour that is holding Canada back from being world class, not the SR&ED program. Thanks for that Barrie.
Anyone reading this would say I am biased as well as I am a consultant, and that is fair. But I have to confess I was morally troubled back in 1985 when I asked myself why any company should get a government hand out, grant, tax credit or subsidy. Governments should help the poor and disadvantaged and create an infrastructure of roads and community in which to live, but why in capitalist society should government fund business? Looking back over the past 25 years, I have grown to understand the particular difficulties of being a small business. This group has difficulty obtaining financing for accounts receivable let alone product development or process improvement. The large companies have much more access to capital markets for product and process R&D. This inequity can be bridged by government assistance to small business that objective, fair and open to all businesses that meet the rules and criteria. The SRED program fits this need.