The SR&ED tax credit program is odd in that from a tax policy viewpoint it is an incentive program, nudging companies to carry out more R&D in Canada and develop innovative products and processes. However, because the program is administered by CRA, one must deal with tax auditors SRED claim audits, which are intrinsically a disincentive.
To be fair, CRA is tasked with administering the Act, including any incentives in the Act. This partly means protecting the integrity of tax collection. Those old enough to remember the SRTC program, forefather to SR&ED, know how such a program can be abused quickly.
Under the SRTC program, well over a $1 billion of tax credits flowed out before CRA could examine the underlying R&D projects, many of which were bogus. This program lasted for only a few years with significant damage inflicted on the R&D ecosystem. As the SR&ED program now has been around for over 30 years, CRA has seen its fair share of questionable SR&ED claims.
As the SR&ED program now has been around for over 30 years, CRA has seen its fair share of questionable SR&ED claims. However, the turning point came in 2012, when a body of literature appeared in various news outlets covering suspect SR&ED projects. The government at the time provided CRA with $10m in funding to hire and retrain SR&ED auditors to prevent any perceived abuse.
The result has been the administration of SR&ED by CRA as a program prone to abuse and not as an incentive program with a lighter touch on audits. We now have more intense and frequent audits of SR&ED claims, supported by the following stats:
- In 2015, roughly 23,000 SR&ED claims were filed in Canada, down from roughly 25,000 from the prior year. This figure appears to be trending downward each year.
- In 2015, ITC’s claimed were roughly $3.8 billion, down from $4.3B the prior year.
- Nationally, nearly 60 per cent of all SR&ED claims were referred to a local office for further review and of that 27 per cent resulted in a site review.
- Upon a detailed site review, 60 per cent of all SR&ED claims were reduced.
The chance of having your SR&ED claim audited at least once every 5 years is over 90 per cent. This is a very high audit rate for an incentive program. Countries with similar R&D tax credit programs like the UK, Netherlands, and Australia have much lower audit rates.
The SR&ED audit process: CRA’s “Audit Culture”
Anecdotally, companies that have gone through an audit of their SR&ED claim by CRA can tell you why and how their claims are diminishing. They feel the definition of what is eligible is more restrictive and more detailed documentation is required to support the claim; despite SR&ED legislation remaining unchanged.
CRA has service standards to process claims except when a review or audit takes place, then all bets are off. Many companies experience long delays, waiting several months after the initial meeting with CRA before they get any indication of a reviewer’s determination on their SR&ED eligibility. The burden on the claimant is also increasing as reviewers are asking companies to respond to multiple requests for information or to add to their current contemporaneous documentation systems by summarizing their existing documentation; documenting their documents as it were.
Due to this high audit/review rate, many CRA reviewers have large file loads with increasing difficulty to process the files in a timely fashion. Sometimes it feels like reviews end up dragging for so long that it becomes difficult to imagine that a reviewer can recall the facts when so much time has passed since the first review meeting took place.
A Lack of Consistency
Currently, there is no centralized control over the specific practices used across the country. The Headquarters in Ottawa issues high-level policy documentation and leaves interpretation specifics to the Regional Offices. As a result, there is a wide discrepancy when it comes to results among districts. For example, in 2015 the national average of ITCs adjusted on a site review was nearly 23 per cent. However, a number of large district offices reported adjusted ITCs of twice this amount. Overall, this leads to inconsistency and unpredictability.
What Can Claimants Do?
SR&ED claim preparation
It really helps if you have a process like RDP’s Innovation Connection Program (ICP) to identify, capture and document SR&ED projects, activities, and costs. If you follow this process, you will be ahead of the numerous companies who file SR&ED without a formal process.
Here are a few pointers on filling out the SR&ED claim forms especially the project descriptions:
- Make sure you describe the technological uncertainty at the right level and clearly separate it from routine development. This is easier said than done, but often the uncertainty is either too vague (described at too high level) or described at so low a level that it appears routine.
- Make sure you do your due diligence and set a baseline for the technology. CRA will check online to see if a solution to your Technological Uncertainty is public knowledge. If they find information online, even if it is only vaguely related, CRA will interpret it as known and try to deny the claim.
What to do during an audit?
The most important thing to do is to prepare. RDP recommends mock reviews as a good dress rehearsal for the real thing; to understand what needs to be demonstrated to CRA in terms of eligibility. If you go in cold there is a good chance you will get tripped up answering a question in such a way that it hurts more than it helps.
CRA will likely have prejudged your SR&ED claim before the initial meeting. They would have read your project description and developed a plan to review the claim. If they have a negative view of your submission, you have an uphill battle to change their minds. You should address these issues as soon as possible in the initial meeting. If you can find out these issues before the meeting, even better.
Ensure the key technical person is at the meeting. This person is the competent professional and will know more about the company’s development work than CRA. He/she needs to believe in the technological uncertainty and stay confident so as not to be swayed by CRA during the meeting.
What happens when CRA denies your SR&ED claim?
If you have concerns about the outcome of a review or how the review was conducted, you should bring them to the attention of the CRA Reviewer and Manager. If that fails, a company can request an Administrative Second Review. Anyone of these options can resolve the concerns, but to ensure a good outcome, concerns should be raised before the report is written and the file is closed. This is the best chance for a company to influence the determination and improve the outcome. However, disappointingly, success rates for changing a determination at this stage are still relatively low.
If the issue relates to mistakes that could result in a misunderstanding or omission, undue delays, employee behavior, etc. a Service Complaint can be filed with CRA. This can be a fairly quick process as the goal is to resolve it within 30 business days. The narrow scope of a Service Complaint means it isn’t the answer for issues such as disagreements with eligibility determinations.
Another option is to file an Appeal through a Notice of Objection to request that CRA’s Appeals Division reconsider the facts of the claim. On the surface, this seems like a good option, and it can be if there is an obvious error in interpretation on the part of the Reviewer(s), if there is additional (and convincing) documentary evidence to provide, or if a specific expenditure was denied within a claim that had been otherwise deemed eligible.
In CRA’s Guidelines for Resolving Claimants’ Concerns document, CRA states that filing an Objection is an option if a Claimant feels that “facts have been misinterpreted or the law has been incorrectly applied”.
However, in practice, the review through Objection is rarely effective for a claimant. It appears that the Appeals Officers do not consider any new information unless it is a new, contemporaneous document (information through argument or explanation is not considered), making it very difficult to argue that the facts have been misinterpreted. Through Appeals, the decision-making process by CRA is not evaluated. Issues related to how the review was conducted are not within the scope of a review under this process. Worse, this process takes as long as several years to resolve and while a claimant can provide additional documentation to the Appeals Division, there is no meeting or discussion for this review.
Tax court is another option, and quite possibly a more successful one, but it does involve costs that not all claimants can afford. The benefit of taking a claim to the Tax Court of Canada is that it relies on the law rather than on CRA’s administrative policies. The definition of SR&ED in the Income Tax Act has not changed so the tightening companies are seeing through CRA’s administration of the law is not at play in this arena. This process is much faster than the Objection route and settlement is also an option. Not every company whose claim is denied or reduced has the time, inclination, or resources to go to the Tax Court.
Can we fix what appears to be broken?
It does not appear that the SR&ED program is high on the government’s list of priorities. This is evidenced by the fact that the Government promised to review all Innovation Programs and in parallel, review the SR&ED program. Budget 2018 announced upcoming changes to many grant programs, but there was no mention of the SR&ED program whatsoever. At present, it is unclear what became of that promise. It is unclear if it would be reviewed behind closed doors and without consultation with key stakeholders and participants.
Know your rights, know your options
Irrespective of changes in the SR&ED landscape, there are still many businesses that rely on SR&ED to fund their R&D and help them remain competitive in the global marketplace. A large number of companies are still receiving SR&ED credits annually and without incident with positive and collaborative experiences with CRA’s staff during reviews of their claims.
However, when things don’t go well, remember that you have options.