The last time that a major report came out offering recommendations to the SR&ED program, the effect was profound. In 2011, Innovation Canada: A Call to Action – colloquially known as the Jenkins Report was released. One of the recommendations was to modify the SR&ED process to help small businesses scale into larger firms by basing the credit on labour costs.1. The following year, Stephen Harper’s Conservative government made changes in the 2012 Federal Budget that had significant impacts on the SR&ED program, including reducing the investment tax credit rate from 20 percent to 15 percent.2 Many of the changes were based on the recommendations of the Jenkins Report.
Could the same thing happen again? Perhaps it is already happening. In September, the Department of Innovation, Science and Economic Development Canada published a report on its website called the Report from Canada’s Economic Strategy Tables. In it, there are recommendations to make it easier for larger Canadian corporations to benefit from the SR&ED tax credit. Could this mean that in next year’s federal budget – and do not forget that 2019 is an election year in the federal government – there could be significant changes to the SR&ED program that will make it harder for Small and Medium Enterprises (SMEs) to obtain the tax credit?
This article will examine the changes outlined in the report.
A Call to Encourage Companies to Scale Up
One of the recommendations from the Report from Canada’s Economic Strategy Tables is that Canadian businesses need more encouragement to scale up, likely owing to the usual complaints from industry that Canadian companies are risk averse and this aversion may factor into the reason why they do not grow to the scale of a global competitor such as Google or Facebook. 3 The report notes that, currently, Canadian SMEs receive a refund of up to 35% of the first $3 million in eligible expenditures each year, but larger companies do not receive as much of a refund.4
The report then notes that “[t]he government should refocus to support more high-performing scale-ups to increase our chances of building billion-dollar anchor firms. Low-performing firms must be allowed to fail in order to free up tax dollars.” 5
That’s a shocking proposition: that the SR&ED program should go to reward companies once they become big businesses, while smaller companies may be more vulnerable by denying them with the same level of tax incentive support. The report notes that “government programs [such as SR&ED] tend to focus [too much] on entrepreneurs and small and medium-sized enterprises.” 6
However, this criticism does not exist in a vacuum. For instance, The Information Technology Association of Canada (ITAC), a national information and communications technology (ICT) business association, wrote in a pre-2018 Federal Budget submission during 2017 that “SR&ED is highly successful at supporting start-ups, but less effective at helping our small companies scale to middle- and large-sized businesses. The reason for this is that SR&ED can inadvertently incentivize companies to stay small by scaling back the credits as companies grow and reach commercial success.”7
Are Entrepreneurs Really the Problem?
The report then provides the following illustration of this “problem”:
[U]nder SR&ED, Canada’s largest innovation support program, Canadian SMEs can earn cash-refundable tax credits for 35% of eligible expenses. Provincial R&D tax credits raise that support from 35% to nearly 45%. Larger Canadian businesses, on the other hand, are eligible for tax credits on just 15% of their eligible expenses. An additional 7% from provincial R&D tax credits raises the total to 22%.8
According to this document, “supporting SMEs is important” but notes that the result is too many small firms in Canada in a global economy dominated by giant corporations.9 On the other hand, if programs such as SR&ED supported “high-performing scale-ups,” then Canada would have a “community of digital anchor firms,” and regional technology clusters would be more likely to be built to keep firms growing.10
Calls for an SR&ED Program Review.
The Report from Canada’s Economic Strategy explicitly calls for the SR&ED program to be reviewed. “Beyond a slow application process, … [the program’s funding parameters] are out of step with the kind of research in today’s digital era.”11 The report then notes that, again, there is a need for a review to address the scale-up gap. It says that while R&D activities are successfully supported in Canada by the SR&ED program, “production is then often shifted to other countries. New and existing programs should aim to retain these firms’ production in Canada by creating additional incentives to do so. 12
What is the point of SR&ED?
From our perspective, this report overlooks the whole point of the SR&ED program. As stated, the purpose of the SR&ED program is to offer tax incentives that encourage and support scientific research and experimental development (SR&ED). The program does this by letting individuals or businesses deduct SR&ED costs from their income for tax purposes. Also, the program gives them an investment tax credit that they can use to reduce their income tax.13
It is our opinion that it is not to help or reward companies that are on the cusp of becoming global behemoths. The proposed changes would not address a key underlying issue: many of our top companies are supported using SR&ED and IRAP but are subsequently purchased by international organizations. We are, in essence, providing “discount startups” by celebrating these acquisitions as successes, when the funding for their growth comes from Canadian taxpayers. In fact, in 2016, PwC reported that in the five years preceding, 183 Canadian companies had been acquired, and nearly 70% of those were by U.S. companies. In addition, the report from PwC found that 77% of tech founders were planning an “exit strategy” – meaning that they were hoping to be bought out or acquired by another company rather than try to grow their firm into a billion-dollar empire such as Facebook or Google.14
An alternative option would be to find ways to retain the knowledge and jobs within Canada once they have passed the high-growth phase. Right now, two-thirds (66%) of software engineering students are leaving Canada to work after graduation. Other occupations where graduates typically leave Canada to find work include computer engineering, computer science, engineering science, and systems design engineering. More than four-fifths (81.5%) of graduates leaving Canada picked the U.S. as their destination of choice.15
To put things into perspective, one of the chairs of the report is the Chief Executive Officer and Founder of Shopify, which has arguably become the biggest – or at least most well-known -Canadian company in the digital retail space. It should be noted that Shopify was once a start-up. What led to the organization staying within Canada? How can this success be reproduced? Should SR&ED be revamped to benefit research done by bigger companies, at the expense of smaller ones? The report’s recommendations of rewarding larger companies doing R&D that is more apt to be commercialized over the intended purpose of the program to foster R&D first and foremost seems suspect.
If that seems bothersome to you – that the SR&ED program could change to place more emphasis on companies that are large or more prone to growing and the commercialization of products, perhaps at the cost of research’s sake – the best approach is to let your Member of Parliament know how you feel.