RTA Contingency Fees A few weeks ago, the Department of Finance launched a Consultation Regarding The Impact of Contingency Fees on The Effectiveness of the Scientific Research and Experimental Development (SR&ED) Tax Incentive Program. 

Many people took the time to respond, including our in-house expert Gilbert Lance. His letter to the group is visible below. Be sure to follow our blog to read the opinion of some of our other key writers who submitted their responses.

SR&ED Contingency Fees In The Opinion Of A Former CRA Advisor

September 28, 2012

To The Reviewer:

I worked in policy and operations between 1986-2005 as a Research and Technology Advisor (RTA) at the Canada Revenue Agency (CRA), and later as a consultant with a couple of the Big Four accounting firms, a few local boutiques consulting groups, and finally in my own practice. As I have experienced the evolution of the program and the attitudes around the program, I no longer believe that companies should apply independently. The exception is if they are part of the Account Executive program and an extremely knowledgeable RTA that takes the time to get to know the company and actually visits it is assigned to their file. Otherwise, it is better to have someone assist with navigating the system.

With regards to compensation, I firmly believe it is up company and the consultant to make this decision on their own. Just as any consumer has the option to shop around for the best price and fit for their needs (indeed, it is their right to be able to decide who they utilize), the same applies to the selection of SR&ED consultants.

In my experience, the reasons that R&D performers use the services of third party preparers is exactly the same reason that certain activities and skills are outsourced by companies:

1. SR&ED Knowledge

It takes time to remain current on the legislation and the legal precedents set by the courts. In most cases, a company does not have the resources to devote to this endeavour, nor should they as most of these companies are focused on technology. The knowledge necessary for staying up to date on SR&ED is technological, legal and financial, with a heavy dose of politics and bureaucracy. Maintaining current knowledge of the program is not itself an overly onerous task; however, dealing with the highly variable and inconsistent administrative and attitudinal changes is particularly arduous. Companies for decades – if not centuries – have outsourced the performance of activities that require specific knowledge.

2. Cash Flow

Incentives are not delivered until after expenses have been incurred, sometimes up to 18-24 months later. Although the turnaround time for submissions has improved, for many companies it is still often long, onerous, and an increasingly unpredictable process. This is particularly apparent when there is back-and-forth because of missing information or misperceptions that require clarification.

In particular, most start-ups and small companies are traveling through the Valley of Death. They tend to be underfunded and focused almost exclusively on development of the technology and products that will generate income. They do not have the funds to pay for services under different structure (hourly, fixed-fee). With a contingency-fee structure – even if it means higher fees in the long term – they are able to offset the payment and share the “risk” of filing. One of the major advantages is that if the file is delayed the time it takes to resolve it and fees are adjusted accordingly.

If these companies were able to borrow money at a very reasonable rate from the financial institutions, the need for expensive “risk free” services would drop dramatically; however, banks are traditionally risk-adverse and are unable to advance funds to early-stage companies due to the level of financial security that is required. Thus a small business must either borrow from a company at a high rate or sell (“factor”) their credits for a reduced percentage of the refund if they wish to have funds available to pay consultants. A contingency-fee structure is thus preferable to the alternatives.

For the consulting firm, the risk of not being paid is much higher with early-stage (or even more advanced) companies who are investing heavily in high-risk R&D. A brief look at the job boards shows that that many consulting firms are forced to hire in-house counsel to help with collections of payment. Regardless of the ethics of the individual entrepreneurs, invoices are often left unpaid as they have other priorities (such as keeping the lights on while they innovate). Thus those organizations that utilize a contingency fee approach must charge a higher rate to ensure that they are also able to meet all their commitments.

3. Trust in the CRA

During my time at the CRA one of the first things I noticed was that taxpayers did not trust Revenue Canada. They will however trust an individual when that individual is shown to be experienced, knowledgeable and fair.   The CRA is important for maintaining the cash flow of the government and arguably of the nation and should be applauded for the great institution that it is; however, it suffers from a history pock-marked with tax collectors who were not the most reasonable individuals. A quick search online shows that brand management issues still exist due to individuals who are overly zealous in their roles and the reputation of the organization suffers as a while. In short, most people hate the taxman. This is compounded by the secretive nature (required due to administrative and legal reasons) of the organization. No one knows what takes place behind closed doors at the CRA.

The administration of the SR&ED program – administered by the CRA – suffers from similar issues of trust. For organizations that survived the “bulge” after the September 13th, 1994 sunset date for older claims and the resulting “dark years” of SR&ED, there is a lingering distrust that the CRA can handle this as part of their mandate. While considerable efforts were made to improve the program in the late 90s and early 00s, due to budget cuts industry partnerships have declined and the approach has shifted from providing helpful, incentive-oriented service to a risk-management approach, with rigid interpretations and poor communication. This has not helped in building the trust of either new or returning applicants to the program; consequently, many taxpayers prefer either: (a) not to claim or (b) to hire someone to interact with the CRA on their behalf.

When an individual is dealing with a representative from CRA who they do not feel is either listening or communicating effectively, this adds a distractive and emotional burden to their life. Many people often forget that the pay check of the CRA employee is guaranteed; the pay check of the entrepreneur is not. Business owners would prefer to minimize the stress already present in their lives and, in many cases, hire consultants and tax professionals using a no-risk approach to avoid cash flow issues.

4. Size of the SR&ED Contingency Fee

The size of the contingency fee is dependent upon many circumstances. The biggest one is whether or not the company hiring external consultants chooses to compare rates (opting to negotiate a lower fee). Contingency fees seem to very between 10% and 35%, though most are in the lower range. This is in-line with the cost of compliance identified in the 1996 study Measuring the Compliance Cost of Tax Expenditures: The Case of Research and Development Incentives. Further information that answers these points can be found in the 1996 Department of Finance studies (not consultations) where many of these questions were addressed.

Other factors include the size of the risk shared (is it in a contentious field?) as well as time between contract execution, work performed, and ultimate payment. Time to prepare, organize and help the company to set up more appropriate processes for future clients also comes into consideration.

A successful claim made under a contingency-fee arrangement will return a higher profit, unless the CRA has shifted into a forensic audit approach and sent an overwhelming number of information requests. In this instance, hourly fees also become an issue – trying to track down an RTA who will not return calls can quickly increase the cost of hiring under an alternate arrangement without adding any value.

From what I’ve seen in my 25+ years both at a Research and Technology advisor and external consultant, I seriously doubt that the fees have a major impact on the effectiveness of the program.

By contrast, the timeliness of a refund has higher impact. Consultants can have a major impact on how fast the claim is processed by helping to provide the right information to CRA and to help the company capture the right information in an appropriate process. Thus they perform a service both to the government and to the entrepreneur.

There is no doubt that there are firms that charge too much – just as there are financial institutions that also charge exorbitant fees when the risk is higher. The consumer always has a choice as to who to engage, just as they would when selecting a lawyer. What always surprised me during my time at the CRA was the high percentage of companies that still either did not know about or did not choose to participate in the program. This to me is considerable inefficiency and failing of the current structure of the program. Consultants often play a role in educating potential claimants, and they are able to see the SR&ED merit of companies while an RTA with limited time may not initially be able to see the eligibility.

If one eliminated SR&ED contingency fees, one would find that the companies that require the most assistance – first time claimants and start-ups – would quickly cease to apply. This would not serve the companies nor the government objectives. (Tweet this quote by clicking here.)

If they government is truly concerned regarding the cost of compliance, the role of consultants, and the net benefit to taxpayers, there are multiple studies that have been conducted by Industry Canada, the Department of Finance, the Canada Revenue Agency, and others that provide templates for a methodologically-sound investigation of the issues. Indeed, many of them contain answers to the very questions being asked.

Finally, if the process is simplified to the point where consultants are no longer needed, the debate regarding fees will become irrelevant.

It is my hope that within my lifetime this will occur and that innovation in Canada will be supported without excessive red tape – and administrative conflict.

Sincerely,

Gilbert Lance, MSc

Retired CRA Research and Technology Advisor (1986-2005)

 

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Gilbert Lance

Gilbert Lance is the CEO and founder of The InGenuity Group. He has over two decades of experience as an RTA with the CRA and has assisted with over ten thousand (10,000) SR&ED claims. Gilbert specializes in risk assessment, audit defence, and complex software applications. Find out more about Gilbert's SR&ED experience on his LinkedIn profile.    

3 Comments

LM · October 10, 2012 at 9:43 am

Gilbert, I don’t have your depth of experience, yet I couldn’t agree more. I think you’ve hit the nail on the head in describing not only the value of contingency fees, but why we exist as a consulting industry.

Mark Daugela · October 10, 2012 at 10:44 am

I applaud your comments Mr. Lance. Is there any comparison for the cost effectiveness of advertising the gov’t action plan vs. SRED contingency fees?

The studies also showed that the cost of compliance was significantly more for refundable companies than those receiving credits- presumably due to the increased likelihood of a CRA review. It’s a shame for many companies to learn from their self assessment mistakes at the review stage – sometimes years after the work was done. Many banks will use a proven positive track record of SR&ED refunds as suitable for A/R financing. Thus the SR&ED refunds are effectively multiplied due to financing leverage. These “first timer” mistakes cause less leverage for several years, and often require a SR&ED consultant that the banks trust to regain their leverage. The true cost of compliance is more than the simple rate of $30/hr or $40/hr of technical time – businesses have a significant loss in opportunity cost when not using consultants. I am surprised at the number of start ups that have seen the television ads for the government action plans – but yet don’t know that they are missing their opportunity from benefiting from SR&ED. Isn’t a 25% burden for marketing and overhead of SRED compliance a terrific ratio compared to the television advertisements?

    Gilbert Lance · October 10, 2012 at 6:06 pm

    Mark,

    That is an interesting question that goes far beyond the analysis that I have seen within CRA. I’m certainly not aware of anything in the other government departments that I have looked at. Statistics within CRA tend to be more of those from a manufacturing process in terms of when did it arrive, how fast did it go through the system, and how much money was clawed back or given relative to what was asked. Statistics addressing your question would tend be collected in specialized studies that are not always made available. Have you perhaps seen leads or studies that would address such a question?

    When I was within CRA, I was actually happy to have consultants involved as they did a certain amount of the due diligence before applying and also they did a lot of the marketing to turn up new clients. I do remember one study done by IRAP that showed that over 50% of their clients either did not apply for and most of those were not aware of the program. Certainly the advertising costs in having consultants find participants for the program was nil. Unfortunately when the agency is in a recovery mode, the cost of complying is much higher for a small firm and this holds in all aspects of red tape hence the broader government study and recommendations to address the red tape and disparity between small and large companies.

    I was also aware of the disparity in availability of funding from financial institutions. It was reasonable for them to ask for the track record is this certainly reduces the institutions risk. It is the vulnerable start-ups that proportionately need the most help in terms of information or cash flow and this seems to have fallen through the cracks in both public and private sector assistance.

    In my opinion, having the program either underutilized by companies not apply or having small companies denied and possibly bankrupted because of lack of involvement from someone prior to applying is a waste of the scarce private and public resources of the country. I know that there is at least a small bias against small companies in the minds of some of the research and technology advisors as two in one office have specifically stated that small companies don’t have the capacity to do research. Also it is much easier to pick on a small company to get recovery because they are less likely to have the resources to contest the situation. Again this is done by a small number in the agency but its impact can be significant.

    I would tend to agree with you that the burden for marketing and overhead of the SRED compliance is not out of line at 25%. Having said that, I do think that by shopping around companies can often get a better ratio of cost to return.

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