2012 Federal Budget – Changes to SR&ED
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The 2012 federal budget was just released, and we wanted to give all of our readers a heads up for how the Conservative government’s budget has affected the SR&ED program, and funding sources in general. This is a summary of the major R&D developments. If you’re adventurous, you can download your own copy of the 498-page manuscript here (PDF).
General Changes Based on Jenkins Report
- Double the contribution budget of the Industrial Research Assistance Program to better support research and development by small and medium-sized companies.
- Support private and public research collaboration through internships for graduate students and funding for business-led research and development.
- Support innovation through procurement by connecting small and medium-sized companies with federal departments and agencies to build their capacity to compete in the marketplace.
- Refocus the National Research Council on demand-driven business-oriented research that will help Canadian businesses develop innovative products and services.
- Help high-growth firms access risk capital by committing significant funds to lever increased private sector investments in early-stage risk capital and to support the creation of large-scale venture capital funds led by the private sector.
- Streamline and improve the SR&ED tax incentive program by removing capital from the expenditure base, making it more cost-effective through design improvements and a measured rate reduction, and providing greater predictability through administrative improvements.
All of these changes seem to be a fairly reasonable response to the recommendations. The doubling of the IRAP budget, and increased access to the venture capital funds (the budget quotes $500 million over the next few years). Of particular note is that the government recommends that this venture capital money be overseen by private individuals/groups, not the government. This was a worry that many people had before the budget was released, of bureaucrats deciding who would get the funding money.
Federal Changes to the SR&ED Program
The following highlight the major changes to the SR&ED program. Additional commentary will be provided in upcoming days.
- The rules regarding the eligibility of capital expenditures are the most complex for businesses to comply with. In order to simplify the program, Economic Action Plan 2012 proposes to narrow the base of eligible expenditures by removing capital. The other expenditure elements will remain eligible, including salary and wages, materials, overhead expenses and contract payments. This proposed change will affect capital expenditures incurred in 2014 and subsequent years.
- To limit instances where the rules result in tax credits being provided for overhead costs that exceed the actual costs incurred, Economic Action Plan 2012 proposes to gradually reduce the “prescribed proxy amount” that is used to compute overhead expenditures under the so-called “proxy method,” from 65 per cent to 55 per cent of direct labour costs. The 55-per-cent rate will be fully phased in as of January 1, 2014.
- To remove the profit element from arm’s length contract payments, Economic Action Plan 2012 proposes to allow only 80 per cent of these contract payments to be used for the purposes of calculating the SR&ED tax credits. This change is consistent with the current tax treatment of non-arm’s length contracts, and will target the tax credits to SR&ED expenditures incurred, and not on profit margins. It will be effective as of January 1, 2013.
- Economic Action Plan 2012 also proposes a reduction in the general SR&ED investment tax credit rate. The recent corporate income tax rate reductions (from 22.12 per cent in 2007 to 15 per cent in 2012) have effectively increased the relative generosity of the SR&ED tax incentive program and resulted in growing pools of unused investment tax credits. Effective January 1, 2014, the general SR&ED investment tax credit rate will be reduced from 20 per cent to 15 per cent.
These are all significant changes to the program. Of particular note, the government did not change the enhanced refundable rate that CCPC companies who conduct less than $3 million in expenditures per year receive. They remain at the 35% level.
Changes to the CRA Review Structure
Based on the recently released Ombudsman report and Jenkins report, the government will refine the CRA review process as follows: The Canada Revenue Agency (CRA) has recently implemented a number of administrative improvements to address challenges that have been identified by stakeholders in the areas of accessibility, predictability and consistency. These improvements include:
- Increasing the number of technical reviewers.
- Providing additional training and establishing coordinated technical support for the technical reviewers.
- Devoting more time to program services.
- Enhancing the quality assurance methodology.
- Reviewing dispute resolution procedures to ensure their effectiveness.
In addition, the CRA is in the process of consolidating and clarifying the administrative policies that are currently contained in about 70 documents pertaining to the SR&ED tax incentive program. The revised information will ultimately be presented in a user-friendly format on the CRA website in December 2012, with the objective of reducing complexity and improving accessibility. These recommendations are desperately needed, though we will see how quickly the CRA is able to implement them.
Summary of Changes
The changes proposed by the government will be phased into the system over the next few years. It will be conducted as follows: January 1, 2013: Contract Payments reduced to 80% of the paid value. January 1, 2014: Proxy overhead calculations reduced to 55% from 65%. January 1, 2014: General SR&ED refundable credit reduced to 15% from 20%. 2014: All capital expenditures incurred during the 2014 fiscal period will not be eligible for SR&ED.
Changes to the eligibility of the contract eligibility is a backward step. While the objective of eliminating a tax credit on profit is understood, not all contracts involve profit, but are rather a pass-through of cost. My company used the University of Saskatchewan as a contractor, with the funds being used to pay graduate students working mainly at the university rather than my laboratory. The change will be a disincentive to involve university researchers. Secondly, the change will likely complicate relationships between companies with joint venture research agreements. A provision to allow pass-through of actual cost would be helpful.
The federal government listened to the Tom Jenkins’ panel report and made significant changes to the SR&ED tax credits and other investments in research and[….]