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Posted November 3, 2011

R & D Credits

Expert Panel Calls for Changes to Canadian R&D Tax Credits

The Jenkins Panel Reports Potential adverse impact on small-and medium-size technology businesses

TORONTO - On October 17th, a six-member panel appointed by the Canadian Federal Government released a report recommending significant changes in the methods by which it distributes the $6.5 billion spent annually on tax credits and other incentives for private sector R&D.

Scitax, an independent consulting firm specializing in the taxation of technology business, has produced a detailed analysis of this report and how the Panel's recommendations would impact Canadian business if they are implemented by government.

The panel is headed by Thomas Jenkins, Executive Chairman and Chief Strategy Officer of OpenText Corporation and, because of this, has come to be known as "the Jenkins Panel" rather than its official title which is The Independent Panel on Federal Support to Research and Development.

The 150-page report entitled "Innovation Canada: a Call to Action" makes six "core" recommendations, amongst which are reductions in the SR&ED R&D tax credit program and re-direction of the resulting savings towards so-called "direct funding" incentive programs. In this context, direct funding generally means either grants or contingent-repayable loans. One example of such a direct funding program was Technology Partnerships Canada (TPC) which had disbursed about $2.5 billion of public money before it was cancelled by the newly elected Conservative Government in 2006.

After a detailed analysis of this report, our firm has flagged four broad concerns pertaining to the panel's recommendations vis-a-vis changes to the SR&ED tax credit:

1. Any money that is shifted out of tax credits and into direct funding
programs is money that becomes less subject to democratic scrutiny and
the rule of law. Distributing incentive money through the tax system
guarantees universal access under legislated rules. The tax system has
well established informal- and formal-mechanisms for dispute resolution
- up to and including the Supreme Court of Canada. This means that
anyone who is denied funding can apply for an impartial review of that
denial. It also means that government can recover funding that is paid
out to anyone not entitled to receive it. The processes of direct
funding are more opaque and do not have the similar redress channels or
established legal protocols.

2. The proposed changes would have a disproportionate impact on various
sectors of industry. Small- and medium-sized private corporations
("CCPCs") would see significant cutbacks in their SR&ED benefits whereas
public- and foreign-owned corporations would see no change. Furthermore,
the recommended changes would impact different sectors of industry in
different ways: The big losers are likely to be secondary manufacturing
industries such as plastics, metal forming, printing, packaging and food
processing. The beneficiaries would be pharmaceuticals, biotech,
aerospace and defence, electronics, semiconductors, optics, forest
products, and environmental and alternative energy technology companies.
In the computer industry, companies involved in the development of
business-application software would likely suffer, while those involved
in development of "core" technologies such as operating systems,
embedded firmware, graphics technologies, encryption and biometrics
could fare somewhat better.

3. Globally, there is increased (and increasing) use of R&D tax credits as
a public policy instrument for economic-stimulus of businesses in the
science and technology sector. Historically, Canada has had one of the
world's best R&D tax credit systems. Over the last few years other
countries (notably France, Ireland, Australia and the U.K.) have
implemented equal or better systems. While in the U.S., tax credits at
the federal level have been somewhat dysfunctional, an increasing number
of individual states have implemented their own cash refundable R&D tax
credit schemes that equal or exceed Canada's.

4. Various international trade agreements - specifically the World Trade
Organization (WTO) Agreement on Subsidies and Countervailing Measures -
constrain direct subsidies to businesses. Article 3 (Prohibited
Subsidies) has already been applied against Canada's Bombardier by
Embraer of Brazil in a 1998 WTO action over funding Bombardier received
from the former Technology Partnerships Canada (TPC) program. This is a
significant issue in Canada, which does not have a large enough domestic
market to support the commercialization of technology. Any Canadian
Government assistance program that does not require the applicant to be
export-capable would be folly.

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