RDP Associates - Canadian Life Science - Innovation and SR&ED Tax Credits

HOT BUTTON Canadian Life Science // by ChriS bodnar ISSUES innOvatiOn and Sr&ed HOT BUTTON tax credits ISSUESO ver the past few years, President urged investment in various Canada’s global innovation sectors to increase innovation. The gov- ranking has been called into ernment can go a long way to establish- question. The Conservative ing a vision and call to action. Many othergovernment, concerned with Canada’s government leaders in other countries arepoor results, has commissioned an expert delivering the same message.panel to review Canada’s ranking and To implement innovation requiresrelated innovation funding and support resources, including funding. In Canada,programs and to make recommendations the largest component of the $7 billionfor improvement. in annual funding for innovation is the According to the Conference Board, Scientific Research and ExperimentalCanada ranks 14th in a list of 17 peer Development (SR&ED) program, whichcountries. However, Canada’s funding is now providing annual funding of ap-of innovation ranks second among these proximately $4 billion. Other fundingcountries. Canada’s pharmaceutical/bio- comes from targeted government grants.tech industry’s innovation performance A 1997 study published by Financemimics Canada’s overall ranking among Canada and Revenue Canada concludedthe OECD countries. that the federal SR&ED credit generates If Canada is providing substantial fund- $1.38 in incremental R&D spending pering, why don’t we rank higher on the dollar of foregone tax revenue. A furtherinnovation scale and what can we expect study in 2007 (Parsons and Phillips) con-from government programs to fund In- cluded SR&ED tax credits generate a netnovation? economic benefit. The conference board defines innova- Apart from positive econometric stud-tion as “the ability to turn knowledge into ies, funding of this nature can be greatlynew and improved goods and services.” accelerated with the right framework inIn addition to this brief definition, I would add that the definition also place as well as vision and leadership.includes the ability to export these new and improved goods and ser- There is currently a large push in the US to increase their R&D taxvices. This is based on the fact that exports are one of the key criteria credit program. The Information Technology and Innovation Founda-used to rank a country’s innovation performance. tion have prepared a report on the significant limitations on the current So why doesn’t Canada rank higher? Some comments have been U.S. R&D tax credit. In addition, draft legislation has been pending tomade that our resource industries, which comprise a large portion of increase the credit.our GDP, have preserved their existing commercial production meth- In the UK, Lord Richard Dyson submitted a report which is currentlyods and have not advanced new processes. Others suggest having too being considered by the Tory government. In the report he is urgingsmall a domestic market to reach critical growth along with the dif- the government to increase the tax relief for small and medium sizedficulty in establishing a viable business in foreign markets as possible businesses developing new and improved products and processes.causes. These are excuses. France introduced a new R&D tax credit program in 2009 which The real questions are “What is needed to be done to improve in- provided for refundable credits for virtually all French companiesnovation?”, and secondly, “What role does government funding play in of 30 per cent (and in some cases up to 50 per cent) of qualifiedthis area?” When we look at countries that are successful, there seems expenditures.to be both a consolidated vision and focus on innovation. The US does By definition, SR&ED tax credits in Canada fund two main areas:this in a number of industry areas, but countries like Switzerland have basic and applied research and experimental development. However,excelled in select areas of concentration, such as pharmaceuticals. experimental development is where most claims are made under theVision comes from leadership. Focus is the single minded effort of an SR&ED program. To make a claim under this category, a business needsorganization to achieve its vision. to be creating or improving a new product or process. Extrapolating the Who, then, is responsible for setting the framework for innovation SR&ED tax credit program funding of roughly $4 billion for experimentalleadership and vision? In his recent State of the Union address, the U.S. development each year, Canadian companies are creating or improving14 BIOTECHNOLOGY FOCUS MARCH 2011

HOT Canadian Life Science BUTTON ISSUESFrance introduced a new R&D tax in terMs of why sr&ed is iMportant and how it fosterscredit program in 2009 which provid- innovation, the following coMMents are provided; 1. Tax credits are a fair and more objective manner of distributing funds to business ased for refundable credits for virtually opposed to government grants. My experience is that grants tend to provide littleall French companies of 30 per cent certainty to business that funding with be received. Grants tend to be underfunded for the applications received with a small percentage of applicants actually receiving(and in some cases up to 50 per funding leaving the decision to the government to decide who should receive funding.cent) of qualified expenditures. 2. The SR&ED tax credit program is doing exacting what it is intended; focusing HOT companies on developing new products and processes. BUTTON ISSUESproducts or processes at a total cost of approximately $17 billion. 3. If the government wants a practical simple solution to trimming the SR&ED fund- There is one statistic that I believe is very important to keep in mind ing, eliminate the 18-month filing requirement and reduce it to six months. Thiswhen discussing SR&ED tax credits in Canada: each year roughly time frame is when corporate tax returns need to be filed. Further, if a company25,000 companies claim for SR&ED. Of the $4 billion given out each does not see the value in filing early to receive funding or tax savings, then it eitheryear, roughly 1,500 or 6 per cent of the companies making claims, does not require funds or its business processes need improvement.receive roughly $3.2 billion or 80 per cent of the SR&ED funding.The remaining 23,500 companies receive $800 million of the SR&ED 4. Our firm’s experience is that Canadian companies, especially small and mediumfunding. This statistic is comparable with the claims made in the US sized businesses, will opt to develop their own product or process as opposed toand other countries giving out R&D tax credit funding. purchasing the technology, which is a more prevalent course of action in the U.S. The other important point to keep in mind is that governmentsprovide incentives in part to deal with economic inequities. Small 5. There is very little statistical information provided by the conference board on how small business supports and contributes to innovation. Generally all statistical infor-companies have a difficult time obtaining bank loans to finance mation is sampled from large business. It is also interesting to note the expert panelreceivables let alone product or process development. Small reviewing innovation and the SR&ED program have no small business representa-companies have to finance innovation from profits whereas large tion on the panel.companies have access to capital markets. Thus, it is important to keep in mind that these two groups face 6. Virtually every country in the OECD, ( U.S., UK, France, Australia, Japan and Ireland)different issues and receive substantially different levels of govern- is moving, or recently has moved, to increase their R&D tax credit program. Appar-ment funding. ently Germany is set to bring in a R&D tax credit program soon. R&D tax credits are the choice to assist innovation in OECD countries. Further, India and China have R&D tax credit programs. 7. From working in other countries our firm has come to appreciate how competent Canadian firms are at developing new products and processes on time. I have heard this comment from engineers and other professionals who have worked in other countries like the US and UK. If we have a weakness I think marketing, selling and other commercialization issues need to be addressed. 8. The comment we receive most from our clients is that SR&ED funding helps them My specific recoMMendations to foster innovation and undertake technically risky projects that they would not otherwise undertake, as obtain the largest return froM the sr&ed tax credit well as being able to hire more skilled labour. prograM are as follows; 1. Create more industry clusters within defined geographical areas. When we think about successful innovation clusters, areas such as Silicon Valley always come to mind. France has set up approximately six clusters around To say that the SR&ED tax credit program is not working is suggesting the country to foster innovation, aided by a very generous R&D tax credit. that simply funding an initiative will accomplish an objective. Without vision and leadership any funding method or vehicle will not achieve 2. Create trade associations within these clusters provide more leadership as strong results as when accompanied with such vision and leader- and provide them with some funding to assist in the marketing and selling ship under a clear framework. Given virtually all other countries are of products in foreign markets. implementing and improving their R&D tax credit program, it would be a step backward to reduce or impair the SR&ED program. The 3. Have one or two large companies carrying out significant R&D SR&ED program is achieving what it set out to do, providing assistance anchor the cluster. to fund technically risky development. What is required are strategies to improve and assist in the commercialization of these innovations 4. More export guarantees and assistance in this area would help. within the global technology marketplace. 5. Keep the SR&ED program intact especially for small businesses, to compensate for inequities in access to financing. For more information on CAnAdA’S Sr&ed PrOgrAM, visit www.bioscienceworld.ca MARCH 2011 BIOTECHNOLOGY FOCUS 15

RDP Associates - Canadian Life Science - Innovation and SR&ED Tax Credits

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