Canada's Scientific Research and Experimental Development (SR&ED) Program continues to be one of the most generous programs of its kind in the world. The tax incentives are delivered through the Income Tax Act (ITA) and administered by the Canada Revenue Agency (CRA). Unlike the comparable U.S. program, Canada's SR&ED program is legislated, i.e., it is not subject to annual budgetary limitations.
The Canadian Federal Budget 2012 (Budget 2012) contains important changes to the SR&ED program which are modeled on the recommendations of an expert panel and widely published in the report, Innovation Canada: A Call to Action (the Jenkins Report). Generally, despite certain changes introduced by Budget 2012, the SR&ED program continues to offer opportunities and benefits to the life sciences industry in Canada.
Relative to the fundamental changes and reductions recommended in the Jenkins Report, changes to the SR&ED program proposed by Budget 2012 are incremental rather than revolutionary. Budget 2012 recognizes the importance of the SR&ED program by maintaining the existing framework.
The general investment tax credit rate applicable to SR&ED qualified expenditures will be reduced to 15 per cent from 20 per cent after 2013. However, the negative impact of this reduction to life sciences companies will be limited, as the enhanced rate of 35 per cent will continue to be available to Canadian-controlled private corporations (CCPCs) as defined in the ITA.
The remaining amendments to the SR&ED program will impact all companies. In 2014, SR&ED capital expenditures will no longer be eligible for SR&ED deductions and investment tax credits. It is likely that such expenditures will now be capitalized and amortized over the life of the capital property. Additionally, the amount of an arm's-length contract payment eligible for SR&ED tax credits for the payer will exclude any amount paid in respect of a capital expenditure incurred by the performer of the contract.
Furthermore, the 65 per cent prescribed rate to be applied to the simplified proxy SR&ED overhead expenditures will be reduced to 60 per cent for 2013 and to 55 per cent thereafter. Finally, beginning in 2013, the expenditure base for tax credits will exclude the profit element of arm's-length SR&ED contracts, such that only 80 per cent of the contract costs will be eligible for tax credits. This is unfortunate as it unnecessarily penalizes cost-efficient life sciences companies that outsource to reduce costs.
Undeniably, the overall reductions to the SR&ED program will reduce its benefits to life sciences companies. These reductions are expected to save the government approximately $1.3 billion over the next five years. Government is directing these savings towards increased expenditures in other programs which will mitigate negative impacts and may indeed prove to be a net benefit to life sciences companies located in Canada.
Early-stage funding is crucial for life sciences companies that are heavily dependent on cash to fund their R&D activities. However, capital markets continue to be hobbled by economic uncertainty, and venture capital financing remains anemic in Canada. Therefore, Canadian innovation companies, particularly in the life sciences industry, are often unable to access adequate funding to develop into full commercial enterprises. Budget 2012 acknowledges this problem and includes $500 million over five years to stimulate and support venture capital activities in Canada. Furthermore, $95 million will be provided over the next three years, and $40 million annually thereafter, to make the Canadian Innovation Commercialization Program permanent.
In addition, the National Research Council's (NRC's) Industrial Research Assistance Program, which is currently underfunded, will receive an additional $110 million per year. NRC will also create a concierge service to assist small and medium-sized businesses. Private and public sector research collaboration will be enhanced through additional funding for new and existing programs. There is also additional funding to support R&D in universities and other institutions.
Budget 2012 also introduces measures to inject more predictability into the SR&ED program which should reduce compliance costs. These measures include a CRA pilot project to determine the feasibility of a formal pre-approval process, enhancing CRA's self-assessment eligibility tool and collaboration between CRA and industry representatives, and improving the Notice of Objection process to allow for a second review of scientific eligibility determinations.
There are indications that Budget 2012 is only the initial step of a comprehensive overhaul of the manner in which innovation and R&D is publicly financed in Canada. The government has stated that there will be additional changes and initiatives in response to the recommendations in the Jenkins Report.
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