An Impact Assessment of the 2012 Federal and Provincial Budgets on the SR&ED Program and Other Innovation

Funding

An ICAA Webinar prepared by TSGI-Chartered Accountants

May 30, 2012

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This presentation is not sufficient for unassisted tax planning © TSGI-Chartered Accountants 2012

Webinar attendance tip: turn off power and screensaver options on your computer and ensure your zoom settings allow you to see the entire slide

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About the presenters TSGI – Chartered AccountantsTSGI is a chartered accountancy that works exclusively in the field of R&D funding for companies headquartered or operating in western Canada. The firm has over 20 years of experience in SR&ED and are former instructors for the ICAA course on this topic. A significant portion of TSGI’s clients are referred by independent and mid-sized CA firms. TSGI does not undertake general accounting or non-SR&ED taxation engagements.

KEN CUDMORE President

Ken is a veteran CA with more than 30 years experience in public practice and SR&ED services. He spent three years as a fulltime faculty member at the University of Calgary and is a past instructor of the ICAA SR&ED course. Ken holds a B.Sc. in computer science and a M.B.A. from Dalhousie University

GRAHAM SMITH VP of Bus. Development

Graham has been active in the SR&ED industry for more than 7 years as a claimant and tax preparer. Prior to joining TSGI, Graham spent 11 years in the manufacturing industry as a researcher, manager, and VP at a Calgary-based engineering firm. Graham holds a B.Sc. in physics from the University of Calgary.

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Presentation scope and formatThis 1 hour presentation discusses the impact of the Federal and Provincial 2012 budgets on the SR&ED program and other innovation funding. Familiarity with the SR&ED fundamentals is assumed. If you require an introduction to SR&ED, please refer to tsgi.ca/resources/frequently-asked-questions.

A slide show and audio stream are both part of this presentation. If you are having trouble hearing the sound stream, please ensure your computer sound system is enabled and is not muted. Further technical support is available by clicking the topic “Common Issues When Joining Meetings on PCs” at the following address support.citrixonline.com/en_US/GoToMeeting

Questions from the listening audience are encouraged during the presentation. To submit a question please use the built-in question tool: click the dropdown arrow to see the “Questions Pane” and type in your question.

A copy of this presentation will be available shortly after this webinar at tsgi.ca/resources/sred-presentations

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Context of the changes to innovation fundingFall 2011: studies of Canadian R&D performance• Jenkins report (Innovation Canada: A Call to Action. 148 pages)• Mowat Center Report (Canada Innovation Underperformance. 20 pages)• Conference Board of Canada (How Canada Performs 2011)

Key indicators that Canada is underperforming in R&D• Canadian labour productivity has fallen to 71% of the US’s over 25 years• Canada ranks 15th out of 31 in the OECD in R&D performance (Jenkins)• 14th out of 17 (The Conference Board of Canada)• By contrast we are 4th in investment in higher education

Conclusions• Canada is lagging in R&D performance; the problem is commercialization• Sweeping, revenue neutral, changes are recommended to the $5 billion in

Federal R&D incentive spending

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The Federal 2012 budget: themes on innovation funding

• Reduction in SR&ED funding and redistribution of $ to direct grants

• Simplification of the SR&ED program

• Increased use of federal procurement funding to drive innovation

• Improved access to capital

• Re-focusing of federally funded organizations towards industry-led, commercially relevant research

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Overview of changes to Federal SR&ED

1. General investment tax credits (ITCs) rate reduced starting Jan 1, 2014

2. SR&ED capital expenditures eliminated starting Jan 1, 2014

3. SR&ED contracts benefits reduced to 80% starting Jan 1, 2013

4. Overhead proxy amount reduced to 60% by 2013 and 55% by 2014

5. Funds provided for administrative improvements

We will look at each of these individually and then examine the overall impact in a later slide.

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General ITC rate reduced

Currently• CCPC’s receive an enhanced ITC rate of 35% on their expenditures below their expenditure limit (often $3M/year)• CCPC expenditures above their expenditure limit and expenditures by non-

CCPC’s receive the general ITC rate of 20%

Proposed• As of Jan. 1, 2014 the general ITC rate will be reduced from 20% to 15%• Enhanced ITC rate to CCPCs not affected!• The ITC rate will be prorated for non Dec. 31st yearends

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SR&ED capital expenditures eliminatedCurrently • SR&ED capital expenditures may be deducted 100% in the year incurred• They are also eligible for ITCs

Proposed• As of Jan. 1, 2014 capital expenditures will no longer be SR&ED deductions

and will not be eligible for ITCs• Applies to lease payments on the right to use property that would, if it were

acquired by the taxpayer, be capital property are also excluded• Applies to property acquired on or after Jan 1, 2014 or lease payments paid or

payable on or after that date

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SR&ED contracts benefits reduced to 80%Currently • Contracts for SR&ED by arm’s length contractors are 100% eligible for ITCs

Proposed• As of Jan. 1, 2013 arm’s length contracts will only be claimable at 80% • Also: capital expenditures incurred by a SR&ED performer will be subtracted

from the contract amount before applying the 80% ratio (in 2014 when the capital rules come into effect)

• SR&ED performers will be required to inform the payer of their capital expenditures on SR&ED

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Overhead proxy amount reducedCurrently• Claimants may choose to claim overhead costs by the “traditional” method or

by the “proxy” method• The proxy method allows a 65% increment on labour costs for employees

directly engaged in SR&ED.

Proposed• As of Jan. 1, 2013 the proxy increment will be reduced to 60%• As of Jan. 1, 2014 the proxy increment will be reduced to 55%• Claimants with non Dec. 31 fiscal yearends will prorate their proxy claims

according to the number of days in appropriate period

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Funds provided for administrative improvements

Proposed• $6 million in additional funding to the CRA to improve the predictability and

administration of the program:• Enhancing the online self-assessment tool• Feasibility study of more effective Pre-Claim Project Review • Work more collaboratively with industry• More frequent use of “tax alerts”• Improvement of the Notice of Objection process to include a second

science review

• Commitment to study SR&ED consulting fees

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Other innovation funding proposalsImproved access to capital• $100 million to the Business Development Bank Canada• $400 million for private sector early-stage and venture capital

Increased direct government funding of R&D• $110 million/year to double the highly acclaimed NRC-IRAP• Launch of the Western Innovation Program (regional mandate)

Increased support for R&D via Federal procurement programs• Expansion of the Canadian Innovation Commercialization Program (CICP)• $95 million for 3 years starting 2013• $40 million/year thereafter

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Other innovation funding proposals - continuedIncreased focus on industry-led commercially relevant R&D• Increased emphasis on public private partnerships •$67 million to NRC to re-focus activities on industry-driven R&D• $12 million/year to make the Business-Led Networks of Centres of Excellence program permanent• $105 million over 2 years to support forestry innovation• $37 million to post-secondary granting organizations to support industrial-academic research collaborations

• The Budget contains additional changes not listed here!

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What do the SR&ED changes mean to claimants?• Changes are projected to reduce SR&ED funding by $500 M/year (13.9%)• Possibly an underestimate• Compare budget capital estimate of $40M/year (1.1%) on p.380

Secretariat report to the Jenkins panel estimates $151M (4.2%) on p.4 • Impact on claimants will be highly variable depending on mix of corporate expenditures

• Firms statistics indicate:• CCPC’s can expect a 5-10% reduction in ITCs• Non-CCPC’s can expect a 30-60% reduction in ITCs

• No substantial change in complexity to date – possibly more complexity• New capital rules may add work, especially due to contracts in O&G• Changes to proxy may increase traditional overhead claims

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Update on Alberta Provincial SR&ED programCurrently• AB legislation: Federal ITCs must be deducted from AB qualifying expenditures

in the subsequent year.• Federal legislation: AB ITCs must be deducted from Federal expenditures in the

current year• Net result is multi-year iterative calculation that ITCs • Double-grind effect: CCPCs get 39.4%; non-CCPC’s 26.5% (on expenditures up to Federal expenditure limit)

Proposed• AB budget proposed to eliminate the AB grind• Result would be CCPCs would get 41.5%, non-CCPCs 28%• Roughly 5% increase in ITCs• Significant administrative improvement for all stakeholders• Effective for yearends after March 31, 2012

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Update on Saskatchewan and British Columbia programsSaskatchewan Currently • All corps. eligible for 15% refundable ITC

Saskatchewan Proposed• Exclude non-CCPCs from refundability• Cap CCPC refundability to an annual max of $450k benefit

(after that ITCs become non-refundable)• To be effective for expenditures incurred on or after April 1, 2012

British Columbia Status• Current program (10% ITC rate) expires August 31, 2014• BC’s budget planning assumes continuation past that date

but does not enact it.

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Updated - Audience Question

Do the Federal Changes get mirrored in Alberta?

The question from the audience on Alberta mirroring the federal changes was answered "no" because Section 26.6(3) cites the Proxy election at "65%"; therefore requiring AB to change their Act in order to mirror the Fed effects. The changes to SR&ED contract payments and Capital expenditures should flow through to Alberta's SR&ED program because of AB Income Tax Act Section 26.6(d).

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QuestionsTo ask a question please:• Go to the dropdown arrow to see the “Question Pane” and type your question• Presenters will endeavour to address questions with the widest appeal to the

general audience on a priority basis.

For further information on SR&ED issues please email graham.smith@tsgi.ca at TSGI-Chartered Accountants.

DisclaimerThis presentation has been prepared for the Institute of Chartered Accountants of Alberta (ICAA) for the benefit of its members by TSGI-Chartered Accountants. Reasonable efforts have been made to ensure the accuracy of the information presented here but attendees are cautioned to exercise due diligence before proceeding with tax decisions.Statements of opinion made during this presentation are those of the presenters and do not represent the position of the ICAA.