Fresh thinking for R&D Funding   |  May 27, 2009  

Revamping Canada’s tax credit system will create long-term economic stimulus

By Al Katiya

The 2009 federal budget’s focus on infrastructure spending may help stimulate the economy in the short term but, in my view, the focus should be on research in science and technology. This is crucial to Canada’s long-term productivity and growth. Cash-strapped manufacturing and service companies could be helped through an improved R&D tax credit system, and with minimal government funding. Fresh thinking and a bold approach are all that are required.

Under the present plan, small Canadian-controlled private corporations (CCPCs) qualify for refundable R&D tax credits. Refundability means credits are payable in full whether or not the company has tax to pay, so this maintains R&D activities and jobs through a start-up phase or during tough economic times.

Tax credits for larger CCPCs, public companies and subsidiaries of foreign companies are not refundable. Instead, credits reduce taxes payable and, if the company’s taxes are less than the credit, the extra amount is carried to future years. Since some of these companies will not pay taxes in the current economic climate, the credits are akin to coupons that cannot be cashed. Unfortunately, lenders are seldom willing to loan funds against these future assets.

So while Canada is reputed to have the world’s best R&D incentive program, it often does not help keep or create R&D jobs. For an illustration, look to Quebec: it offers full R&D refunds to all and that partly explains Quebec’s continued success in creating and retaining R&D jobs.

Action required
KPMG, industry associations and others have called for the extension of tax credit refundability to all companies, but these proposals have been rejected on the grounds of affordability.

If the cost is indeed too high, then we need creative ways to monetize deferred tax credits in the hands of larger companies earlier. The answer could be an R&D Tax Credit Bank.

Here’s how this may work. Industry Canada would create a new bank to buy R&D tax credits at a discount from companies that cannot immediately use them. For example, where a seller has filed a claim for $100,000 in R&D tax credits, the bank could buy the credit for, say, 70 per cent of its value, providing the seller with $70,000 in immediate cash. When the seller later turns a profit and is liable for $100,000 in income tax (to match the earlier credit) the Canada Revenue Agency (CRA) would pay the $100,000 suspended tax credit amount to the R&D Tax Credit Bank.

The bank could use the 30 per cent profit ($30,000 in my example) to pay interest on money borrowed to fund the credit purchase and to cover losses on unsuccessful tax credit purchases (if a company went out of business, for example).

Immediate stimulus
This means the selling company gets cash now, before it becomes profitable; the bank’s administrative costs would be covered, perhaps with a small gain; and the government would be shielded from the cost of making the credits immediately refundable for all R&D claimants. The government would also benefit from income taxes generated by the selling company when it starts producing income.

Of course, the bank would need to conduct due diligence to ensure the seller’s business is viable. It would require access to the selling company’s current and historical tax credit claims and other tax records.

Critics may argue this plan will lead to fraud schemes similar to those under the R&D tax credit flow-through mechanism of the 1980s and 1990s, or raise concerns about administrative hassles and costs. However, unlike then, credits would not be discounted until approved by the CRA. If the bank is connected with the CRA and partners with other financial institutions by providing guarantees on their transactions, the bank can operate with minimal capital and administrative costs.

As with any innovative framework, the devil is in the details. A host of practical issues, such as whether the bank should finance older tax credits and whether R&D credit sales to the bank should be capped, need to be worked out. But discussing this or similar proposals can create effective approaches to financing innovation in Canada. 

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Al Katiya, FCA, is leader of KPMG’s national Scientific Research and Experimental Development Tax practice.


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