Potential SR&ED Tax Credit Changes on the Way?

The Scientific Research and Experimental Development (SR&ED) tax credit is an incentive program administered by the Canada Revenue Agency (CRA) that provides more than $3 billion annually to Canadian businesses for work done to resolve technological challenges and improve their technological knowledge base.

A recent study and report by The Logic¹ found that the SR&ED tax credit, a prominent program in Canadian research and development (R&D) funding, continues to disproportionately benefit large companies, although the report also indicates a gradual narrowing of the gap between large and small enterprises.

Persistent Disparities

While the SR&ED program aims to incentivize innovation across all businesses, the data in The Logic’s analysis reveals that, from 2013 to 2017, large companies accounted for a significant share of the tax credits claimed, with many of the recipients having their headquarters outside of Canada.

As noted in The Logic’s report, critics, including leading entrepreneurs in Canada, have long complained that the SR&ED program favors big foreign companies over domestic ones. Indeed, the federal government has acknowledged such concerns and initiated a review of the program, which underwent its last overhaul in 2012.

Through the SR&ED program, companies can claim a corporate income tax credit on expenses related to R&D, including researchers’ wages and materials. The program offers a 35% non-refundable tax credit on up to $3 million of eligible expenses for Canadian-controlled Private Corporations, with a 15% credit, without a spending cap, available to public and foreign companies.

Recent Shift in Beneficiaries

New data from the CRA obtained by The Logic unveils a change in the types of companies benefiting most from SR&ED, although large companies still appear to receive a disproportionate share of the program’s total funding value. According to the data, corporations with a gross income of at least $250 million received an average total of about $1.1 billion in SR&ED tax credits each year from 2018 to 2022. However, this marks a decline from the average total of $1.6 billion in each of the preceding five years. The data also shows that, during 2021 and 2022, large companies received an average total of less than $1 billion annually in SR&ED tax credits. In contrast, small and medium-sized businesses saw a slight increase, collecting an average total of $2.4 billion (up from $2.2 billion) over the last five years.

David Douglas, Principal and Practice Leader of Ryan’s SR&ED practice, noted in The Logic’s report that the recent shift in SR&ED tax credit use is attributable to market dynamics and other government initiatives, rather than changes to the program itself – a logical conclusion, since there haven’t been any significant changes in recent years. According to David, the noted increase in claims received by large corporations in 2020 “… was in part because CRA was pushing through a backlog of credits, but also because of corporate windfalls like Ottawa’s emergency wage subsidy program. That government support, coupled with historically low interest rates and a robust investment landscape, enticed many large companies to spend big on research and development.” David goes on to suggest that rising interest rates and the end of pandemic relief programs curtailed spending on R&D by large businesses in 2021 and 2022, leading to the noted drop in SR&ED claims.

However, even given the recent trend, it can be argued that large corporations still receive a disproportionate share of SR&ED tax credit funding because of the large number of claims submitted by small businesses. For example, in the data noted above, almost 13,000 claims were submitted by small businesses in 2022, while large businesses submitted about 500.

The Need for Change

Critics of the existing SR&ED tax credit argue that the program needs a major overhaul to ensure it genuinely benefits Canadian companies and fosters economic growth in this country. Concerns range from relatively low spending on R&D in Canada relative to other G7 countries—The Logic’s report cites Organisation for Economic Co-operation and Development (OECD) data showing that Canada ranks sixth in R&D spending—to the overall efficiency of the program in promoting R&D spending in Canada. 

Despite the significant funds allocated to the SR&ED program, there is a consensus that more needs to be done to enhance the effectiveness of these investments, including measures to ensure innovation and the commercialization of any resulting intellectual property takes place in Canada, rather than merely subsidizing multinationals for the sake of job creation. 

Ongoing Review

Ottawa has heard the concerns and has embarked on a program review to modernize the SR&ED tax credit and ensure the program aligns with its innovation and commercialization economic strategy. On January 1, 2024, the federal government launched a first round of consultations to explore cost-neutral ways to enhance the SR&ED program. Those consultations closed on April 15, and this year’s budget announced a second round of consultations, which closed on May 27, to hear further views on certain topics, including how Canadian public companies might be made eligible for the enhanced SR&ED tax credit. Providing Canadian public companies access to the enhanced credit, if enacted, would represent a significant increase in the value of the credit and improve cash flow for eligible organizations.

The federal government has already demonstrated a willingness to bend on its cost-neutral approach to SR&ED program reform, allocating an additional $600 million in program funding over four years, starting in 2025–26, in this year’s budget. Through the consultation and review process, the government also hopes to identify ways to ensure the retention of intellectual property in Canada and support innovative businesses in remaining Canadian.

Parallel to the SR&ED program review, the federal government is also investigating the potential in creating a patent box regime. In a typical patent box scheme, income from certain underlying intellectual property is segregated and taxed at a favourable rate, which is intended to encourage domestic commercialization of intellectual property resulting from Canadian R&D.

According to David, “Stepping back and looking at Canada’s emerging industrial policy, including various direct and indirect incentives, this year’s budget provides the skeleton of a future framework that has some logic to it. It is expected that the implementation of rules to meet international Base Erosion and Profit Shifting (BEPS) Pillar 2 requirements will likely increase tax revenues by rendering structures that would place intellectual property in a low or no tax jurisdiction invalid. These revenues could be channeled to further incentivize R&D in Canada at relatively low levels of taxation, while keeping the intellectual property and commercialization of the technology here. Investment tax credit rates could be adjusted higher or lower, depending on where the intellectual property and ultimate taxation resides, to retain wealth creation for Canadians in the long run.” This approach would preserve the cost neutrality of Canada’s industrial policy, while addressing Canada’s well-studied challenge of achieving global commercial scale from within.

More Innovation Funding

In the dynamic landscape of R&D funding, SR&ED stands as a catalyst, speeding up the course of innovation in Canada. While recent data sheds light on challenges within the program, it remains a driving force for technological advancement and economic growth.  To learn more about the SR&ED tax credit program, download our free guide. 

For those exploring alternatives, the Industrial Research Assistance Program (IRAP) offers a viable option, as do many other diverse funding opportunities. For further information on the benefits and availability of these programs, please reach out to your Ryan representative or check out the Mentor Works, a Ryan Company, website here.

Malaga Mashrur
Specialist, Marketing, Scientific Research and Experimental Development
malaga.mashrur@ryan.com

¹ McIntyre, Catherine, “Flagship R&D tax credit still rewards large firms disproportionately, though new data shows gap is narrowing,” The Logic, February 15, 2024, https://thelogic.co.