Canadian organizations that collect Scientific Research and Experimental Development (SR&ED) incentives may be in for a rude awakening come tax time, thanks to a ruling by the Tax Court of Canada.
In late May the Supreme Court of Canada dismissed an appeal application seeking to overturn an earlier decision by the Tax Court, which deemed below-market federal loans a form of government assistance, excluding them from being used in conjunction with SR&ED.
As such, Canadian organizations may see some of what previously qualified for SR&ED benefits no longer eligible for the widely used tax incentive program if those expenses were paid for via a low or no-interest loan from a federal institution. According to the Canada Revenue Agency (CRA), SR&ED provides more than $3 billion in tax incentives to 16,000 businesses annually.
The ruling could undercut federal loan programs like those offered through the BDC, CIB, EDC, and FCC.
“A longstanding part of SR&ED is you cannot double dip; you cannot [apply] SR&ED [to] government assistance, and traditionally government assistance has mostly been viewed as grants,” explained Bryan Watson, the managing director of CleanTech North and senior vice president of business development at Venbridge, which specializes in helping technology firms apply for SR&ED financing. “Anything that is not a market rate debt instrument is now considered to be government assistance.”
The landmark ruling came after Quebec-based aviation, defence, and healthcare provider CAE Inc. received a $250 million loan over five years from Industry Canada’s Strategic Aerospace and Defence Initiative to manufacture flight simulator systems with an interest rate of 2.5 percent. Court filings suggest that was about one-third the market rate at the time, in 2014.
As part of the same project, CAE logged $700 million in R&D expenditure, $250 million of which a judge later ruled, in 2021, was disqualified from SR&ED incentives, as the funds were received through what it deemed to be another government assistance program.
“There is significant concern within the tax community on the implications of this decision,” reads an open letter penned by the Canadian Bar Association and Chartered Professional Accounts (CPA) of Canada, submitted to the Director General of the Tax Policy Brand of the Department of Finance on August 11th.
The open letter warns that the ruling could undercut the stated goals of federal loan programs like those offered through the Business Development Bank of Canada (BDC), Canada Infrastructure Bank (CIB), Export Development Canada (EDC), and Farm Credit Canada (FCC).
“The treatment of unconditionally repayable loans as government assistance appears to be inconsistent with the tax policy objectives of the [Income Tax] Act,” it states. “Such treatment might result in the desired projects not being economically viable because of the increased tax burden.”
“While the government continuously reviews the tax and benefit system, it would be inappropriate to speculate on any potential or prospective changes,” a Department of Finance representative told BetaKit.
A BDC representative provided the following statement: “As the BDC is required to be financially sustainable, it prices to risk, with interest rates that are generally greater than those offered by other lenders.”
BetaKit also reached out to CPA Canada, but representatives were not available for comment.
“SR&ED is a huge amount that a lot of companies get back, and if this is pursued, there will be bodies in the water.”
– Bryan Watson, Venbridge
Prior to the ruling Canadian companies had operated under the assumption that funds from government-issued no or low-interest loans could be used for activities that would later receive further financial assistance under SR&ED.
While the ruling came down in the spring Watson says most remain unaware of its implications, as the majority file taxes at the end of the year, at which point they can apply for SR&ED incentives.
“About 90 percent of companies have a calendar fiscal year, so 90 percent of companies haven’t really thought or paid a lot of attention to this sort of stuff at all,” he said. “My big concern about all this is not a lot of companies know, so they’re not necessarily planning for it, and I know of zero companies that are sitting on a cushy war chest in this economy that they can use to absorb the shock.”
BetaKit reached out to a number of other Canadian venture capitalists for comment on the matter, with most either not aware of the decision, or not concerned by it.
“It’s not really of any impact to our companies,” said Inovia Capital president and CEO Chris Arsenault. “While Canadian tech companies across our portfolio are claiming SR&ED when applicable, we follow the rule of not accounting for such in any budgeting.”
Watson added that a quick scan of the publicly available list of Grants and Contributions published by the Government of Canada demonstrates how common it is for firms to apply for low or no-interest government loans explicitly for research and development purposes.
“If your loan application or funding application was to do all your R&D, then that might be an issue if you get into an audit,” he warned. “If you have any of this money, my recommendation to companies is, A, try to patrician your general accounts to really nail down what that money paid for between the proposal you made to the government and where you actually spent it; and B, plan for the worst.”
In the meantime, Watson hopes that the open letter from CPA Canada and the Canadian Bar Association will inspire the Department of Finance to provide further clarity.
“It wouldn’t reverse the ruling, but it would give the CRA guidance as to how they should act on the ruling,” he said. “SR&ED is a huge amount that a lot of companies get back, and if this is pursued, there will be bodies in the water.”
UPDATE (11-21-2023): In its Fall Economic Statement, the federal government proposed amending the Income Tax Act so that “concessional loans with reasonable repayment terms from public authorities” would not be considered a form of government assistance.
Feature image courtesy Unsplash.
