Thoughts on the Recent SR&ED Update
Changes to SR&ED are a step in the right direction, but there is still work to be done
This will be my last CanInnovate article for 2024. See you in the new year, and happy holidays!
Three days ago, long-awaited changes to the SR&ED program were announced following two rounds of public consultation. These updates are set to take effect as of December 16, 2024, and include the following changes:
Increase the expenditure limit on which the enhanced 35 per cent rate can be earned from $3 million to $4.5 million. As a result, qualifying CCPCs would be able to claim up to $1.575 million per year of the enhanced, fully refundable tax credit;
Increase from $10 million and $50 million, to $15 million and $75 million, respectively, the taxable capital phase-out thresholds for determining the expenditure limit;
Extend eligibility for the enhanced 35 per cent refundable tax credit to eligible Canadian public corporations on up to $4.5 million of qualifying SR&ED expenditures annually.
Restore the eligibility of capital expenditures for both the deduction against income and investment tax credit components of the SR&ED program. The rules would be generally the same as those that existed prior to 2014 and would apply to property acquired on or after the date of the 2024 Fall Economic Statement and, in the case of lease costs, to amounts that first become payable on or after the date of the 2024 Fall Economic Statement.
While these are all welcome changes, they, like most Canadian government support structures, remain focused on later stages of company development without offering any substantive process reform that would be needed to drive impact in the earlier stages of deep tech development. In this article I breakdown what changed, and highlight areas for further improvement with respect to the earlier stages of technology commercialization.
What Changed
The changes outlined in the first two points are simply in line with updating SR&ED numbers for inflation. The $3M expenditure limit and the taxable phase-out thresholds date back to 2008, with cumulative inflation amounting to about 46% in that time. The updated numbers reflect a 50% increase, bringing these limits back in line. While it should have been indexed to inflation the whole time, better late than never.
The third change is more substantive: while previously publicly traded companies could not claim the full enhanced SR&ED amount, this change allows public companies to claim SR&ED on the same footing as CCPCs. This is certainly a positive step, though the announcement remains ambiguous as to what constitutes an “eligible” public corporation (**see edit at the bottom for clarification**). It remains to be seen if this credit is enough to incentivize listing in Canada. In either case, this change removes an active disincentive to going public in Canada, where small companies considering the change would have previously had to give up enhanced SR&ED eligibility to do so.
The fourth point reverts a change from 2012-2014, once again allowing capital expenditures to be claimed on two different tax incentives (income deduction and investment tax credit), effectively allowing research and development-related capital expenditures to be doubly-tax advantaged. All else being equal I have no reason to object to this change, but it was not on my radar as a target outcome. It may help in the early stages with deep tech companies that need to find and outfit independent lab space, but as with the rest of SR&ED still requires upfront commitment of capital without a guarantee of reimbursement.
What Didn’t Change
SR&ED limits are still not tied to inflation, meaning that the value of the credit will decline over time, as it has since the last time these numbers were updated in 2008. It would likely be simpler to just peg these limits to inflation and be done with it, avoiding the need for a similarly complex process a decade from now.
More of an issue, however, is that all of the changes are focused on the numbers and details of what can and can’t be claimed under the existing procedure, rather than structural and procedural changes to streamline SR&ED operations.
Supporting Canadian companies post-IPO is an excellent goal, but requires first that companies get to a stage where an IPO is possible. The way the SR&ED credit is paid out, requiring up-front commitment of funds without certainty of reimbursement, means that SR&ED is more useful to later-stage companies that can afford the initial outlay. For a Canadian company to benefit from these incentives requires that they first survive the process of getting to that point. Companies rarely hit the SR&ED cap in the early stages of building, and this is when the support is most needed.
Aside from the numbers, most things stayed the same. Intellectual property and the costs of bringing the results of R&D to market (marketing new technologies, for example) remain ineligible under the updated rules. The cottage industry of SR&ED consultants and lenders will continue to reduce the impact of the investment, re-energized with a shot at 50% larger returns.
In other words, these changes do nothing to help with the valley of death that prevents commercialization of Canadian research outputs, and as such, any impact will be limited to the companies that first survive the gauntlet that is Canadian early-stage development.
As previously noted, as much as a quarter of SR&ED credits are paid out to Canadian branch plants of foreign multinationals. It is unclear how these changes, particularly the third point, will impact this fraction.
Looking Ahead
These changes are all positive, but fall far short of what I had hoped to see resulting from the SR&ED consultation. The CCI response hits the nail on the head:
“While this announcement is welcome, and it moves to address some of the specific issues that we have been talking about in recent years, it must be the beginning, not the end, of SR&ED reform.”
That said, I am encouraged to see movement at all. I hope that the effort continues, and that further updates to the program go deeper than just tweaking the numbers, focusing on streamlining procedural elements of SR&ED that currently reduce the potential impact of Canada’s more important innovation-related incentive program.
Edit 2024-12-18
It was brought to my attention that the definition of eligible Canadian company is provided in the tax measure section of the Fall economics statement. The definition in summary is that an eligible company:
is resident in Canada;
has a class of shares listed on a designated stock exchange (a list is available on the Department of Finance website) or, if not, has elected, or been designated by the Minister of National Revenue, to be a public corporation; and,
is not controlled directly or indirectly in any manner whatever by one or more non-resident persons.
While this does allow for companies traded on exchanges outside of Canada, the approach to determining eligibility appears to be reasonable. My apologies for missing this.