
Canada's R&D tax credit program hurts R&D in Canada - wwhchung
https://medium.com/@wwhchung/sr-ed-hurts-canadian-innovation-4fbcf4898d7d
======
lucisferre
SR&ED is a terrible program that is actively hostile to software startups.

To begin with under the definition of what the program considers claimable, in
the strictest sense, most software work doesn't actually qualify, but the
program is so poorly administered that most of them are able to successfully
claim it anyways so they try, however you are always under the risk that your
claim will be denied or clawed back.

Adding to this problem for startups, first time claimants have a much higher
chance of being audited, as well as any time a claim increases significantly
over the previous year (think high growth company). If an audit goes poorly
enough you can also have previous years claims clawed back.

Then there is the time wasted in preparing and submitting, the pedantic time
tracking that startups implement which is a drag on development teams in order
to file these claims.

Finally, because the process is confusing and daunting enough most companies
will hire a SR&ED consultant to file the claim for them where they will likely
pay around 20% of the total claim.

In short, SR&ED is a great program for consultants to siphon money from tax
payers but a terrible program for funding innovative startups.

~~~
lazyant
On one hand you are saying that there's bad claims and on the other hand you
complain about having to document and having audits.

All you are saying is true except the conclusion in the last sentence, which
may be a valid point but doesn't follow from the other facts.

~~~
barkingcat
That's how poorly administered the system is. I've seen companies go through
SR&ED and it's fairly random whether the paperwork is going to be accepted.

Some companies document everything and end up being rejected for a random
formerly unknown minutia, whereas other companies document less, and
ultimately get approved for a bad claim.

Anyone I've talked to who's even been close to the process (a claimant, a
technical contact, an interviewee, an administrator) have had traumatic
experiences with the process.

------
bhouston
This post is a load of shit, serious shit.

Claim 1: > Promotes excessive executive compensation

You can not claim executive compensation in a SRED claim. If you do it is
fraud.

It is an excluded expense see here:

[http://www.cra-arc.gc.ca/txcrdt/sred-
rsde/clmng/ttlqlfdsrdxp...](http://www.cra-arc.gc.ca/txcrdt/sred-
rsde/clmng/ttlqlfdsrdxpndtrsfrtcprpss-eng.html#s10_0)

Claim 2: > We’re paying foreign entities to take IP and profits out of Canada.
Not a very good use of taxpayer dollars, is it?

Actually that is illegal, see this:

[http://www.cra-arc.gc.ca/txcrdt/sred-
rsde/clmng/ttlqlfdsrdxp...](http://www.cra-arc.gc.ca/txcrdt/sred-
rsde/clmng/ttlqlfdsrdxpndtrsfrtcprpss-eng.html#s9_0)

Claim 3: > Removes emphasis on sustainable growth

It isn't meant to be sustainable, it is mean to fund the initial R&D in
something that is risky. As you grow, and you slow down R&D, yes it gets
smaller -- by design.

This is a really weird post and seems to be spreading FUD.

SRED is not a perfect program, but the main faults outlined in this article
are complete wrong.

~~~
wwhchung
Hi there. Claim 1 is not incorrect. I am not stating executive compensation is
used to claim SR&ED. I am stating it is used to suppress net profits to
qualify for the higher rate. Also,

Claim 2, there is no requirement for IP to be owned by the Canadian entity for
its development to be qualified for SR&ED (I’ve verified this from multiple
accountants and the CRA).

As for Claim 3, you realize that this is indefinite right?

~~~
bhouston
If you say these are major issues, how often have you seen these two instances
in the real world as a percentage of total SRED claims? Are these theoretical
concerns or do you know that these are very serious practical concerns about
SRED?

Regarding Claim 1, you are advocating that company will sacrifice its growth
in order to live off of SRED. The larger one’s SRED claims and the larger they
are in respect to total expenditures, the more likely to gain scrutiny and
audits. I’ve been SRED audited, it isn’t fun. If a company could make $1M, why
couldn’t it make $2M? This seems like a contrived scenario.

Regarding Claim 2, if a company is not going to act in its own best interests,
it doesn’t matter who owns the IP. The company could license it for nothing to
other companies even if it owned the IP.

In both scenarios you are outlining companies acting against their own best
interests. Maybe it is possible, but it doesn’t seem like a very common case.
Do you have numbers to back it up, or just the theoretical possibility that it
could technically happen?

~~~
wwhchung
Yes, it happens a LOT. I can't point fingers (it's not polite, and I'm
Canadian), but it's what prompted me to write the article.

And yes, it does matter who owns the IP. If a sale happens, the proceeds to to
the residing country's tax base. If it's not in Canada, we lose out on those
gains.

~~~
s73v3r
Why can't you point fingers? If you know this is happening, which is supposed
to be illegal, then blow the whistle.

~~~
wwhchung
Because it's not illegal as my post points out. It's a flaw in the structure.

~~~
s73v3r
So? Nobody says that you're supposed to claim they're breaking the law. You're
just pointing out a company abusing the law.

------
GnarfGnarf
The SR&ED reporting process is a nightmare. I once spent 170 hrs. defending a
piddling $100K claim. Hell is spending 8 hrs. in a room trying to explain
polymorphism and encapsulation to an accountant. The whole process is geared
towards engineering, physical processes and manufacturing. The subtleties and
abstraction of software development make it look like we take no risks.

The time-tracking requirements seriously degrade your productivity.

I joked that if you discovered time travel, you wouldn't qualify for SR&ED
because you were successful, so there was obviously no risk involved, ergo you
don't qualify.

~~~
rbobby
It's pretty difficult to get software development to qualify for SR&D. The way
it was explained to me by a consultant was to qualify there had to be
technological risk of failure (i.e. it is unknown whether or not it is
possible to do task X via software).

So your average SAAS startup doesn't face technological risk, even though they
face lots of business risks (might not be able to hire good enough developers,
might not be able to produce bug free app, etc).

However the first few companies using deep learning to do facial recognition
from photos (eg. facebook automatic tagging)... well they would have faced
technological risk. It wasn't known at the outset that deep learning would
produce sufficient quality matches to be useful.

On the downside... big organizations that can pay big bucks for assistance
with writing SR&D applications can qualify for S&RD. Several of the big
Canadian banks have recovered considerable amounts. Which is pretty outrageous
on the face of things... how much actual SR&D and technological risk is being
faced in a banking environment? None that I've ever seen (well... except for
one project I was involved in... but that was a trivial "lets try this and see
if we can use shared record locks as activity signals for a job scheduler").

In a way scientific/technological risk is a bad measure for software R&D. In
general there is very little technological risk, and what risk there is is
generally tackled via prototyping and/or early testing. The meat of the
development costs comes much later... and there's no gov't tax support for
that at all.

~~~
thaumasiotes
> The way it was explained to me by a consultant was to qualify there had to
> be technological risk of failure (i.e. it is unknown whether or not it is
> possible to do task X via software).

Ok...

> However the first few companies using deep learning to do facial recognition
> from photos (eg. facebook automatic tagging)... well they would have faced
> technological risk. It wasn't known at the outset that deep learning would
> produce sufficient quality matches to be useful.

This is a wildly different standard. It certainly _was_ known at the outset
that facial recognition from photographs is possible to do in software,
because people do it all the time. They just didn't know how.

------
bcantrill
In my experience, SR&ED is a system that exists to employ government
bureaucrats and their symbiotic ecosystem of consultants and auditors --
everyone else is a loser. And I felt this way _before_ we at Joyent were
audited; after we were audited (which came back clean, but was incredibly time
consuming and extraordinarily painful) my opinions on SR&ED are much more
pointed: we still have a Canadian office and it hasn't affected our hiring
there (Joyent is hiring in Vancouver![1]), but I want absolutely nothing to do
with SR&ED ever again in my life. (That is, we have not applied for SR&ED
credits since and will never do so again.)

If Canada wants to do something for startups, they should setup a sovereign
wealth fund that does early stage investment in Canadian companies -- and then
it should actively help make those companies successful. SR&ED is a transfer
payment from Canadian taxpayers to Canadian consultants; it should be
scrapped, not fixed.

[1]
[https://news.ycombinator.com/item?id=10312448](https://news.ycombinator.com/item?id=10312448)

~~~
sintaxi
This is nonsense.

SR&ED is not a grant you apply for, it is a tax credit that you are ENTITLED
to for taking technical risk and venturing into areas of technical
uncertainty.

SR&ED is a tax credit and a perfectly reasonable one. The problem with SR&ED
is that it is a badly abused which leads to painful auditing processes for
everyone.

Since Joyent Canada is (as far as I'm aware) a 100% wholly owned subsidiary of
a US corporation it doesn't surprise me the CRA took a close look at the
claims as Canadians ultimately wont see the extent of the benefits that the
program hopes to achieve for Canadian corporations. The fact that you call it
the "Canadian office" rather than the "Canadian company we own" illustrates a
frame of thinking that likely makes the CRA uncomfortable. The program is
designed to help Canadian companies.

So.. you are an American, working for an American company, managing a team
that is receiving Canadian tax breaks for generating I.P. for the American
corporation and you are complaining that you received friction from the CRA?
Yeah, no shit.

> SR&ED is a transfer payment from Canadian taxpayers to Canadian consultants;
> it should be scrapped, not fixed.

No, SR&ED is not funding from Canadian tax payers. Once again it is a tax
credit for money spent on salaries for performing tasks that have abnormally
high risk. Its critical to understand the difference before voicing an opinion
on the matter.

edit: wording

~~~
bcantrill
You fundamentally misunderstand SR&ED: it has nothing to do with "helping
Canadian companies" and everything to do with encouraging companies to do R&D
work in Canada. That Joyent Canada is a fully owned subsidiary of a US
corporation is immaterial (indeed, SR&ED is designed to attract R&D investment
from multinationals not based in Canada!), and as a I learned as part of the
audit, the audit that we received is considered "routine" for the first year
that a company applies for SR&ED credits. Our consultants didn't think it was
a big deal, and Revenue Canada was very polite about it; they (apparently)
just wanted to make sure that we employed everyone that we said we employed
and that they were engaged in eligible activity (which we did and they were --
it was all fine). But the audit was expensive for us in terms of time, and we
made the decision that SR&ED wasn't worth it. That's not nonsense; that's a
business decision.

------
HorizonXP
SR&ED was pretty decent for me this year. I claimed almost $120k in qualifying
expenses (a roughly $90k salary for myself and the proxy amount).

I spent about two weeks putting together the application (along with the rest
of my corporate tax return, so time was spent there too), and wrote up a few
pages about the software development work that we did.

It took about 2 months for them to respond, and I was approved without a
request for additional supporting documents. I received $48k.

I don't think I'll try and apply for it again next year, since I think it's
going to be harder to justify the time expense, but overall, it wasn't so bad
for a small claim.

I can certainly see how larger claims than mine become onerous though.

~~~
tlb
Two weeks! Neglecting the rest of your startup for 2 weeks can easily kill 10%
of its long-term potential. For $48k, so if you value your startup at more
than $480k, you shouldn't do it.

(Taking a 2-week vacation doesn't do that, because you're fresh and energized
afterwards, rather than beaten down by the grim bureaucracy).

~~~
HorizonXP
Precisely why I wouldn't do it again. Right now, $48k was the difference
between paying myself, or not. In the future, as we grow, that hopefully won't
be the case.

------
Afton
I'd also mention that what counts as 'R&D' is often paper thin. Normal
developer activities can count if they are spun correctly.

Whether that's a problem depends on the amount that you think of this as a
general small business tax credit vs an incentive to do research.

~~~
stormbrew
I was once told of a _restaurant_ that managed to get SR&ED for their chefs.

Second-hand, and supposedly they've tightened the rules since then, but I feel
like it's really telling of the flaws with the program at a fundamental level.

Either make it a handout directly or tighten up the rules so that it can only
apply to things with really rigid processes that are capital intensive, imo.

------
mmastrac
As a Canadian, I'd prefer it if the government took the entire SR&ED budget
and put it into an early/mid-stage venture fund like VCAP:
[http://www.actionplan.gc.ca/en/initiative/venture-capital-
ac...](http://www.actionplan.gc.ca/en/initiative/venture-capital-action-plan)

I've seen SR&ED abused at companies I've worked at, and on the flip-side I've
seen claims that _should_ qualify as R&D get denied.

By investing in startups (doing some due-diligence up front as any venture
fund would), we can increase the amount of R&D in Canada while simultaneously
reducing the operational cost of running it dramatically.

Big companies can take advantage of this program by acquiring earlier-stage
startups in their field.

~~~
_delirium
Since only a small percentage of startups are doing significant R&D, that
seems likely to just direct money towards general business development, the
majority of which ends up being "business model innovation" combined with
straightforward web development, vs. science/engineering innovation. Granted,
that may not be much worse than the status quo if it's currently funding a ton
of non-R&D things anyway, but it doesn't seem likely to really stimulate R&D,
either.

------
waterside81
It's great getting that money back and the author makes some good points about
the shortcomings of the program, but as a recipient of this credit 3 years in
a row now (just got our 2015 claim approved in record time), here's my issue
with it: It just seems like a handout for optics' sake.

In my circle of fellow SR&ED recipients, none of us have ever said "Well if it
wasn't for this program, we wouldn't have hired these people, built that,
researched this etc."

Although in spirit it's meant to act as incentive to take risk, profit is all
the motivation you need. I can't help but think that $4B could have been
better spent on a few km of track for the subway in Toronto, for example.

~~~
peeters
Isn't the goal to keep the R&D in Canada? It might make no difference to _how_
a startup is run, but I could see it making a difference of _where_ the
startup is run.

------
byron_fast
This is definitely true, but not news to anyone who has followed how
government program "X" for business actually works. These programs are defined
by who they favour, and it has nothing to do with merit as defined by business
or legislators; it is defined by bureaucrats who invariably favor things that
benefit them directly.

I managed to get a decent amount of money back from SR&ED, but it required (as
expected) an incredible time investment. A time investment that was negative
to our business in every way; there's no way to reap a return on that later
unless you return to SR&ED in the future.

The best thing, as always, would be for the government to simply lower taxes
and eliminate these circuitous loops.

------
ska
SR&ED can work very well for its intended audience. Most of the really vocal
complaints I've heard were from people and companies that really shouldn't
have applied in the first place.

However, I agree that there is confusion and external pressure to apply which
doesn't help things at all.

Most startups, don't do this sort of R&D at all (or hardly at all).

------
lazyant
"there are some bad unintended consequences" != "SR&ED Hurts Canadian
Innovation"

~~~
wwhchung
Bad unintended consequences was a nice way of phrasing 'it sucks and is
draining money away from real R&D/innovation'

------
mercurial
France has something like that as well, and boy, you wouldn't believe the
number of software companies which totally do massive amounts of R&D. And they
really do, it's just that for them, R stands for Read and D for Debug.

------
bvanvugt
It's really important that programs like Canadian SR&ED are being scrutinized
in the context of startups, and on that theme I'm really happy to see this
discussion.

I think it's more interesting to see how Canadian founders can shape these
sorts of policies over the next 5-10 years, and this is a great starting
point.

------
mikeklaas
For all its faults, Zite/Worio would've surely folded without SR&ED credits.

(In the end, we launched and were acquired by CNN.)

~~~
wwhchung
Or, it could have folded and made something else. Or any number of other
scenarios. But debating SR&ED being good or bad is too theoretical and
everyone can point to examples on all sides. This is why I chose a very
specific issue with SR&ED and proposals on how to fix it.

I'm not stating that SR&ED does not have its benefits, but there are some
glaring flaws that need fixing. Others include the SR&ED process itself,
evaluation of SR&ED claims and more. However this is the first one I could
concretely back up with examples and math and give real solutions to.

------
cheez
I actually had this discussion with my accountant yesterday: it only makes
sense if you're so profitable that you're paying taxes.

Guess who that favours ;)

Not me!

~~~
boonez123
Get a new accountant.

~~~
cheez
That's the thought I had for other reasons, but good to know that it was
justified.

