The federal government’s more-than-$3-billion flagship R&D tax credit may be the single most important source of capital for startups and scaleups in Canada. It has been a lifeline for scores of startups in their early days. But ask any founder that’s used the Scientific Research and Experimental Development (SR&ED) credit and they’ll describe a tense love-hate relationship. 

Now, with the first major program review since 2012, business leaders are getting their say on how SR&ED should change to better serve the companies that use it, and the Canadian economy at large. 

As it stands, the program lets private Canadian companies claim a 35 per cent refundable tax credit on up to $3 million of R&D-related expenses. That amount of eligible spending declines as a company’s taxable capital rises. Once a firm earns $50 million, it’s no longer eligible for the return. Public and foreign-owned companies, meanwhile, can collect a 15 per cent non-refundable credit for R&D work done in Canada. There’s no cap on the amount of spending against which they can claim.

The program’s critics—many of whom rely on the credits—say SR&ED is falling short of its potential to stimulate productivity. Claimants have told The Logic the application process is overly burdensome. Both the program’s eligibility criteria and its basic objectives are unclear and outdated, some said, creating an inefficient use of tax-payers’ dollars as companies hire third-party SR&ED consultants to help them navigate the onerous process. 

The Department of Finance is now soliciting the public’s suggestions on how to improve the program without spending more money on it. 

The Logic spoke with CEOs and industry representatives about how to fix SR&ED, and reviewed some recommendations already submitted to the government. Here are the changes Canada’s innovation economy leaders most want to see.

Help commercialize IP: As part of the review, the federal government is considering a “patent box regime,” which offers tax breaks to encourage companies to develop and keep intellectual property in Canada. 

Prompting companies to spend money on IP-generating discoveries could have an outsized impact on the economy, said Council of Canadian Innovators (CCI) president Benjamin Bergen. “That’s where all of the value in the economy has shifted,” he said, referencing wealthy Big Tech giants like Microsoft, Apple and Google, which churn out piles of IP. “It’s not so much in their labor, but it’s actually the intellectual property that they generate, hold, and then are able to seek rents from.” 

John Ruffolo, Maverix Private Equity founder and managing partner, said many Canadian companies transfer their IP out of the country to take advantage of tax incentives offered elsewhere. “Once these profits are taxed outside of Canada, they can be repatriated back to Canada tax-free, and Canada has therefore lost its ability to tax any of these ‘intangible-based’ profits,” he wrote in his recommendations to Finance. Having comparable tax incentives—like a lower rate for profits from patent royalties and licensing, for example—could help Canada compete globally, he argued.

CCI, meanwhile, suggested companies should be allowed to claim SR&ED credits for the work involved in generating patents in the first place. 

Give public companies more credit: The TMX Group, which operates the Toronto Stock Exchange, is urging the government to let public Canadian companies take advantage of the full 35 per cent SR&ED credit, up from the 15 per cent non-refundable credit to which they’re currently entitled. “Governments often will think that public companies are big and successful, and they don’t need help. And so they miss the fact that the bulk of the Canadian public-company ecosystem is actually small and medium enterprises,” TMX Group CEO John McKenzie said in an interview with The Logic earlier this month. “We’d love to see reform of the program to put more funding into small companies, regardless of structure. And that’ll get more money actually into innovation and less into consultants.”

Raise the capital limit: CCI wants the 35 per cent credit extended to companies whose capital may exceed the $50-million threshold. Often venture-backed Canadian startups, for example, have more capital than that, but are spending heavily on R&D and aren’t yet generating revenue. 

Dennis Darby, president and CEO of Canadian Manufacturers and Exporters, said the limit doesn’t incentivize startups to scale. “It really doesn’t encourage growth,” he said. The limit is also outdated, CCI argued in its submission. Adjusted for inflation alone, it should rise to over $70 million, the organization estimated. 

For large “revenue-secure” firms, CCI thinks the non-refundable rate should be lower than the current 15 per cent. (An analysis of Canada Revenue Agency data by The Logic found that large firms receive an outsized share of SR&ED credits.) 

Simplify the process: There’s widespread concern that a lack of clarity on the program’s objectives and eligibility criteria makes SR&ED complicated to access. Many companies hire specialized accountants to file their applications, sacrificing as much as 30 per cent of their return on consulting fees. “For a lot of small companies who were on the fence about doing SR&ED, it tends to be the biggest blocker,” said Kevin Kliman, CEO of HR software firm Humi, which has started offering its clients SR&ED processing services for what he said is half the cost of the market rate. 

Another barrier, said Alex Greco, senior director of manufacturing and value chains at the Canadian Chamber of Commerce, is that CRA auditors often aren’t familiar with the work companies describe in their claims. Greco said the department of Innovation, Science and Economic Development—which better understands the industries in which SR&ED recipients operate—should help determine what activities qualify for the credit and help speed up approvals. 

Reward tinkering: SR&ED doesn’t explicitly reward firms for iterating on existing work. Business leaders told The Logic that needs to change. “We need to make sure that we’re encouraging companies to invest in process improvements, in technology improvements, that make them more productive,” said Darby. 

CCI said some of its members working on artificial intelligence technologies have been denied SR&ED because of this. The CRA took “the position that a series of incremental improvements to the technology using data was ‘routine’ and therefore not eligible to receive SR&ED dollars,” CCI wrote in its submission to Finance. 

Andrew Casey, president and CEO of BIOTECanada, said the SR&ED rules should make clinical trials of pharmaceuticals, for example, explicitly eligible. Restricting tax credits for clinical trials may drive some firms to do this work in countries with more generous incentives, which could weaken Canada’s biotech sector, he said. 

Measure the outcomes: The CRA doesn’t disclose much information about SR&ED recipients or how the billions a year in tax dollars impact the economy. Bergen said increasing transparency is the first step to improving SR&ED. “You can’t measure what you don’t know,” he said, “and if you can’t measure it, then it’s hard to determine how well something’s working.” 

Greco agreed that SR&ED needs clear outcomes and measurable objectives to know whether Canada isn’t just meeting its R&D goals, but its “commercialization and innovation targets as a country.”