Finance Industry Workshop Finance-Industry Workshop July 10, 2008 Clarification – SR&ED Legislation and

Finance-Industry
Finance
Industry Workshop
July 10, 2008
Clarification – SR&ED Legislation and
Regulation
Analysis
and
d
Recommendations
1
•
CATAAlliance appreciates the opportunity that this meeting with Finance
provides. We recognize the commitment this represents to the SR&ED
program, given your busy schedules.
•
We need to compliment the CEA for the excellent technical review of the
issues that they have submitted to you and for sharing it with us. As the IT
sector does have different perspectives than other sectors on the nature
and degree of problems, we have at times come up with slightly different
recommendations but, frankly, the issues are fundamentally the same. And,
we fully
f ll supportt the
th CEA analysis
l i and
d particularly
ti l l we b
believe
li
th
thatt th
the
exclusions (e) through (k) in 248 (1) are an extremely confounding factor
that needs to be addressed through a legislative solution.
•
CATA and those of us here today believe that refinement of the legislation
and associated regulations would be a significant contribution to improving
relations between CRA and its clients, and inherently a contribution to the
effectiveness of the program.
2
Clarification – SR&ED Legislation
g
and Regulation
g
Agenda
Objectives
Today’s
Today
s discussion format
Contributors and Introductions
Discussion of Issues:
1.
Definition of SR&ED
2.
Contracts
3.
Filing deadline for SR&ED claims (18-month deadline)
4.
Use of normally kept books and records as basis for allocating costs to
SR&ED work
3
Clarification – SR&ED Legislation
g
and Regulation
g
Objectives
•
Understanding legislative intent
•
Identification of source of current confusion around the legislative
purpose
•
Identification and review of potential solutions
4
Clarification – SR&ED Legislation and Regulation
Today’s Discussion Format
Topic-by-topic explorations
• Finance discussion of government intent for each issue
• Presentation and discussion by industry participants of each of the 4
issues
• Discussion of potential approaches to addressing the problems
identified
• Next steps and follow-ups
5
Clarification – SR&ED Legislation and Regulation
Contributors / Introductions
•
•
•
•
•
•
•
•
•
•
•
Winnifred Brown
Anil Chawla
Phil F
Feely
l
Joanne Hausch
Denis Lajoie
Don Lush
Mel Machado
Bob McCue
Ken Murray
Russ Roberts
Catherine Bishop
6
Clarification – SR&ED Legislation
g
and Regulation
g
Why improvements are required
•
repeated cycles of restrictive, inconsistent interpretations
– 1985-1986 transition from SRTC to SR&ED program
– mid-1990s backlash to introduction of the 18-month reporting requirement
(bulge)
– currently - source unknown
•
repeated
t d attempts
tt
t att policy
li clarification
l ifi ti off relatively
l ti l consistent
i t t legislative
l i l ti
– conduct of R&D in a commercial setting, including prototypes and experimental
production
– treatment of contracts, generally and under the proxy
– requirements for books and records / appropriate allocation methodologies
– continuous process of clarification of what is included as a technology
– ARE THE ABOVE RIGHT? PLEASE THINK OF ANY OTHER EXAMPLES
FOR HERE.
7
Clarification – SR&ED Legislation
g
and Regulation
g
The result
Lack of consistency, predictability, timeliness and cost-effectiveness.
This is unacceptable for Canada’s primary mechanism for support for
business innovation.
innovation
When this program is out of sync with business reality, Canada’s ITC investments are
ineffective, becoming simply windfall profits when businesses cannot book their ITC with
assurance.
When the program is functioning,
We believe it is an excellent contributor to the Canadian business environment and
innovation in our businesses.
Conclusion: Improvements are needed. CRA and their claimants need
help.
8
Clarification – SR&ED Legislation
g
and Regulation
g
Conclusion
•
CRA and their clients need help.
•
What is needed is refined, clearer legislation where policy
conundrums are not resolving.
g
•
Neither the CRA nor clients have been able to find solutions where
these conundrums exist. Question: How can we help them?
9
Clarification – SR&ED Legislation
g
and Regulation
g
•
What is needed?
•
CEA has said SLIDE 8
•
We agree.
QUOTE
10
Clarification – SR&ED Legislation
g
and Regulation
g
Issue
Definition of SR&ED
248 (1)
( )
11
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Historical perspective - 248 (1) (formally Reg. 2900)
1985
The term “scientific research and experimental development” (SR&ED) was
introduced as a new title for Reg. 2900 to clearly distinguish between what is
eligible development and what are simply routine engineering and routine
d
developments.
l
t Th
The tterm ““experimental
i
t ld
development”
l
t” was nott iintroduced
t d
d iinto
t
the body of the Regulation.
1986
Revenue Canada (CRA) seeks clarification from Finance of the
meaning
i off th
the tterm ““experimental
i
t ld
development”
l
t” (ED)
(ED). M
March
h4
4, 1986
1986,
R.A. Short, General Director, Tax Policy and Legislation Branch, Department of
Finance, wrote to Revenue Canada:
With respect to the general guidelines, this department is in basic agreement with the
approach
hb
being
i ttaken,
k
namely
l th
thatt tto qualify
lif ffor th
the research
h and
dd
development
l
t ttax
incentives, an activity must embody some scientific or technological advancement, have
some elements of scientific or technological uncertainty, and be carried out in a systematic
and organized fashion. In other words, the research or development activity will advance
our understanding of scientific or technological relationships. In our view, these criteria
capture the spirit and intent of the legislation
legislation.
12
Definition of SR&ED
248 (1) (formally Regulation 2900)
1986
Information Circular, IC 86-4, “Scientific Research and Experimental Development”
(SR&ED) was issued. It was a consensus of industry leaders on how to apply the
term “experimental development” (ED). It established the cornerstone for identifying
eligible
li ibl SR&ED through
th
h 3 criteria.
it i
1992
Finance issues proposed definition of ED and conducts public consultations.
p
was to develop
p a definition consistent with the understandings
g that had been
• Purpose
developed through IC 86-4, including the 3 criteria.
• Tried to eliminate subjective judgment about what is routine engineering and routine
development vs. ED.
• Tried to move to facts-based test rather than peer test normal to a “knowledge” test.
• Focused on process of achieving an advancement, i.e., moving from existing
engineering capabilities and understandings to a new or improved advanced state
g new,, or improving
p
g existing,
g, materials,, devices,, products
p
or
needed for “creating
processes, including incremental improvements thereto.”
13
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
1998
Chief Justice Bowman issues a key decision in Northwest Hydraulic
C
Consultants
lt t Limited
Li it d d
drawing
i ffrom consensus concepts
t off IC 86
86-4R3
4R3 ffor kkey
guidance in developing a test for SR&ED. Subsequent jurisprudence
reinforces this decision.
2000
Community and the CRA develop software guidance to expand on these
concepts and to stabilize the CRA’s decisions in the IT sector.
14
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Results
Since 2000
• Acceptance of what is considered to be a technological advancement for SR&ED was
stabilized in the IT sector from the perspectives of both the CRA and the community
Acceptance rates of IT claims approaching 90% have been acknowledged by some
senior CRA officials.
•
Finance found that the definition and guidance effectively handled the eligibility of
internal software, particularly that of the financial institutions, which was a major issue
i th
in
the llate
t 1990
1990s and
d concluded
l d d that
th t changes
h
were nott needed
d d to
t the
th definition
d fi iti off
SR&ED, because of the progress.
•
However, periodic problems still existed with the scope of work, i.e., 248 (1) (d),
“work
work…commensurate
commensurate with the needs
needs, and directly in support
support, of work described in
paragraphs (a), (b), or (c).” Albeit, this issue is much more pronounced in non-IT
engineering sectors, particularly manufacturing and consulting engineering.
•
Finance considers that the current definition of SR&ED is “largely consistent” with
i t
international
ti
l standards.
t d d
15
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
But
Recently, problems have arisen about scope in 248 (1) (d) and whether work
that would normally be associated with any software engineering in the
absence
b
off SR&ED should
h ld be
b carved
d outt off what
h t is
i eligible
li ibl iin spite
it off it
meeting the “commensurate” and “directly in support” tests in (d).
16
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Our take on the problems being observed today
17
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Observation re current definition of “ED” in 248 (1) (c)
•
Finance dropped the knowledge test found in (a) and (b), arguably, to move away from subjectivity
of the peer test normal to identifying when scientific knowledge gains are significant enough to be
called an advancement.
•
The definition of ED was specifically intended to emphasize that ED did not occur in a
stereotypically research environment but rather in the real world environment of the shop floor
where the objective is to develop technologies that deliver under commercial conditions.
•
Finance moved to an action based test founded on a dual purpose test using gerunds, i.e., “for the
purpose
p
p
of achieving
g technological
g
advancement for the p
purpose
p
of creating….”
g
Arguably,
g
y,
gerunds (verbal nouns) were used to emphasize the action or process of figuring out how to
achieve (searching) in a field of technology a technological advance needed to create new or
improved materials, devices, products or processes, including incremental improvements.
•
Our understanding is that Finance included the emphasis on incrementality to further indicate that
th d
the
definition
fi iti off ED was meantt tto extend
t d iinto
t th
the shop
h flfloor environment
i
t – nott simply
i l b
be ffocused
d
on technology eurekas!!
18
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Then, where are the problems with 248 (1)?
1.
Predominantly, problems seem to be sourced in questions on the interaction and
primacy of 248 (1) (d) vs 248 (1) (e) - (k). That is, which exclusions set out in
paragraphs (e) - (k) are substantive exclusions and which are intended simply “for
for
greater certainty.”
2.
Some problems appear to relate to restrictive interpretations of some of the
wording
di in
i (d) and
d to
t whether
h th or nott the
th activities
ti iti lilisted
t d iin (d) are meantt tto b
be allll
inclusive or whether they are meant to include, but not be restricted to.
3.
Some p
problems,, particularly
p
y claims for advancement in manufacturing,
g, seem to be
associated with a very limited view taken by some in the CRA on what are
technologies, which contradicts the CRA’s established policies, Finance’s position
per Mr. Short’s letter, and internationally accepted definitions.
19
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Problem # 1 - Primacy of 248 (1) (d) vs (e) - (k)
The exclusions (e) - (k) are confusing.
• Some are substantive exclusions
exclusions.
•
Some are simply clarifications for greater certainty.
•
Some look like they could be either.
For analysis, see handout Table A.
20
Legislative Construction
• Possible interpretation of current definition
Extract from CEA slides provided
previously to Finance
Legislative Construction
• Probable legislative intent
Extract from CEA slides
previously provided to Finance
Legislative Construction
• How individual exclusions now work
Extract from CEA slides
previously provided to Finance
Legislative Construction
• How individual exclusions should work
Extract from CEA slides
previously provided to Finance
Legislative Construction
• How individual exclusions should work
Extract from CEA slides
previously provided to Finance
25
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Problem # 1 - Primacy of 248 (1) (d) vs (e) - (k)
Examples
TO BE DEVELOPED
26
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
PROBLEM # 2 – What is included in (d)?
The problem may be related to the following wording in bold type and
underlined:
•“work undertaken by or on behalf of the taxpayer with respect to engineering,…”
•“where the work is commensurate with the needs, and directly in support, of work
described in paragraph (a), (b), or (c)….
Is (d) limiting or illustrative? Does (d) include only the particular types
of work specified or is it meant to be illustrative of a much larger
number of types of work that are eligible? What is the intent? If it is
limiting, the current definition works but we believe that the exclusions
in (e) - (k) are conflicting with (d) creating an unnecessary interpretative
problem.
27
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Problem # 2 - What is included in (d)?
Examples
TO BE DEVELOPED
28
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Problem # 3 - Definition of technology
Technology incorporates a range of fundamental advancements going all the way from
the development of new practice knowledge to the creation of a hard technology such as
a device or a machine. Currently, some CRA technical reviewers cannot accept the full
spectrum of technology advancements as commonly accepted both by CRA national
policy and international understandings.
CRA’s official view of Technology
• IC 86-4R3, 2.3 - “Here technology refers to the systematic study of the application of scientific knowledge to
industrial processes or product development.”
• This idea is expanded in Application Policy “Recognizing Experimental Development”, dated 2002-09-23 – “A gain in
knowledge that advances the understanding or application of the technology involved
involved, ii.e.,
e know-how
know how, (for example
example,
new or improved practices, methodologies, or techniques) also represents a technological advancement.”
Commonly accepted view of Technology
“The study, development and application of devices, machines and techniques for manufacturing and productive
processes.” (Encarta Concise English Dictionary, Microsoft Encarta, Bloomsbury Publishing Plc 2001.)
p
29
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Problem # 3 - Definition of technology
Examples of CRA’s restrictive positions
TO BE DEVELOPED
30
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Problem # 3 - Definition of technology
Our view of what is needed
•
The CRA needs to see that their technical reviewers understand and manage the fact
that the definition of technology includes studies to advance engineering practice
knowledge. This is a common, well established concept and it should be
manageable.
bl
•
Two concepts critical to an effective definition of technology in the engineering
sectors, including
g IT and manufacturing,
g are that eligibility
g
y of technology
gy is driven by:
y
– the development of new understandings and capabilities; and
– the relations that control process.
31
Definition of SR&ED
248 (1) (f
(formally
ll R
Regulation
l ti 2900)
For Problem # 1 - Primacy of 248 (1) (d) vs (e) - (k), we recommend:
Revise 248 (1) to eliminate all the exclusions, except for the one truly
substantive exclusion “(g)
(g) research in the social sciences or the
humanities.” This substantive exclusion should be moved to the
preamble, as suggested in the CEA submission.
32
Definition of SR&ED
248 (1) (f
(formally
ll R
Regulation
l ti 2900)
Problem # 2 - What is included in (d)? We recommend:
If (d) is meant to be all-inclusive, then maintain the wording. If (d) is
meant to be illustrative of a much larger
g number of types
yp of work that
are eligible, then indicate that the list includes, but is not restricted to
these types of work.
33
Definition of SR&ED
248 (1) (f
(formally
ll R
Regulation
l ti 2900)
Problem # 3 - Definition of technology. We recommend:
There is no reason why the CRA cannot use the full existing definition of
technology embodying practice knowledge together with 248 (1) (d) by
effectively
ff ti l going
i th
through
h th
the 4 sets
t off relevant
l
t ffacts
t that
th t claimants
l i
t can
provide to substantiate eligibility. This concept has been established in CRA
policies, proven effective throughout software engineering and other areas of
engineering. It cuts an effective, demonstrable line. The 4 sets of facts are:
–
facts related to their technology base / their base level / existing engineering capabilities that
is currently available to the claimant’s engineers;
–
facts showing that the technological targets (objectives) are real and outside their base level,
nott simply
i l ttargets
t created
t d to
t claim
l i SR&ED
SR&ED;
–
facts to establish that the technological uncertainties associated with achieving the
technological targets are real;
–
facts showing how solutions were explored.
34
Definition of SR&ED
248 (1) (f
(formally
ll R
Regulation
l ti 2900)
(…cont’d.) Problem # 3 - Definition of technology. In summary, we
recommend:
), (b),
( ), (c),
( ), and (d)
( ) not be modified,, other than minimally;
y; and
• that ((a),
• that the CRA manage the issue to deliver the full spectrum of
technology in accordance with their current national policies and the
internationally accepted definition.
We believe that the elimination of the exclusions of (e) through (k) is
needed and that it will greatly assist the CRA.
35
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Why amend legislation
Some CRA senior officials are taking the position that they are not there to
apply CRA’s national policy but rather to re-interpret the Act.
Reviewers are turning to 248 (1) (e) - (k) and applying these as exclusions to
override (a), (b), (c) and (d). At least in one public meeting, CRA
representatives explained that this is the policy and it is reflected in audit
practices in a n
number
mber of offices
offices.
Reviewers are using (i) to argue that work meeting the requirements of (d) that
are also associated with commercial activities need to be carved out. What
remains to be claimed is the increment.
Paragraphs (e) - (k) encourage individualistic interpretation and office-to-office
differences in decisions on eligibility.
eligibility
36
Definition of SR&ED
248 ((1)) ((formally
y Regulation
g
2900))
Anticipated results of amending the legislation
•
Increased consistency and predictability will result in the program being
much more effective in influencing business decisions.
•
Costly disputes and administration for both the CRA and claimants will
become more manageable. Currently, disputes create costs that materially
consume the credits actually earned.
•
The focus will be more on what is SR&ED rather than on what is not. That
is, the focus will be on delivering incentives.
•
Hopefully, regressive administrative cycles will be eliminated.
•
policy
y will be delivered with minimal distortion.
Fiscal p
37