Background on Tax Executives Institute

Transcription

1 OFFICERS CARITA R. TW IN EM President Spectrum Brands Holdings, Inc. Madison, Wisconsin TERILEA J. WIELEN GA Senior Vice President Allergan, Inc. Irvine, California MARK C. SILBIGER Secretary The Lubrizol Corporation Wickliffe, Ohio C. N. (SANDY) MACFARLANE Treasurer Chevron Corporation San Ramon, California KIM N. BERJIAN Vice President-Region I ConocoPhillips Canada Calgary, Alberta Geoff Trueman Director, Business Income Tax SR&ED Consultations Department of Finance 140 O Connor Street Ottawa, Ontario K1A 0G5 Please Respond to: Kim N. Berjian Manager, Commodity Tax Conoco Phillips Canada th Avenue, South Calgary, AB T2P 2H Kim.N.Berjian@conocophillips.com BARRY S. AGRANO FF Vice President-Region II Pearson Inc. New York, New York Re: Consultation on the Effect of Contingency Fees on Scientific Research & Experimental Development Tax Incentives TIMOTHY R. GARAHAN Vice President-Region III Unifirst Corporation Farmington, Massachusetts TIMOTHY J. GO LD EN Vice President-Region IV Syngenta Corporation Wilmington, Delaware RICHARD H. WIREM AN, II Vice President-Region V Principal Financial Group Des Moines, Iowa KATRINA H. WELCH Vice President-Region VI Texas Instruments Incorporated Dallas, Texas MARCU S S. SH O RE Vice President-Region VII Duke Energy Corporation Charlotte, North Carolina TAVIN SKOFF Vice President-Region VIII SAIC San Diego, California CH RISTER T. BELL Vice President-Region IX LEGO Systems A/S Billund, Denmark Dear Mr. Trueman: On August 2, 2012, the Department of Finance and Canada Revenue Agency launched a consultation on the effect of contingency fee arrangements on the Scientific Research & Experimental Development (SR&ED) tax incentives. The consultation follows up on the Government s commitment in Economic Action Plan 2012 to study the contingency fees charged by tax preparers for SR&ED claims. On behalf of Tax Executives Institute, I am pleased to provide the following comments on the use of contingent fee arrangements in the preparation of SR&ED claims. Background on Tax Executives Institute TEI is the preeminent association of in-house business tax executives worldwide. The Institute s 7,000 professionals manage the tax affairs of 3,000 of the leading companies in North America, Europe, and Asia. Canadians constitute 10 percent of TEI s membership, with our Canadian members belonging to chapters in Montreal, Toronto, Calgary, and Vancouver, which together make up one of our nine geographic regions. Many of our non-canadian members, including those in Europe and Asia, work for companies with substantial activities in Canada. Thus, both Canadian resident and non-resident members must contend daily with TIMOTHY J. MCCO RMALLY Executive Director ELI J. DICKER Chief Tax Counsel 1200 G Street, N.W., Suite 300 Washington, D.C P: F:

2 Page 2 the planning and compliance aspects of Canada s business tax laws, including the SR&ED provisions. The comments set forth in this letter reflect the views of the Institute as a whole, but more particularly those of our Canadian constituency. Consultation Background The SR&ED tax incentive program encourages Canadian businesses of all sizes and in all sectors to conduct research and development (R&D) in Canada that will lead to new, improved, or technologically advanced products or processes. Out of concern that contingency fees may be diminishing the benefits of the program to Canadian businesses and the economy, the Government announced in Economic Action Plan 2012 that it would undertake a study of contingency fees charged by tax preparers. The consultations are aimed at understanding (1) why firms choose to hire third-party tax preparers on a contingency-fee basis, (2) why these tax preparers charge such fees, (3) the prevalence of the practice, (4) the size of the fees charged, and (5) the effect of the practice on the benefits derived by Canadian businesses and the economy from the SR&ED program. Rationale for Contingency Fees 1. The Government would like to understand why certain SR&ED performers use the services of third-party tax preparers on a contingency fee basis to prepare their claim form. Taxpayers, especially the large case file taxpayers for whom TEI members work, employ contingency fee arrangements for many reasons depending on the nature of the business and the type of SR&ED performed. In all cases, contingency fee arrangements expand the resources taxpayers have available for identifying whether new or existing projects qualify and, as important, whether a taxpayer s business processes properly document the qualification of the projects. Because of business exigencies and continuing constraints on corporate headcount, few taxpayers have the resources necessary to identify and document all their qualifying activities and expenditures and to timely complete the required tax forms. While the SR&ED tax incentive remains a powerful incentive, taxpayers seeking to remain competitive with their business peers in Canada and globally may not be able to sufficiently staff the laboratory, manufacturing shop floor, business unit, or tax department in order to monitor and document their qualifying eligible activities. With a contingent fee arrangement, there is generally no immediate hit or expense to a business unit s or tax department s budget for the incremental cost of performing the study. Instead, the cost and the related tax benefit will be accounted for at about the same time. As important, consultants can often identify more quickly whether an activity is eligible for SR&ED. Regardless of a taxpayer s eligible activities whether basic scientific research or shop-floor experimentation in manufacturing there is a varying level of tax expertise and savvy in the company. Thus, given the range of their duties, in-house tax professionals may not be aware of the most recent changes to the SR&ED legislation or CRA s assessing practices. The consultant can bring the extra resources to bear in focused fashion and educate employees (both tax and non-tax personnel) on the eligibility of projects or expenditures or identify business process improvements enabling taxpayers to better record and document the eligibility and costs.

3 Page 3 Employing consultants saves on full-time equivalent employees especially where the work of identifying and documenting a project s eligibility is a one-time task as opposed to a recurring activity. Next, the tax compliance tasks associated with documenting SR&ED are at once extensive and time limited. Form T661 (Scientific Research and Experimental Development (SR&ED) Expenditures Claim) requires a detailed explanation and documentation of SR&ED on a project-by-project basis. Moreover, the form must be completed and filed within 18 months of the end of the year during which the eligible activity occurs. The regular three- or four-year statute of limitations for amended returns and assessments does not apply to an SR&ED claim omitted from the return and not claimed within the 18-month window. Thus, companies are under time constraints to review their business processes and ensure that documentation and support for each claim is available. The services of a consultant are often necessary to complete the required work within the time constraints. Finally, documentation that is essentially for tax compliance purposes only is burdensome and viewed as just a tax requirement. To be sure, the SR&ED program provides a significant benefit, but no one whether in the laboratory or on the shop floor likes filling out forms for the sake of the tax man. A third-party consultant insulates the tax department from employee complaints about paperwork burdens while also serving as a useful independent check on or confirmation of the company s compliance and documentation processes. 2. The Government is interested to learn why some SR&ED performers pay for these services on a contingency-fee basis rather than a more traditional billing method. Contingency fees are one means of compensating third-party consultants for SR&ED consulting and compliance arrangements. Per-diem, per-hour, or fixed-fee arrangements are also commonly used. The consultation document intimates that claims filed on a contingent fee basis may be either more expensive or less reliable (or more aggressive ) than claims filed using traditional billing methods. We disagree. Contingent fee arrangements are usually undertaken pursuant to a request for proposals. The RFP process enhances the taxpayer s due diligence inquiry into the reputation and skill of the third-party consultants who respond; maintains the reputation of the taxpayer by permitting the taxpayer to evaluate the quality of a consultant s proposals, references, and prior projects; enhances price competition among consultants (i.e., keeps a curb on the contingency fee as a percentage of the claim) by permitting the taxpayer to test what the consultants are willing to offer; and enhances the taxpayer s ability to negotiate the contractual arrangements and maintain control over the quality of the consultant s work.

4 Page 4 Moreover, there are a variety of ways to control the cost of contingent fees. For example, many taxpayers will cap the total dollar amount of the consultant s fee regardless of the dollar amount of the claim(s) identified. In addition, nearly every contingency fee will be success-based. For large corporations, a success-based fee will generally be determined on a post-audit, postappeals, or post-litigation basis, whichever occurs last in time. In other words, the contingency fee amount in a large business file claim is generally not based on the return or claim as filed. In large file cases, CRA scrutiny is presumed, so the claim is not based on evading audit detection. As a result, a dollar cap or a success-based fee requirement will limit the amount paid without increasing the risk to the government. The fundamental difference between a contingent fee arrangement and a fixed fee, per hour, or per diem charge is which party bears the risk of identifying additional undocumented but eligible activities or expenditures to claim. With a contingent fee, the fee risk is shifted to or shared with the consultant. On a per diem or per hour billing arrangement, the taxpayer bears the risk for identifying the additional undocumented claims. Few taxpayers are willing to bear the risk of engaging consultants without a cap on the total number of hours for the project; similarly, well-advised taxpayer will never accept uncapped contingency fee arrangements. 3. The government is also interested to learn more about the size of the fees being charged and whether businesses are more likely to hire tax preparers on a contingency-fee basis only for the first time claim or on a recurring basis. TEI s experience is that the amount of contingent fees expressed as a percentage of the claim filed has decreased over the years. As an example, one company noted that a contingent fee arrangement undertaken a decade ago had a fee of 20 to 25 percent of the claim. More recently, a contingency-based SR&ED review was nine percent of the investment credit, but with a cap the total fee as a percentage of investment tax credits claimed was reduced to four percent. The fee represented less than one percent of the taxpayer s aggregate SR&ED spending. Some businesses will hire a consultant on a contingency fee basis only for a first-time claim in order to enable it to establish (or validate) the business processes necessary to comply with the tax filing requirements. More often, companies hire consultants on a recurring basis to serve as a periodic check on whether established processes are capturing and documenting information on qualified projects and expenditures as efficiently as possible. 1 In addition, companies may use contingent fee consultants on a recurring basis where the nature of the SR&ED activities is variable, where the business changes (e.g., as a result of an acquisition), or where the business processes change (e.g., implementation of a new enterprise resource planning database system). In other words, companies know their businesses and know their processes, but they may not know whether their processes are optimal for documenting the SR&ED credit. On a recurring basis, a consultant can either (1) remediate a process gone astray or (2) provide a benchmarking service or efficiency check for a well-functioning SR&ED compliance process. 1 Thus, while the company may continue using the contingent fee consultant, the fee, as a percentage of the overall claim, will decline as the taxpayer improves its internal processes and leaves less on the table for the consultants to identify.

5 Page 5 4. The government would like to understand the motivations of tax preparers for charging on a contingency-fee basis, and the relative importance of this type of revenue for tax purposes. Clients will request contingency fee arrangements as a way of mitigating the risk of undertaking an SR&ED process study. 2 The service providers would often prefer a noncontingency fee arrangement or a combination of fee arrangements that would ensure recovery of their out-of-pocket costs should their review fail to identify incremental expenditures or activities qualifying as SR&ED. Effects of Contingency Fees 1. The Government is seeking input from stakeholders in order to assess the impacts of contingency fees on the cost-effectiveness of the SR&ED tax incentive program in meeting its objective of providing broad-based support for the performance of R&D. Contingency fees are one means of ensuring taxpayers have access to qualified consultants. The contingency fee arrangement can defer the taxpayer s budget cost until the related tax credit claim is paid and the tax credit amount is final following CRA review. 3 Alternatively, contingency fee arrangements can be structured so that the fee related to disallowed SR&ED expenditures is refunded to the client. 2. In particular, the Government is interested in stakeholder views about whether contingency fees systematically result in higher costs to the SR&ED performer compared to more traditional billing methods. In properly structured agreements, contingency fees result in no higher costs to the SR&ED performer than traditional per diem, per hour, or fixed-fee billing methods. Indeed, the costs can be lower, since a per hour or per diem billing method can be a highly inefficient means of conducting an SR&ED review. A consultant might spend hours looking for something to qualify and the business would be required to pay regardless of the consultant s lack of success in identifying missed opportunities. On the other hand, where a business has rigorous controls and documentation of its SR&ED processes, i.e., knows the scope of its activities including what, where, and how much, a third-party consultant would likely be unwilling to engage in an SR&ED review on any basis other than an hourly or per diem charge. Where the scope of an SR&ED project is circumscribed (e.g., review of a taxpayer s T661 documentation), the SR&ED performer and the consultant are likely to agree on a per diem or flat fee. The overall cost of an SR&ED review is a question of who knows more the consultant or the SR&ED performer and which is better able to negotiate the scope and terms of the SR&ED review. 2 As explained earlier, the focus is properly on fee risk rather than the tax risk that a claim may be improper or may not withstand CRA scrutiny. Taxpayers will not engage a consultant unless there is some prospect for increasing the claims or mitigating the risk of noncompliance on eligible activities and expenditures. 3 Another common contingency fee arrangement involves paying a portion of the fee upon filing the claim and holding back a portion until the audit is completed.

6 Page 6 3. The Government is also interested in understanding the potentially positive impacts associated with contingency fees, including an increased awareness of the SR&ED program and greater accessibility. TEI s comments to this question are provided above in respect of Experience with Contingency Fees. In summary, the consultant brings expertise in identifying the qualification of projects or expenditures and in benchmarking best practices in business process design for documenting the qualification of SR&ED projects. In addition, the consultant brings diverse experience in preparing claims across taxpayers within an industry sector, across industries, and, indeed, across the various offices of CRA. The limited corporate resources available to perform SR&ED reviews (whether in the business unit, the engineering or laboratory departments, or the tax department) are augmented by off budget dollars because the consultant is not paid until the tax credit is received. In a large business file case, that often means after a claim is audited by CRA. Limits on Contingency Fees 1. The Government is interested to learn the views of stakeholders on various types of restrictions that currently exist in Canada and other jurisdictions and whether one or some of these approaches (or other types of restrictions) could or should be considered in the context of contingency fees charged by tax preparers in Canada for the preparation of SR&ED claims. The most important thing in ensuring the quality of SR&ED claims is the quality, competence, and integrity of the consultant and the taxpayer. In every large file case, the taxpayer will undertake multiple reviews of the correctness of the claims prepared by a consultant. In addition to the tax department s review, most taxpayers will require the affected business unit (or laboratory or manufacturing unit) to confirm the description and documentation of an eligible project, process, or expenditure. Thus, CRA s initiatives in assigning taxpayers a risk assessment grade and designing and performing audits based on the taxpayer s risk assessment will do more to enhance the quality of SR&ED claims than restricting the availability of contingency fees for SR&ED reviews. 2. In addition, the Government is interested in stakeholders views about whether other actions could limit the use of contingency-fee arrangements, for example, through further initiatives by the CRA to assist firms in completing their claims, or through other forms of disincentives to the use of contingency fees. Companies have a significant incentive to increase efficiencies, implement routine processes, or put qualified people in place in order to capture the greatest amount of credit consistent with the activities performed. The tasks involved in identifying or documenting SR&ED performed, however, may be temporary or episodic. As a result, companies cannot generally justify maintaining a headcount to ensure that every project is documented all the time only most projects, most of the time. Even with highly automated and efficient practices, taxpayers will use external consultants to identify or document SR&ED, especially for new (or incremental) projects.

7 Page 7 Contingency fee arrangements are important to taxpayers who desire to have SR&ED identified at the lowest cost. The Government should not presume that per diem or per hour arrangements are less expensive or that they will result in less aggressive claims. The nature of the claim is independent of the fee arrangement. Large corporations will be very concerned with reputational risk as well as potential audit adjustments and civil penalties. 4 Similarly, service providers such as the major accounting firms will be concerned with both reputational risk and client satisfaction. Having an SR&ED claim disallowed is a significant disincentive for using the firm. Although the SR&ED program can always be improved, we do not believe it will be improved by imposing restrictions on fee structures. Indeed, we believe that restricting fee arrangements will only increase the cost of the program for taxpayers without affording CRA additional tools for identifying improper claims. Finally, taxpayers welcome the opportunity to work with the CRA in order to increase the level of awareness of the program and to implement changes to simplify the completion of the SR&ED claim. Many large taxpayers already consult with their CRA audit team and the Research & Technology Advisor in order to determine whether a particular project constitutes qualifying R&D because the claim will be subject to review. Conclusion TEI s comments were prepared under the aegis of the Institute s Canadian Income Tax Committee, whose chair is Bonnie Dawe. If you should have any questions about the comments or recommendations in the submission, please do not hesitate to call Ms. Dawe at (or bonnie.dawe@finning.com) or Kim N. Berjian, TEI s Vice President for Canadian Affairs, at (or Kim.N.Berjian@conocophillips.com). Respectfully submitted, Tax Executives Institute Carita R. Twinem International President cc: Susan Betts, Director General, SR&ED Directorate, Canada Revenue Agency Kim N. Berjian, Vice President for Canadian Affairs Bonnie Dawe, Chair, TEI s Canadian Income Tax Committee 4 During a September 21, 2012, meeting attended by TEI representatives, a question was posed whether the use of contingency fees increases the risk of improper SR&ED claims. The Institute does not believe the nature of the fee arrangement unduly influences the risk that the taxpayer or the consultant will prepare or file improper claims. In a voluntary self-assessment system, a taxpayer s or consultant s appetite for tax risk will be curbed by the taxpayer s or consultant s internal controls as well as its overriding self-interest in protecting its business reputation. Moreover, CRA has an abundance of tools, including civil and criminal penalties, to deter improper claims.