Consultation Process on the Impact of Contingent Fees on the Efficiency of the Scientific Research and Experimental Development Tax Incentive Program

Transcription

1 Consultation Process on the Impact of Contingent Fees on the Efficiency of the Scientific Research and Experimental Development Tax Incentive Program Response submitted to the Department of Finance Canada and Canada Revenue Agency October 2012

2 Foreword With a keen interest and solid expertise in research and development issues, Raymond Chabot Grant Thornton s team of specialists recognize the pertinence of the joint consultation of the Department of Finance and the Canada Revenue Agency. For several years, we have been helping corporations operating in Quebec, and the Ottawa and Edmundston regions, determine the projects and activities that meet the criteria of the Scientific Research and Experimental Development (SR&ED) Tax Incentive Program. We are involved in numerous business sectors and as such, it is our mission to anticipate our clients changing needs by constantly adapting our services to emerging market realities. By supporting businesses in technological development partnerships, we enable them to fully contribute to Quebec and Canada s economic growth. This response, led by Michel Rheault and Michel Lefebvre, was developed by Raymond Chabot Grant Thornton s SR&ED team members who help more than 100 offices across the firm s network. Our team of experts includes experienced engineers, technical staff (all sectors and industries), tax specialists, lawyers and accountants. We have been helping our clients prepare SR&ED claims for more than 20 years. Our clients, in particular, small and medium enterprises (SMEs) generally claim $30,000 to $50,000 in investment tax credits (ITCs) per year and an equivalent amount in Quebec investment tax credits (QITC). About Raymond Chabot Grant Thornton Founded in 1948, today Raymond Chabot Grant Thornton is a leader in the fields of assurance, tax, consulting services, business recovery and reorganization. Its strength is based on a team of almost 2,300 people including some 230 partners in more than 100 offices in Quebec, Eastern Ontario and New Brunswick. For the past 30 years, Raymond Chabot Grant Thornton has been a member of Grant Thornton International Ltd providing its clients with the expertise of the member and correspondent firms in more than 100 countries. Raymond Chabot Grant Thornton 2

3 Summary A question of predictability Contingent fees encourage the introduction of new SR&ED claimants. For current claimants, this type of fee promotes risk-sharing with consultants and a better alignment of the timing of fees and obtaining of credits. This type of fee, which is a financial arrangement like any other, is popular in the field of SR&ED credit claims because results are unpredictable. This lack of predictability is due to the great complexity involved in preparing a claim file and the inconsistency of decisions, which are based on professional judgment and as a result, are highly arbitrary. Technological advancement in particular is a field where two experts may not agree on the same criteria. While other elements pertaining to contingent fees will be discussed in this response, we believe that the best way to eliminate contingent fee billing is to increase predictability. We propose the following five measures: Simplify the SR&ED program by making criteria easier to measure objectively; Pre-approve SR&ED programs; Create an innovation support program; Have the CRA certify external SR&ED consultants; Drive out professional exaggerators. Raymond Chabot Grant Thornton 3

4 Contingent Fees and How They Impact SR&ED Program Efficiency: A Question of Predictability Introduction In today s world, contingent fees are, in our opinion, an important element of the SR&ED program. They encourage more taxpayers from small or medium enterprises (SMEs) to use the SR&ED program, which promotes the growth of innovation and related investments. We can change the current situation and increase the predictability of SR&ED claims by rendering contingent fees obsolete. Until 2002, Raymond Chabot Grant Thornton had produced few contingent fee proposals. We remained true to the traditional accountant office model. However, we quickly realized that our competitors were using SR&ED file preparation services to poach our clients. Contingent fees had become the norm in this market. We adjusted our methods and, since then, contingent fees have become a current means of billing SR&ED assignments in our firm. Why use a specialist? Let s ponder this question first: why do two thirds of taxpayers use external services to prepare their SR&ED claims? The answer is simple. While the tax and accounting aspects can be compared to taxation in general, the scientific and technological aspect of the SR&ED program is still quite complex. We believe the problem lies in the technical interpretation (i.e. what qualifies as a technological advancement and the demonstration of a much documented, systematic resolution of technological obstacles). Today, there are more than 60 information notes, interpretation documents and public guidelines posted on the Canada Revenue Agency (CRA) s Web site that define the interpretation limits of what qualifies as SR&ED. Training offered by the CRA on technological and scientific aspects remain quite vague and insufficient and are no help to claimants wishing to file their own claims. At the CRA, technical specialists, aka Research and Technology Advisors (RTAs) are in charge of interpreting program eligibility. Since 2008, the CRA has hired several new RTAs with graduate degrees in various sciences, thereby reaffirming interpretation toward a more scientific approach, one that is closer to applied research. This results in an expert debate between RTAs and taxpayers, especially SMEs, which cannot afford such experts. Using these highly educated specialists has become a necessity for reducing the risks in this type of funding, which is essential to the growth of businesses. Raymond Chabot Grant Thornton 4

5 The root of the problem There are currently two opposing views in this conflict: RTAs interpret the program as support for applied research, asking taxpayers to demonstrate scientific and technological developments using systematic, detailed documentation (CRA laboratory point of view); Taxpayers are essentially innovating or developing their products to sustain their business projects. RTAs and taxpayers are therefore speaking two different languages, which has created a new set of interpretation conflicts. Why use contingent fees? In a context where the predictability of obtaining credits is low, contingent fees are welcomed by most taxpayers for three main reasons: 1. It is a way to share the risk. Earlier on we mentioned the gap between RTAs technical interpretations and the market reality. These differences in interpretation affect the predictability of the SR&ED credit. Furthermore, despite the CRA s concrete and publicized efforts, interpreting the eligibility of an SR&ED project still varies much from one year to the next for a same taxpayer, from one RTA to another, even among tax service offices. This is a constant battle for the CRA, one that it fights with the help of its internal training programs, among others. 2. It is a liquidity financing method offered by consultants. The time between filing a claim and obtaining refundable tax credits, as applicable, may vary from several weeks to several years when a review is conducted. Contingent fees present taxpayers with a means of aligning the timing of disbursements for preparing the claim and obtaining their credits. 3. It is the best method for new claimants in particular of accepting the risk associated with SR&ED. As there are no precedents to predict the level of acceptance for their claims, new claimants are highly motivated by this type of billing. Scope of expenses An article in the October Globe & Mail stated that contingent fees totalled 30% of credits. This is far from our reality. Most likely, some preparers exaggerated or took advantage of the system. The fees applied in 2003 in Montréal were about 20% of investment tax credits (ITCs) and Quebec investment tax credits (QITC). Since 2009, the CRA has increased the thoroughness of its interpretations, decreased the number of pages of description in the T661 form and increased the frequency and depth of reviews. This further reduced the predictability of claims and contributed to an increase in competition among SR&ED consultants. 1. Barrie McKenna, Dubious claims diminish R&D tax credit, Globe and Mail, February 6, 2011, [page consulted on September 24, 2012]. Raymond Chabot Grant Thornton 5

6 Contingent fees dropped 15% to 10%, and often, today, in some regions are less than 10% of ITCs and QITCs combined. As current rates are often determined based on amounts claimed, it is normal that these be higher for a $50,000 claim than for a $1M claim. This is a logical consequence of the time invested by preparers to cover their true file preparation expenses. Moreover, data from the Canadian Institute of Chartered Accountants (CICA) enables us to estimate that total consultant SR&ED fees are about $100M to $200M per year. This represents less than 2% of the approximate $3.5B to $4B in SR&ED credits granted each year by the CRA. Why offer contingent fees? Contingent rates constitute a significant billing method in the market which is often requested by clients. There used to be a link between risk and yield. The risk was assumed by the consultant, similar to the time between the delivery of a service and the billing for said service. It was therefore normal that motivation played a part in funding this kind of billing. However, SR&ED consultant fees are decreasing. Recent changes in the interpretation of eligibility make this risk increasingly intolerable for a firm like ours. The added value to finance the risk has disappeared. When the CRA performs a technical review, the fees billed in the end no longer cover the actual work performed. This reality has led us to reconsider our offer and provide lighter services such as file review instead of complete delivery so our rates remain competitive and to prioritize fixed-fee or effort-based assignments. Despite all of this, several SR&ED specialized competitors are still offering only contingent fees. How do contingent fees impact the program s efficiency? Contingent fees tend to attract new claimants to the SR&ED program, since they reduce taxpayers risks. In this sense, they increase interest in SR&ED and promote innovation in Canada. Total compliance costs for SMEs are not limited to consultant fees. The internal cost of delivery can double compliance costs. This internal cost represents internal resources efforts to document activities, file claims and defend any reviews, as applicable. An increase in compliance costs for taxpayers results mainly from an increase in requirements to prove the eligibility of SR&ED activities. This is a major factor of the SR&ED tax incentive program s cost-efficiency ratio in attaining its goal to provide general SR&ED support. Unrealistic claims have long existed 2. Perhaps contingent fees contributed to this type of claim in some circumstances for certain taxpayers and consultants. We do not believe that contingent fees systematically increase costs for carrying out SR&ED work compared to more conventional billing methods. Professional consultants are not more interested than taxpayers in adopting aggressive strategies that go beyond the limits of the law since their fees would be at risk and the long-term credibility of the file would be damaged. 2. Department of Finance Canada and Canada Revenue Agency, The Federal System of Income Tax Incentives for Scientific Research and Experimental Development: Evaluation Report, December 1997, page xiv. Raymond Chabot Grant Thornton 6

7 The assumption presented in this consultation, that is, that consultants paid with contingent fees would be more aggressive and more likely to defend their claims, can be rectified using the current methods prescribed under the Income Tax Act, in accordance with the Taxpayer Bill of Rights. The Business Development Bank of Canada It should be noted that some federal institutions such as the Business Development Bank of Canada (BDC) provide SR&ED credit claim services to clients using contingent fees. Is it not surprising that a federal body is funding part of its activities with contingent fees paid from funds from another federal body? Are these claims more unrealistic because the fees are contingent? How can we limit the use of contingent fees? We understand the CRA is faced with unrealistic claims stemming from contingent fees. However, we believe that a case with contingent fees billing should not automatically be labelled unrealistic, particularly considering that consulting firms such as Raymond Chabot Grant Thornton are using this billing method for the above-mentioned reasons. There is no doubt that contingent fees help corporations finance the cost of preparing complex SR&ED claims and plan ahead in light of the uncertainties underlying the interpretation of their claims. This is especially true for first-time claimants who regard contingent fees as a means of reducing their risk in attempting to obtain the benefits to which they are entitled. Not much will change for the other claimants if their use of contingent fees is eliminated. If the government wants to eliminate contingent fee billing, we propose five solutions to increase predictability, which is an essential factor for boosting SR&ED program efficiency. 1- Simplify the SR&ED program by establishing more objective criteria. The current process leads to a subjective confrontation of opinions between CRA experts and taxpayers. We believe that by clarifying certain aspects of the program, making it easier to apply and more predictable, compliance costs will decrease and contingent fees will become obsolete. 2- Pre-approve SR&ED projects: This approach is rarely used now, but it reduces uncertainty before the project commences, which eliminates the need to turn to contingent fees. However, pre-approval would have to become an official step in the process to reduce all uncertainty. 3- Create an innovation support program: SR&ED programs are key to developing corporate business strategies. Creating a competitive edge is one of the main factors influencing the decision to allocate funds for SR&ED expenses. Today, the dissemination of technologies and innovations is faster and more extensive than ever. Paybacks from research are global but it is only the benefits obtained in a country or by its population that justify tax incentives or any other form of public aid for SR&ED. It is the adoption of innovations throughout an economy rather than their discovery which is more economically profitable. In our opinion, the real problem with the SR&ED program lies in the fact that most claimants are corporations claiming credits for innovative projects and product development, in a program that aims to support scientific research. This is the problem that creates all communication difficulties between the CRA and taxpayers, and especially, the uncertainty and risk associated with these claims. A new innovation support program would eliminate the need for contingent fees. Raymond Chabot Grant Thornton 7

8 4- Have the CRA certify external SR&ED consultants: once terms and conditions have been decided, these external consultants would be responsible for guiding corporations during the year. They would report to the CRA, which could limit or suspend their certification in cases of non-compliance with program rules. This approach would allow the CRA to become a constant support for SMEs and should only be applied to consulting firms with teams of experts that include members of professional orders such as accounting or engineering orders. 5- Drive out professional exaggerators : The CRA has many tools for penalizing unrealistic claims and their claimants, while respecting taxpayers rights. It is in its best interest to identify the consultants and repeat offender taxpayers and make them stop these practices. Conclusion In short, Raymond Chabot Grant Thornton believes that predictability should be increased substantially to eliminate billing using contingent fees. To do this, we propose five practical measures for promoting predictability. Consequently, billing based on contingent fees could possibly phase itself out. Raymond Chabot Grant Thornton 8