Opening Statement to the Standing Committee on Public Accounts

Canada Customs and Revenue Agency and Department of Finance - Handling of Tax Credit Claims for Scientific Research and Experimental Development
(Chapter 6 - April 2000 Report of the Auditor General)

Thank you, Mr. Chairman, for allowing us to present the results of our audit of the Canada Customs and Revenue Agency and the Department of Finance on handling tax credit claims for scientific research and experimental development.

Research and development is an important factor in improving the productivity of a country’s economy and the standard of living of its citizens. The federal government has encouraged research and development in the private sector for many years through tax incentives.

The tax incentive program for scientific research and experimental development, or SR&ED, is significant. In the last five years the federal government has granted over $6 billion in tax credits to some 11,000 corporations and individuals.

Let me start by pointing out that underlying much of our tax work is the concept of fairness. The reason for this is simple: taxpayers are entitled to know whether they and others are being treated fairly and how their money is being spent.

We conducted our audit in the Canada Customs and Revenue Agency’s head office and seven of its tax services offices and in the Department of Finance. We examined various Agency documents and files and we interviewed science advisors and financial auditors. We also consulted tax advisors and economists from the private sector.

Our audit deals with two main aspects of the SR&ED program — its administration and its impacts.

We identified four major concerns in the administration of the program.

In 1994 the federal government restricted the period for filing tax credit claims for SR&ED expenses to 18 months after the year in which the taxpayer incurred these expenses. As there was no such limit before 1994, the government gave taxpayers three months to file retroactive claims. Consequently, the Agency was inundated with 16,000 additional claims in 1994 — representing $2.8 billion in credits for years as far back as 1985 — and was faced with an administrative nightmare.

In our Report, we comment on the unresolved disputes over eligibility of science work in the financial and telecommunications sectors. In addition, we found that there was insufficient evidence to determine how taxpayers are currently filing claims. This is because of the $5 billion in claims the Agency received for taxation years from 1996 to 1999, $3.2 billion (or 64% of the dollar value) have not yet been processed. Further, in examining the claims of 25 of the 100 largest claimants, we learned that most science reviews and audits were not current.

Our first concern is the inconsistencies in the handling of the retroactive claims, which raised questions of fairness. In some cases, poorly documented claims were rejected. In other cases, financial auditors and science reviewers helped taxpayers to prepare eligible claims. Claims initially rejected were approved after a second science review. Other claims, initially rejected, did not receive a second science review.

Our second concern is that clearer rules are urgently needed to deliver and administer the program effectively and efficiently. I cannot emphasize enough the importance of clear rules. The lack of clear rules has led to the situation where, in the financial and telecommunication sectors, unresolved disputes over the eligibility of science work have reached hundreds of millions of dollars in tax credits.

In a tax incentive program such as the one for SR&ED, the legislative and administrative rules must define as completely as possible who and what qualifies for the tax credit. This helps to ensure that only eligible SR&ED work is claimed and allowed. Resolving disputes over eligibility drains resources, jeopardizes the program’s incentive objective and puts at risk large amounts of tax revenue.

I am encouraged by the Minister of Finance’s statements in his February 2000 Budget. He said that the government is committed to rigorously applying the existing criteria to address outstanding claims related to information technology. He added that the government will ensure that the guidelines on software development, in particular internal use software, both reflect government policy and provide clarity and certainty of application for compliance purposes as well as administration.

Our third concern is about the lack of an effective mechanism in the Agency to deal with differences of opinion on the appropriate treatment of individual claims. The case outlined in our Report illustrates confusion among Agency staff where serious professional differences of opinion arose. The Agency was unable to demonstrate that it had effective procedures to resolve disputes between various officers who work on a significant claim.

Our fourth concern, related to the administration of the program, is the need for the Agency to improve the assessment of risk that taxpayers’ claims are ineligible so that science and audit staff can focus on claims with the highest risk.

In order to resolve some of the administrative problems, the Agency and industry created a partnership to implement an action plan. At the conclusion of our audit the action plan was just being implemented. Consequently, we are unable to comment on its results.

I would now like to take a few moments to talk about the impacts of the SR&ED program.

In 1994 we recommended that the Department of Finance and the Agency conduct an evaluation of the program. We thought that an evaluation was warranted given the costs of the program and the lack of information on its impacts.

To their credit, the Department and the Agency carried out an evaluation. Independent experts reviewed the methodology and content of the evaluation before its publication.

The evaluation concluded that the increase in SR&ED spending generated by the program exceeded the tax revenue forgone. More specifically, it estimated that for every tax dollar forgone, SR&ED spending increased by $1.38. In other words, some of the investment in research and development would not have taken place in the absence of the program.

However, the evaluation, using conservative estimates, also indicated that the net increase in Canada’s real income generated by the program was somewhere between $20 million and $55 million per year.

We referred to this evaluation in our chapter for the same reasons that had led the Department of Finance to put it in the public domain in 1998. It was released to provide information for public and parliamentary discussion of the SR&ED program and to promote improved management of the tax system in general.

The challenge for the government is to explore the issues raised by the evaluation and find ways to strengthen and improve the SR&ED program.

Mr. Chairman, that concludes my opening statement. We would be pleased to answer your Committee’s questions concerning this audit. I would like to mention, however, that it may be necessary for us to decline to answer certain questions that may violate the confidentiality provisions of the Income Tax Act.