Ontario SME owners on edge over potential R&D tax credit changes
If research, development and innovation are the lifeblood of Ontario’s economy—not to mention well-used talking points amongst the province’s business-courting political class—then it’s no surprise that a new review of popular tax credits is giving many small and medium-sized business owners cause for concern.
The recent Ontario budget, the first tabled by the newly-elected Progressive Conservatives under Doug Ford, spared the province an increase in personal taxes, but left many entrepreneurs disappointed about a broken promise (and missed opportunity) to lower the corporate tax rate. But another disconcerting budget item that many entrepreneurs may have overlooked—mention of it was only a few lines in a very lengthy document—was a commitment to review the Ontario Innovation Tax Credit (OITC) and “other R&D tax incentives.”
As the budget notes: “The government is reviewing business support programs to identify opportunities for better value for money. The aim is to ensure these programs are coordinated and integrated across government, and that they can demonstrate benefits for the people and businesses of Ontario.”
In its pledge to assess the benefit of investment tax credits, the government stated that its review “will consider the appropriate level of R&D tax support for business, taking into account research findings on the cost and benefits of R&D tax credits.”
Currently, small and medium-sized companies that engage in qualifying research and development activities are eligible for the 8 per cent OITC, along with the 3.5 per cent Ontario Research and Development Tax Credit (ORDTC) and the 35 per cent federal scientific research and experimental development (SR&ED) investment tax credit. The previous Liberal government had lowered the ORDTC to 3.5 per cent from 4.5 per cent, and the OITC to 8 per cent from 10 per cent in the 2016 budget.
A company that qualifies for subsidies could, in theory, receive funding for nearly half of the value of a specific research and development project when utilizing all of the available federal and provincial programs.
Notably, in this year’s federal budget, Ottawa lifted a cap on the amount of income an SME could generate and still qualify for SR&ED. A recent Globe and Mail article provided a good overview of how the program works: “The government’s Scientific Research and Experimental Development Program offers small Canadian-controlled private companies refundable tax credits of up to 35 per cent on the first $3-million a year they spend on R&D expenditures and non-refundable credits of 15 per cent for all other companies. The program costs the government roughly $3-billion a year and is used by more than 20,000 companies.”
A claw back of the credit had taken effect when a qualifying company reached $500,000 in taxable income, before grinding down and phasing out when a firm earned more than $800,000 a year. The March 2019, federal budget removed the taxable income test in the annual expenditure limit. Companies can now obtain the refundable SR&ED credit at the rate of 35% on the first $3 million of qualified expenditures where taxable capital of the company or associated group is less than $10 million, without regard to taxable income.
The good news is these changes to the federal program will largely mitigate any decrease in provincial R&D subsidies the Ontario government might enact.
Some economists have challenged the benefit of these programs altogether, specifically, their potential return on investment. Many would argue that there are more efficient ways to spend tax dollars and incentivize business investment. Cutting corporate income taxes would be one. Some academics contest that relatively high subsidies such as these are not only inefficient, they can even encourage low-quality innovation (many of these same experts are proponents of subsidizing R&D, but at lesser amounts).
After all, they would argue, the pressure to not only develop, but perfect and commercialize, a new widget is far greater when it’s your organization footing the bill.
But we would argue that R&D subsidies do deliver a positive impact. They allow SMEs to compete with well capitalized, enterprise-sized firms that have far greater innovation budgets. In turn, they help fuel growth and, arguably, attract companies to the province from competing jurisdictions, in particular those lacking equivalent programs.
The argument that subsidies essentially allow companies to roll the R&D dice on potentially ineffectual, long-shot innovations is misguided. Firms are still required to invest their own capital as they develop new technology or conduct research. These programs also enable companies to hire more employees, in some cases by directly subsidizing those salaries. In that sense, they create jobs while also fostering new innovation.
For a government that plastered ‘Open for Business’ across highway signage at Ontario-U.S. border crossings, and will soon replace Ontario’s license plate slogan with ‘A Place to Grow,’ it would be off-brand to make business conditions across the province more challenging than less.
Let’s hope the review of programs such as OITC reveal their clear benefit to Ontario SMEs that can—and do—use the funds to boost the collective economic good.
Hartley Cohen, Partner