Program Administration

The AG in Y2K

In April 2000 the Auditor General released a report entitled CRA and Department of Finance - Handling Tax Credit Claims for SR&ED. This audit is a follows on the 1994 audit, and addresses the handling of the 16,000 retroactive (bulge claims) filed by taxpayers in that year. The audit also addressed the administration of the program, audit risk assessment procedures, and the impact of the program on the economy.

The Auditor General reported that:

There were significant inconsistencies in the handling of claims that compromised the fairness of the review process.
There is a lack of clarity about the eligibility of SR&ED projects resulting in unresolved claims dating back to 1985.
There is a lack of clarity as to what constitutes an eligible activity or project, how thoroughly a claim should be reviewed and how much documentation is necessary to support a claim.
CRA has no standard methodology for audit risk assessment.

In 1997 Finance and CRA undertook a joint study of the value of the program. The benefits of the program were found to be marginal. Versus over one billion dollars in cost to the fiscal purse, the net increase in Canada’s real income was found to be $20 to $50 million.

Large corporations (8% of claimants) earn about 85% of the assistance under this program. Most large company audits are not current.

The new definition of “project” (available on CRA’s web site) modifies the level of eligible work and could result in additional costs.

When claims are found to be ineligible, taxpayers are being allowed second reviews. This second review process is not publicised.

Financial institutions and telephone companies are challenging the disallowance of hundreds of millions of dollars of tax credit claims dating back to the mid 1980s.

The AG in Y2K

The Auditor General recommended that:

CRA should review its procedures so that claims are audited in a fair and consistent manner.
The Agency should establish a process to reconcile internal differences of opinion.
Clearer eligibility rules are needed to improve the administration of the program.
CRA should clarify the rules as to what constitutes eligible work under the program.
Finance should review these rules to insure adequately reflection of tax policy.
CRA, Finance and Justice should develop a strategy to resolve outstanding claims by financial institutions and telephone companies.
CRA should adopt standard criteria to assess the audit risk of claims.
Large claims should be audited in a timely and consistent manner.

The Strategy
If you are unhappy with your audit result obtain professional advice as to whether the result was consistent with other audits. Consider asking for a second review.

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When The CRA Reviewer Calls

Not all SR&ED tax credit claims are reviewed. However, most first-time filers are reviewed so that Canada Revenue Agency staff can visit, explain the program, and evaluate the taxpayer’s level of compliance. Filers that have a history of compliance based on previous reviews, are less likely to be reviewed. When the reviewer does call, providing complete and timely information on all claim years under review is important to a successful review, and to reducing the time spent during reviews.

An SR&ED review has two parts, a financial review and a technical review. A Research and Technology Advisor, an individual with a scientific background, performs the technical review. The science report is passed to the Financial Reviewer, who uses it as a guideline in performing the cost review.

Technical Review

The Scientific Advisor has two essential tasks, which must be conducted for each project submitted, for each fiscal year. First, it is necessary to establish the eligibility of the project itself, and then the eligibility of the activities that make up the project. Secondly, working in an advisory capacity to the financial reviewer, conclusions must be made as to whether the labour and other costs claimed for the project are reasonable.

First, to establish eligibility it is necessary to meet three criteria. These criteria are familiar to most readers, but their importance cannot be over-emphasized, and the entire claim hinges on them. The criteria are: 1) technological advancement, 2) technological uncertainty, and 3) scientific content.

In discussing these criteria with the Science Advisor (SA) it is crucial that technical personnel most familiar with the project be available to lead the discussion. The SA is generally familiar with the field of work, and typically has several years of relevant industrial experience. Facility tours are beneficial to place the research in the context of the business, and bring in some perspective on the advancements made (or sought), the problems encountered, and the work done. Records of the tests conducted, prototypes made, and other evidence of the R&D will be reviewed.

The evidence must be sufficient not only to establish that the criteria for SR&ED are met, but also to show that the costs claimed are commensurate with the work being reviewed. Further, it must be demonstrated that the work was necessary for the SR&ED project described.

Science Advisors will generally discuss their opinions on specific projects and tasks within the projects. This is your opportunity to present new information in the event of disagreement. Subsequent meeting dates may be set to review further materials you gather as a result of these discussions, or information can be sent to Revenue Canada offices.

Once the SA is finished with the review, an internal Revenue Canada science report is written, which the Financial Reviewer uses as a guide to their portion of the review to make both financial and science adjustments. This report is available to you through the Financial Reviewer.

Financial Reviewer

The Financial Reviewer reviews your claim for compliance with a number of rules and regulations that are specific to SR&ED claims. The review is generally of the SR&ED aspects of your tax return only, and rarely encompasses a general company review.

The Financial Reviewer wishes to establish several factors which directly effect the value of your tax credit claim or the rate at which credits are earned. These include the ownership of the company, the prior year’s taxable income, correlation of claimed expenditures to eligible activity, that the costs as claimed are valid expenditures, whether the company received a contract payment or government grant, whether the company made or received a non-arm’s-length payment, whether the proxy amount is calculated correctly, whether any suppliers were non-taxable Canadian suppliers, and usage of capital equipment claimed.

Once the Financial Reviewer has completed the review, a letter is normally sent, which details any proposed adjustments, based on both financial and technical issues. You may again respond with further information, if you disagree with any adjustments but this MUST BE DONE within the time window specified in the letter. Otherwise the claim is processed per the letter and your only option at that point is a formal Notice of Objection.

The Strategy
Have the relevant information available to the reviewers when they arrive. Familiarize yourself with the special rules which apply to SR&ED claims. Your staff should be familiar with the claim, and prepared to discuss both costs and scientific eligibility issues. If the reviewers request additional information, provide it within a short time-frame to help expedite the review process. Professional advice is recommended in the organization of the required materials, and the presentation of your information.

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