Trends in Innovation Funding and SR&ED July 2017

Topics Innovation Funding Influencing Factors Canadian Program Mix / NS Mix Trends in SR&ED Claim statistics CRA activities Our Observations The Future

Global Mix - Direct / Indirect Funding - First – how do governments deliver funding: two means: Indirect – mainly tax based incentive credits such as SR&ED Direct – numerous forms of targeted funding (NRC IRAP, NSERC IRC, SDTC,…) Chart shows mix of funding as % of GDP for various countries (2007 & 2008 data): Canada is a leader – in top 4 But does not share a corresponding level of BERD Why? How to fix? BERD Is it how Canada funds innovation?: has highest proportion of indirect (lower now but still high). ~90% for Canada ~22% for USA Source: Industry Canada Report "Innovation Canada: A Call to Action" Data - 2008

Canadian Program Mix Looking closer at Canada's mix: Data from the "Jenkins Report" on innovation Divided funding supporting business performed R&D into ~4 main categories Overall increase in total funding over the 4 years SR&ED held ~3.4 billion – ~78% in 07-08 to ~70% in 10-11 Source: Industry Canada Report "Innovation Canada: A Call to Action"

Nova Scotia Mix Slide shows 4 main sources of innovation funding in NS – 2015-2016 ACOA & IRAP data from Atlantic Growth Strategy Subcommittee report on Innovation NS SR&ED ITC's from NS provincial budget data Federal SR&ED ITC's estimated based on Statistics Canada R&D investment data – may be a bit low. Main Points of Note: Direct funding more significant in NS: ACOA + IRAP = 63% VS SR&ED SR&ED ~37% NS SR&ED is less than 1% of total NS IRAP is ~2.3% of total Sources: Report of the Atlantic Growth Strategy Subcommittee on Innovation Statistics Canada GERD data

Trends in SR&ED

SR&ED Claim Trends Chart: CRA annual expenditures on SR&ED from 2011-12 to 2017-18 last 3 years are projected amounts. Orange – refundable (think large companies) Grey – non-refundable (think small companies) Blue – number of claims processed Key Points: Drop in 2013-14 - Changes in legislation Proxy, Capital, 20% to 15%, contracts & 3PP to 80% Coincides with headcount increase from ~ 530 (08-09) to 700 (14-15) Interpreting: non-refundable credits – expenditures in year, but ~50% related to claims from other years. refundable claim reduction – in year claims – in ballpark of legislative changes. # of claims – no data on refundable / non refundable – significant drop - would explain $ reductions up to 14-15 on own (w/o legislation changes) Source: CRA Annual Tax Expenditures

Trends in SR&ED – CRA Stakeholder Session Mid point of 3 year project: 3 Areas of Focus: Service development First Time Claimant Advisory Service (FTCAS) Pre-Claim Consultation (PCC) (within 4mo of Y/E) Pre-Claim Review (PCR) - Pilot Outreach National Team of Outreach Coordinators Focus: Gov't. Dep (NRC, Agriculture, etc.), Universities, Industry Groups.

Trends in SR&ED – CRA Stakeholder Session Integrity – "Easier & Harder" Documentation & Information Requests Request as required (vs. as standard protocol) Consistency "Reasonable & Credible" "Large File Project" – Developing national approach to selecting and reviewing Claims > $10M >50% total expenditures claimed Very small number of claims

Trends in SR&ED – CRA Stakeholder Session Atlantic CRA SR&ED: Better audit outcomes: ( ↑ "all work" eligible, ↓ "no work" eligible) Increase in Experimental Production (EP) claims More "reasonable" in scope / scale Better relationships Common Issues: Capital and contracts claimed as materials Business project vs. SR&ED project How described / presented Costs claimed Support for labour hours – estimates without rationale Failure to remove Government Assistance The Atlantic SR&ED AD provided some comments on their observations

Trends in SR&ED – Our Observations Challenges of SR&ED vs. R&D remain: Continued perceptions: "Rules have changed" "CRA is auditing to manage budget" (but seem to be decreasing…) Considered overly burdensome Must present SR&ED - not R&D: In claim, during review, and in documentation CRA may not "find" it for you "Self-compliance" + audit function Their decisions must be supported

The Future Ongoing review of funding programs Some changes implemented already: SR&ED - 2012 Federal Budget Recently announced Strategic Innovation Fund Funding for "Super Clusters" SR&ED proportion could see further decrease: High % Indirect vs. Direct Considered complex & burdensome: Meaningful simplification may broaden eligibility More eligible projects earning fewer tax credits However, Administratively "efficient": SR&ED ~2.3% IRAP ~25% SDTC ~10% Why we could see further SR&ED reduction: Attempting to increase BERD requires changes SR&ED still significant & we're an outlier Continuing complaints of inconsistency, burden, and unpredictability

The Future – My Prediction Will remain with CRA and significant: CRA review process: May ease some… Compliance organization Program Complexity: Bad news: SR&ED vs. R&D complexity Good news: Impact can be reduced: Understand the difference Present SR&ED in your claims Good news: Worth the effort: up to ~45% funding (non-diluting) can stack with other programs no waiting for pre-approval REASONS: Still a big program even with downward trend Diverting significant SR&ED $ to direct would require significant staffing Higher administration costs would consume significant % of SR&ED $ diverted CAVEAT: Given significance of large and non-refundable claims, changes there could significantly impact overall SR&ED program size More significantly impacting large claimants vs. smaller ones. Key Points: Stays with CRA and Significant therefore reviews won't change much: To ensure SR&ED vs. R&D SR&ED vs. R&D complexity will make process more challenging CRA is a compliance organization: CRA Report to Parliament has typically includes: "Tax Recovery" amount ~12-14% of total. Target of 75% of "audit activities" resulting an "adjustments". Auditors need to find mistakes…

R&D and Government Incentives Thank You Greg MacDonald, PEng Senior Manager R&D and Government Incentives Greg.MacDonald@ca.gt.com 902-491-2251 What is SR&ED What are the key components of eligibility