SR&ED vs. direct investing debate: It’s time to speak up

The Federal Government’s Advisory Council for Economic Growth has now issued its first set of recommendations to spur broad economic growth, including recommendations relating to increasing institutional investment in infrastructure, attracting foreign direct investment and enhancing our system of economic immigration.

Importantly for stakeholders in the Canadian technology sector, the Council will next turn its attention to innovation, including a review of the SR&ED program.

We wrote a blog post referencing recent press critical of the SR&ED program and advocating for direct investment. This attack appears to be part of a lobbying effort to shift government funding from a highly democratic SR&ED program (indirect investment) to a highly selective private venture capital program (direct investment). What stands out about the conversation is that it is one-sided. Small businesses who are the unsung heroes of technology commercialization in Canada have been silent on the sidelines. It is time for you to speak up!

CRA provides very little segmented data on the SR&ED program, so we’ve used exit activity as a proxy for R&D commercialization. CB Insights recently reported that Canada ranks fourth globally in terms of number of exits (behind only the US, UK and India). This impressive ranking is due in part to the success of Canadian private small businesses in commercializing R&D. Additionally, more than two-thirds of these exits have no institutional backing (i.e. venture capital), according to CB Insights. The argument that direct investment is better for Canada’s innovation economy rings hollow.

The critics of the SR&ED program focus on Canada’s global R&D rankings and generalize that the SR&ED program is ineffective. While generalizations make for good headlines, they make poor inputs for policy decisions. What these critics fail to mention is that SR&ED is comprised of two parts, approximately $1.2 billion in cash refunds to CCPCs (effectively small businesses), which as shown above, is highly effective and approximately $2.3 billion in credits against taxes payable to public and larger private corporations.

When looking at SR&ED, the more meaningful conversation is whether the public and larger private companies that receive the biggest portion of the SR&ED expenditures should continue to receive this subsidy when they, unlike small business, have access to alternative R&D funding sources.

If the debate was two-sided, supporters of the SR&ED program would highlight that 95% of small businesses are not suitable for the high stakes venture capital investment model; that this subset of the technology sector is responsible for the vast majority of the sector’s employment; and by diverting funding away from small businesses, overall R&D activity in Canada will decline dramatically, as direct venture capital will focus on supporting a small number of later stage companies with expansion capital. Shifting funding from SR&ED to a direct private investment model will not only limit the capacity of small businesses to invest in innovation but will make Canada less innovative in general.

Direct private investment is by nature focused on investing in a limited number of companies promising outsized returns. Direct public investment (i.e. grants) on the other hand is vulnerable to the vagaries of bureaucratic decision making on what does and does not deserve R&D investment. Whereas SR&ED is democratic. Any company performing eligible R&D activity based on objective criteria earns the tax credit.

We think private SMBs, and particularly small non-venture-backed companies are underrepresented in the Government’s consultations and their perspective is missing in the public SR&ED vs. direct investment debate. Founders, CEOs, board members and advisors to private businesses need to speak up, and share with the Government and its Advisory Council firsthand evidence of the SR&ED program’s effectiveness in fostering R&D, commercializing technology, creating jobs and making this segment of the Canadian economy world class.

Your Voice Counts!

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