ExportWise - Winter 2009 - Scientific Research and Experimental Development Tax Incentive Program
By Bruce Gillespie
Thanks to an innovative new use of EDC’s Export Guarantee Program, exporters now have the opportunity to receive an advance against their Scientific Research and Experimental Development (SRED) tax credits. Experts say that means exporters will be able to invest more money in critical research and development without sacrificing cash flow, particularly at a time when credit is increasingly hard to obtain.
What is SRED?
The SRED program is the largest single source of federal support for industrial research and development in the natural sciences, and it is administered by the Canada Revenue Agency (CRA). In 2006, SRED provided more than $3 billion in tax assistance to businesses of all sizes, operating in all industries, across Canada.
Currently, the largest users of the SRED program are manufacturers of computers and computer products, transportation equipment and chemicals. But while many business owners assume the tax credits are only available to companies in the technology sector, they are actually available to any company engaged in research and development, including manufacturers and exporters.
In the past, many small- and medium-sized businesses were reluctant to apply for SRED tax credits because of the work involved and the time it took to receive the payout. “Companies often incurred a cost related to R&D months before they actually got the refund based on their investment since the waiting period is four to six months after the fiscal year end,” explains Vicky Brouillard, EDC Sector Advisor, Light Manufacturing. “For most Canadian companies, there is a federal rebate of 35 per cent in addition to
add-ons that vary by province.”
So, four years ago, with that in mind, EDC started to work on a way to help exporters reduce that lag time and encourage investment in R&D. The result is an innovative application of the Export Guarantee Program that sees companies doing eligible work receive an advance against their SRED tax refund in a fraction of the time it normally takes.
Essentially, with a guarantee from EDC that reduces their risk exposure, banks agree to establish R&D operating facilities for companies doing work that is eligible for SRED tax credits. To qualify for an EDC guarantee, Brouillard says an exporter must have been involved with the SRED program for at least two years.
At that point, the company engages the services of an external consultant who provides an expert opinion as to whether their current work would qualify for SRED tax credits and how much of a refund they could expect to receive. Based on those findings, the bank advances the exporter a percentage of the costs that are deemed eligible, usually between 60 and 75 per cent.
“It’s a working capital solution that provides a kind of real-time R&D financing,” says Brouillard. “It’s a type of bridge financing until they receive that cheque from the government in 18 months.” She says the shorter wait time makes a big difference to exporters. “I’ve talked to some companies that say, ‘If I’m concerned about payroll, I might retract on the research I’m doing,’ so I think this will encourage companies to invest as they see fit in R&D and not hold back because of working capital restraints.”
How AFORE Solutions used SRED
The first company to pilot this new application of EDC’s Export Guarantee Program was AFORE Solutions, a privately owned network equipment and technology provider in Ottawa. The company provides network equipment vendors around the world with custom development solutions, whether it’s software or hardware or a combination of the two. “Our primary focus is on exporting Canadian solutions and technology, although we also do some business in Canada as well,” explains President and CEO Alex Berlin.
When the company was founded in 2003, it had 10 employees. Today, it has more than 60 full-time staff, and Berlin says AFORE Solutions has seen steady growth on a year-over-year basis. He says R&D plays a critical role in the company’s ongoing success, and being able to obtain an advance against its SRED tax credits thanks to a guarantee from EDC has been a big help. “ Canada is not a low-cost geography. So, for us to compete, we have to be able to leverage the R&D tax credit programs the government provides and use them to their full extent.”
Berlin says the opportunity came about in discussions with his bank, RBC Technology Banking Group, when looking at ways of creating additional working capital facilities. After speaking with EDC, AFORE Solutions engaged an external consultant to lead them through the SRED application process in 2004. Berlin says coming up with documentation for the program’s financial review was not a major challenge, since they were already being created as part of the company’s annual external audit.
Preparing the technical review of the company’s R&D work was more involved, so AFORE Solutions worked with a consultant to prepare it to ensure the company stood the best chance of realizing the maximum level of SRED tax credits. Berlin says hiring a consultant to take the company through the process was invaluable experience, and after the first couple of years, though, Berlin says he has moved most of that work in-house.
“We’ve been leveraging our internal resources for the past three years because we know our technology best. It probably takes about three or four weeks of effort, but if you can get 25 or 30 cents return on every R&D dollar you put into the application work, it’s a good investment to make.”
Berlin says that although the SRED application process can seem daunting at first, it’s worth it in the end. “You do need to put in some effort, but the return fully justifies this effort. And once you’ve done it once or twice, it becomes more routine; every year, we spend less effort in preparing the application because we have established a process and have the in-house expertise to process the majority of the documentation.”
The program has helped AFORE Solutions maintain a steady cash flow while expanding its offerings, such as new modular software that allows network equipment vendors to accelerate their time to market and cut costs by using AFORE Solutions’ components to build custom systems. “I’ve recommended this program to many local companies because it’s a great tool that allows companies that have to invest in R&D to stay competitive,” says Berlin.
Get expert advice
Determining which costs the CRA deems eligible for SRED tax credits and which costs are not can be challenging, especially for companies that are new to the program. Generally, the program funds work that leads to new, improved or technologically advanced products or processes in a wide range of industries.
According to William Robinson, a consultant with Research Support Services Inc., of Port Coquitlam, BC, who has worked with companies pursuing SRED tax credits for the past 18 years, the types of work that are eligible include developing new tools or products, extending a product line, exploring ways to work better or cheaper and developing or improving technical processes. He says the SRED program rewards companies employing innovative solutions to both old and new problems.
According to the CRA’s guidelines, eligible projects must meet three criteria: they must attempt to advance a company’s technology base (including technical knowledge), face a question of technological uncertainty (in terms of how to solve a given problem) and feature technological content (in other words, prove that money was spent, R&D work was done and recorded and qualified personnel were used).
The role of the consultant in EDC’s Guarantee Program is to evaluate the work from a technical and/or a financial point of view according to the slew of CRA guidelines that govern the program. “We evaluate the work in terms of all the application guidelines and all the information circulars that are out there to say, OK, the CRA will probably view this as eligible SRED work,” explains Robinson.
“But because eligibility is subjective, and a successful claim largely depends on the reviewer’s industrial R&D experience, no consultant can give guarantees, so we give you our best opinion on what will qualify for SRED tax credits, based on our experience with the SRED program.”
Robinson says the SRED program has been a huge help to his clients over the years, and he expects more companies to show an interest in it going forward, given the current state of the credit and lending industry in Canada and south of the border.
“With the credit crunch being what it is, it’s becoming extremely difficult for small- and medium-sized companies, particularly in manufacturing, to access credit. However, companies who avail themselves of the EDC Export Guarantee Program find the banks view the SRED tax credits as excellent collateral. In these situations the banks are willing to loan up to 90 per cent of the money spent against the future SRED claim, which will be filed at the end of the tax year. So, both parties are winners, as the banks are assured they will get their money back, and the company has the funding to complete its project.”
Robinson says he’s seen the difference the tax credits make to small companies over the years. “It allows for much less disruption in research and development work due to cash flow problems.
Knowing you can get advances like the EDC Export Guarantee Program helps accelerate a company’s R&D program by ensuring a consistent cash flow. In the end, that means they get their products to market much sooner, which makes them, and Canada, more
competitive in the global economy.”
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Photo: Courtesy of AFORE Solutions
The SRED program has helped AFORE Solutions maintain a steady cash flow while expanding its offerings.
Photo: © Ryan McVay/Getty
