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Parsing Canada’s research tax credit boondoggle

This year, it’s estimated federal and provincial governments will spend some $4.7 billion on research tax credits to more than 20,000 companies, but not all of them ae doing legitimate research.


April 15, 2011
by TODD HIRSCH, senior economist, ATB Financial

In Keith Ross Leckie’s novel Coppermine, a phrase from Inuit culture poses a philosophical question. “Il-viunna-hugi-vit,” translated as, “Are you who you appear to be?”

It’s a question that could just as easily be asked of Canadian companies claiming to do research and development (R&D). In the balance hangs the future of the economy. Unless businesses dedicate more time, energy and money to research and development, Canada will fall behind.

So, Canadian businesses: are you who you appear to be?

This year, it’s estimated that the federal and provincial governments will spend some $4.7 billion on research tax credits to more than 20,000 companies. The Scientific Research and Experimental Development program is a financial carrot dangled under the noses of businesses, encouraging more productivity-enhancing research.

Although some companies appear to be doing a lot of research, appearances can be deceiving. According to some estimates, about a third of that foregone tax revenue is being spent on consultants cooking up legal ways to bilk the program without having to lift a finger doing legitimate research.

On the other hand, some sectors of the Canadian economy appear to be lagging on research activity but, in fact, are much more innovative than many companies claiming the research tax credits.

Canada’s oil and gas sector is a prime example. Many economists and policy think-tanks wag their fingers to shame the energy companies because their use of the tax credit is low. But as the Inuit question so wisely notes, things are not always as they seem.

The issue is the very narrow way research activity is measured. The federal government’s research tax credit system, as reported by Canada Revenue agency, is one way. But it’s certainly not the only way to do research.

The energy sector doesn’t operate much in a laboratory. Research is done on the fly. Try it this way. Try it that way. It’s a constant trial-and-error endeavour, not a formal experiment with a beginning and an end. It’s an evolution of trying different techniques until improvements are found. That means there is no price tag for laboratory research that can be submitted for the big, juicy tax credit.

A great example of this is horizontal drilling techniques, many of which were perfected in Alberta and are now being used around the world. It almost defines the word “innovation.” With horizontal drilling, much of the oil and gas previously abandoned in old fields can now be extracted economically.

Another example is the steam assisted gravity drainage (or SAGD) technique in the oil sands, which allows extraction of bitumen with a fraction of the environmental footprint of older techniques. These methods did not come about overnight, but rather were developed over time and largely without tax credits.

Cynics and critics of the energy sector would point out that oil and gas companies receive more than their fair share of other tax breaks, subsidies, and accelerated capital cost allowances. That is a different debate. The issue with the research tax credits is an important one because the implication is that Canada’s resource companies are Neanderthals not doing enough to improve their own productivity.

If anything, though, energy companies are leaders in research and innovation. Efficiency means just as much (if not more) for Canada’s oil and gas producers than it means for other companies. It’s constantly sink or swim.

Some Canadian companies are fraudulently claiming tax credits and are patted on the back for their research work. Other companies – many of them in resources – are constantly pushing the edges of innovation and research, but are demonized as research laggards because they don’t claim the tax credits.

When it comes to research, Canadian companies are not always what they appear to be. Maybe we should ask more questions before jumping to conclusions.

Todd Hirsch is senior economist with the Edmonton-based ATB Financial a business columnist with Calgary-based Troy Media.