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Founding CEO of Altus Assessments Rich Emrich works on his computer in his office located in the tech space OneEleven, on April 18, 2019.

Christopher Katsarov/The Globe and Mail

Ontario small businesses that rely on research and development tax incentives to help grow their companies are concerned that a review launched by the province’s Progressive Conservative government could mean a rollback of the popular credits.

The Ontario budget tabled earlier this month says the province will examine the Ontario Innovation Tax Credit (OITC) “as well as other R&D tax incentives.”

Companies doing R&D in Ontario can apply for the OITC in addition to the Ontario Research and Development Tax Credit (ORDTC), alongside the federal scientific research and experimental development (SR&ED) investment tax credit, commonly referred to as “shred.”

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The Ontario budget states that small-to-medium-sized companies eligible to claim the 8-per-cent OITC credit may also receive the 3.5-per-cent ORDTC and the 35-per-cent SR&ED investment tax credit for the same expenditures. The province said in the budget that its review “will consider the appropriate level of R&D tax support for business, taking into account research findings on the cost and benefits of R&D tax credits.”

Bryan Watson of Flow Ventures, a Toronto-based consulting firm that helps companies file for various government incentives, said “[the review] has folks worried." He added that the program is “a huge part of what helps companies scale.”

The concern is sparked by a footnote in that section of the budget that cites a research paper by John Lester, executive fellow at the University of Calgary’s School of Public Policy. He argues that a high subsidy rate for smaller companies can be counter-productive by encouraging low-quality R&D projects.

“If my work is having any influence at all, it isn’t going to motivate an increase in incentives for small business in general, or for R&D performed by small business,” Mr. Lester said in an interview with The Globe and Mail. He said he wasn’t notified that the government would cite his work, and only found out about it when contacted for this story.

His latest calculations show a small firm claiming the federal and provincial R&D tax credits, on average, received a 42.8-per-cent subsidy on its R&D activities in 2018. For firms also benefiting from the Industrial Research Assistance Program (IRAP), closer to 60 per cent of their project costs are paid for by governments. The average subsidy rate for a large firm benefiting from federal and provincial tax credits is about 20 per cent, according to his analysis.

Mr. Lester says a more generous subsidy for R&D performed by small firms would be justified if it generated more benefits for society than R&D performed by larger firms, but his research shows that’s not the case. In fact, they may generate less.

"Subsidizing R&D is good public policy, but when governments pick up more than around 25 per cent of the cost, I start getting nervous about it actually being a good investment for society,” he says. Anything above that, and Mr. Lester says, “there’s a substantial risk that economic performance will be harmed rather than helped.”

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The Ontario Liberals reduced the OITC to 8 per cent from 10 per cent and the ORDTC to 3.5 per cent from 4.5 per cent in 2016. The Progressive Conservative government, elected last June, is “reviewing support provided for … R&D to ensure that it is effective and efficient,” Robert Gibson, press secretary for Ontario Finance Minister Vic Fedeli, said in a statement to The Globe. He said the government will consult with businesses in the coming months, and then “develop a plan that ensures Ontario entrepreneurs have improved access to the province’s R&D support.”

Many companies have chosen to locate and move to Ontario from across Canada and internationally because of its R&D incentives, said Mr. Watson, of Flow Ventures, who worries a rollback would make the province less competitive compared with other jurisdictions.

“The biggest risk is interprovincial competitiveness,” Mr. Watson said, adding a rollback would be inconsistent with the provincial government’s new “A Place to Grow” and “Open for Business,” taglines.

If the incentive is reduced in Ontario, Mr. Watson says businesses will still benefit from changes to the federal SR&ED program announced in the recent federal budget. The federal Liberals removed the revenue cap on how much income small companies can generate to qualify for the tax credit.

“If the Ontario government lowers the rate, this would decrease the amount that companies would get as a refund, but for some companies the removal of the federal revenue criteria will let them still get more cash back,” Mr. Watson said.

Rich Emrich, chief executive of Toronto-based Altus Assessments Inc., which has a technology that helps health-care training programs assess applicants, says any concern that the incentives are propping up companies that would otherwise be unsuccessful is overblown.

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“You have to have the money up front in order to accomplish the R&D,” said Mr. Emrich, saying that the credits aren’t often realized until a year or 18 months later. “[The government incentives] encourage companies that are viable to continue to do R&D.”

Mr. Emrich says Altus doesn’t rely on the tax incentives to operate, but a rollback could prevent it from hiring more staff in the near term, depending on the potential change.

Markus Latzel, CEO of the Toronto-based cloud-solution provider Palomino Inc., which uses both the OITC and ORDTC credits, says his concern is that any potential rollback might inspire other governments to follow suit.

“If there was a significant case made against this R&D incentive program, what would stop the next federal government, in particular, if it was a Conservative government, to use it as precedence?” he said.

Teri Kirk, founder and president of Fundingportal, which helps companies find and apply for grants, says governments incentives, such as grants and tax credits, “play an important role in incenting and driving business decisions,” including where to locate. "Therefore, a reduction is likely to have an impact on the extent to which innovation companies can move forward with their R&D activities.”

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