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Tax Court ruling to change the government subsidy game

The furor about Chrysler Group LLC's pitch for taxpayer help to modernize its Canadian plants is a vivid reminder that the global subsidy game is very much alive.

Governments everywhere continue to finance factory upgrades, new aircraft models, drug research, and an infinite array of industrial projects.

It's all tolerated despite strict World Trade Organization rules that prohibit most subsidies. The WTO frowns on aid that gives a business a clear edge over rivals, or substantially lowers prices in the home market.

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There are some notable exemptions. The WTO allows assistance that is targeted at research, disadvantaged regions or mandated environmental upgrades.

The R&D loophole in particular is so large that governments routinely drive planes and autos through it. Slap "innovation" on a program and you're good to go.

The federal government was looking at contributing to Chrysler – which now says it doesn't want the help – through its $250-million-a-year Automotive Innovation Fund.

There are countless other federal innovation and research programs, including the Strategic Aerospace and Defence Initiative, Sustainable Development Technology Canada and Investing in Business Innovation.

But a recent Tax Court of Canada ruling is making this type of direct government assistance a lot less attractive to businesses in Canada.

For years, many companies have been billing taxpayers twice when they do R&D – once via R&D tax credits, and then again through direct assistance for the same work, typically in the form of government loans, investments and other repayable contributions.

Governments like loans, even interest-free ones, because they hold out the promise that some money may eventually come back to the public coffers. It's even better for businesses, because loans, unlike outright grants, have traditionally not counted against the value of tax credits.

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But a Tax Court decision last year in a case involving Halifax-based Immunovaccine Technologies Inc. and the Canada Revenue Agency is threatening to turn the rules of the game upside down. Between 2005 and 2008, the company received $3.8-million in repayable contributions from the Atlantic Innovation Fund (a federal program run by the Atlantic Canada Opportunities Agency) to develop a new line of vaccines.

The problem was that Immunovaccine Technologies was also claiming R&D tax credits on its research work. The Canada Revenue Agency rejected a large chunk of the credits, and the company appealed.

The Tax Court upheld the CRA's ruling, effectively ending this form of double-dipping by arguing that companies should not get government assistance and also tax credits.

"If another party has borne the economic cost of a taxpayer's participation in scientific research and experimental development, there is no need to allow deductions or credits as an incentive for that taxpayer to engage in [R&D] activities," Justice Lucie Lamarre wrote in her decision.

Experts say the ruling will have an effect far beyond Immunovaccine Technologies, by making government loans potentially unattractive to thousands of Canadian companies.

"It's a significant change in the funding picture," said David Hearn, managing partner of Toronto-based Scitax Advisory Partners LP, a consultant specializing in Scientific Research and Experimental Development tax-credit claims. "Everyone who receives this kind of assistance is concerned about their SR&ED credits."

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All of the auto makers make large R&D tax claims every year, as does aircraft maker Bombardier Inc., smartphone maker BlackBerry Inc., and more than 20,000 other Canadian companies, large and small.

The bottom line, Mr. Hearn said, is that "a dollar's worth of government assistance, in the form of a loan, is not worth what it was."

He gave the example of a company that does a $1-million R&D project. If it were to get $400,000 in government assistance, it would pocket a $90,000 SR&ED tax refund. Without a loan, the company would get back $150,000. The negative effect on smaller companies, which can earn larger refundable tax credits, is even more substantial.

The case also stokes the ongoing debate about how government can best spur companies to innovate and do more R&D. A 2011 report by a federally appointed R&D panel, headed by Open Text Corp. executive chairman Tom Jenkins, recommended that Ottawa shift its emphasis away from tax credits to direct funding.

That advice could now prove a lot more difficult to implement.

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About the Author
National Business Correspondent

Barrie McKenna is correspondent and columnist in The Globe and Mail's Ottawa bureau. From 1997 until 2010, he covered Washington from The Globe's bureau in the U.S. capital. During his U.S. posting, he traveled widely, filing stories from more than 30 states. Mr. McKenna has also been a frequent visitor to Japan and South Korea on reporting assignments. More

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