Monday, July 05, 2010

SRED Reform: Warning Signs Ahead

I've often worried that Canada does not have a organization that advocates exclusively for the start-up. After all, who has the time? Instead, we rely on organizations such as CATA and the CVCA to address issues on our behalf.

For the most part, this makes sense. But what happens when the interests of the start-up community diverge from those of other members of these associations?

SRED reform is one such area. The federal government currently is undertaking a review of the SRED program, and is soliciting active input from the private sector. CATA, ITAC and all these folk have opened their coffers and paid for handsome white papers, industry studies, advocacy programs and the like. But what they are advocating is not necessarily in the best interests of start-ups.

The SRED program, albeit full of warts, has been a valuable source of additional cash to Canadian start-ups. Under SRED, the federal government will refund up to 35%of the first $2 million spent on research and development each year to Canadian controlled private companies(CCPCs). For companies which do not meet the CCPC criteria (foreign-owned subsidiaries, publicly traded companies, start-ups backed by foreign venture capital), the cash refund is not available; instead, tax credits are awarded.

CATA and ITAC have quite rightly pointed out the many flaws inherent in the system. The process for claiming SRED refunds and credits is certainly no picnic, and has given birth to a lucrative cottage industry of specialists who will prepare the paperwork for you for the price of a small hybrid car. Audits of SRED claims are on the rise as well, making the time to refund, and the amount of any refund, uncertain in some instances.

But for many lobbying groups, addressing these flaws has taken a back seat to a different priority: getting cash refunds into the hands of later stage companies. Public companies, foreign-owned subsidiaries, profitable private companies - all of these folks should also, lobbyists argue, be eligible for SRED cash back.

Now, I know what you're thinking: if Canada provides direct cash government assistance to mature companies, will this turn SRED into an illegal trade subsidy that will cause all kinds of problems for Canadian companies in international trade? (Okay, I know you're not thinking that - it is Monday after the long weekend - but really, could someone explain to me how this would NOT cause problems? Has anyone been watching the increasing tech protectionist tendencies of Europe? Why not just paint a red target on the back of, say Opentext or RIM, and turn them towards the EU?)

What you are really thinking is, why do I care if there's more companies at the SRED refund party? The answer is simple: a tax base of 33 million people. The amount of federal money available is finite, which means that, should the federal government concede the point, the end result may well be less pie for everyone.

Unless advocates can explain where the extra cash to fund an expanded refund program will come from, we need to proceed with caution. Back in high school, I once shared a summer job with Tony Clement. I followed him around the Old City Hall courts for two months, doing furniture inventory for the Ministry of the Attorney General. Let me tell you: even as a university student, that boy could count. I would not bank on him advocating an unfunded policy.

There are valid reasons why CATA and others are advocating SRED cash for bigger industry players, but these needs should be balanced against those of the people currently benefiting from SRED. And you, entreprenuers, need to do the balancing. Agree that there should be cash made available to foreign-backed start-ups, as CATA recommends (although I will note that in my experience, while US VCs and angels have found SRED interesting, it hasn't been a key driver of investing in Canada. It's like leaving cookies out for Santa - sure, he might come, but I know that it's more likely I'll end up eating them)

SRED reform could enhance or further decimate the prospects of Canadian start-ups. Your participation is needed.

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