PACC Committee Meeting

STANDING COMMITTEE ON PUBLIC ACCOUNTS

COMITÉ PERMANENT DES COMPTES PUBLICS

EVIDENCE

[Recorded by Electronic Apparatus]

Thursday, June 8, 2000

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[English]

The Chair (Mr. John Williams (St. Albert, Canadian Alliance)): Good afternoon, ladies and gentlemen.

We will begin, pursuant to Standing Order 108(3)(e), consideration of chapter 6, Canada Customs and Revenue Agency and Department of Finance—Handling Tax Credit Claims for Scientific Research and Experimental Development of the April 2000 report of the Auditor General of Canada.

Our witnesses today, from the Office of the Auditor General, are Mr. Denis Desautels, the Auditor General; Mr. Shahid Minto, Assistant Auditor General; and Mr. Barry Elkin, Principal of the Audit Operations Branch.

From the Canada Customs and Revenue Agency we have Mr. Rob Wright, the Commissioner; Mr. William Baker, Assistant Commissioner, Verification Enforcement and Compliance Research Branch; Ms. Norine Heselton, Director General, Scientific Research and Experimental Development Directorate, Verification Enforcement and Compliance Research Branch—I hope you have a big business card for that—and Mr. Phil Feely, Manager, Operations Section, Scientific Research and Experimental Development Directorate, Verification Enforcement and Compliance Research Branch.

From the Department of Finance we have Mr. Len Farber, Director General of Legislation, Tax Policy Branch; Mr. Paul Berg-Dick, Director of the Business Income Tax Division, Tax Policy Branch.

I think these are all the witnesses. I haven't missed anybody, have I? No.

We'll start with our opening statement from the Auditor General as usual.

Mr. L. Denis Desautels (Auditor General of Canada): Thank you, Mr. Chairman, for allowing us to present the results of our audit of the Canada Customs and Revenue Agency and the Department of Finance on handling the tax credit claims for scientific research and experimental development.

Research and development is an important factor in improving the productivity of a country's economy and the standard of living of its citizens. The federal government has encouraged research and development in the private sector for many years through tax incentives.

The tax incentive program for scientific research and experimental development, or SR and ED, is significant. In the last five years, the federal government has granted over $6 billion in tax credits to some 11,000 corporations and individuals.

Let me start by pointing out that underlying much of our tax work is the concept of fairness, and the reason for this is quite simple. Taxpayers are entitled to know whether they and others are being treated fairly and how their money is being spent.

We conducted our audit in the Canada Customs and Revenue Agency's head office and seven of its tax service offices, and in the Department of Finance. We examined various agency documents and files, and we interviewed science advisers and financial auditors. We also consulted tax advisers and economists from the private sector.

Our audit deals with two main aspects of the SR and ED program: its administration and its impacts.

We identified four major concerns in the administration of the program. In 1994, the federal government restricted the period of filing tax credit claims for SR and ED expenses to 18 months after the year in which the taxpayer incurred these expenses. As there was no such limit before 1994, the government gave taxpayers three months to file retroactive claims. Consequently, the agency was inundated with 16,000 additional claims in 1994, representing $2.8 billion in credits for years as far back as 1985, and was faced with an administrative nightmare.

In our report, we comment on the unresolved disputes over the eligibility of science work in the financial and telecommunications sectors. In addition, we found that there was insufficient evidence to determine how taxpayers are currently filing claims. This is because of the $5 billion in claims the agency received for taxation years from 1996 to 1999, $3.2 billion—or 64% of that dollar value—have not yet been processed. Further, in examining the claims of 25% of the largest claimants, we learned that most science reviews and audits were not current.

Our first concern is the inconsistencies in the handling of the retroactive claims, which raise some questions of fairness. In some cases, poorly documented claims were rejected. In other cases, financial auditors and science reviewers helped taxpayers prepare eligible claims. Claims initially rejected were approved after a second science review. Other claims, initially rejected, did not receive second science reviews.

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[Translation]

Our second concern, Mr. Chairman, is that clearer rules are urgently needed to deliver and administer the program effectively and efficiently. I cannot emphasize enough the importance of clear rules. The lack of clear rules has led to a situation where, in the financial and telecommunication sectors, unresolved disputes over the eligibility of science work have reached hundreds of millions of dollars in tax credits.

In a tax incentive program such as the one for SR&ED, the legislative and administrative rules must define as completely as possible who and what qualified for the tax credit. This helps to ensure that only eligible SR&ED work is claimed and allowed. Resolving disputes over eligibility drains resources, jeopardizes the program's incentive objective and puts at risk large amounts of tax revenue.

I am encouraged by the Minister of Finance's statements in his February 2000 budget. He said that the government is committed to rigorously applying the existing criteria to address outstanding claims related to information technology. He added that the government will ensure that the guidelines on software development, in particular internal use software, both reflect government policy and provide clarity and certainty of application for compliance purposes as well as administration.

Our third concern is about the lack of an effective mechanism in the Agency to deal with differences of opinion on the appropriate treatment of individual claims. The case outlined in my Report illustrates confusion among Agency staff where serious professional differences of opinion arose. The Agency was unable to demonstrate that it had effective procedures to resolve disputes between various officers who work on a significant claim.

Our fourth concern, related to the administration of the program, is the need for the Agency to improve the assessment of risk that taxpayers' claims are ineligible so that science and audit staff can focus on claims with the highest risk.

In order to resolve some of the administrative problems, the Agency and industry created a partnership to implement an action plan. At the conclusion of our audit the action plan was just being implemented. Consequently, we were unable to comment on its results.

[English]

I would now like to take a few moments to talk about the impacts of the SR and ED program.

In 1994, we recommended that the Department of Finance and the agency conduct an evaluation of the program. We thought an evaluation was warranted, given the cost of the program and the lack of information on its impacts. To their credit, the department and the agency carried out an evaluation. Independent experts were also asked to review the methodology and content of the evaluation before its publication.

The evaluation concluded that the increase in SR and ED spending generated by the program exceeded the tax revenue foregone. More specifically, it estimated that for every tax dollar foregone, SR and ED spending increased by $1.38. In other words, some of the investment in research and development would not have taken place in the absence of the program. However, the evaluation, using conservative estimates, also indicated that the net increase in Canada's real income generated by the program was only somewhere between $20 million and $55 million per year.

We refer to this evaluation in our chapter for the same reasons that led the Department of Finance to put it in the public domain in 1998. It was released to provide information for public and parliamentary discussion of the SR and ED program and to promote improved management of the tax system in general.

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The challenge for the government is to explore the issues raised in the evaluation and find ways to strengthen and improve the SR and ED program.

Mr. Chairman, that concludes my opening statement. We would be pleased to answer your committee's questions concerning this audit. I would like to mention, however, that it may be necessary for us to decline to answer certain questions that may violate the confidentiality of the Income Tax Act.

Thank you, Mr. Chairman.

The Chair: Thank you very much, Mr. Desautels.

We'll now turn to the Canada Customs and Revenue Agency.

I note you have a fairly long report, Mr. Wright. We normally try to restrict our opening statements to about five minutes. Do you think you can handle it in five minutes, or would you rather just give us an overview and have your report lodged with the clerk, so if anybody actually wanted a copy of the text they could have it?

Mr. Rob Wright (Commissioner, Canada Customs and Revenue Agency): I'd be happy to do that, Mr. Chairman. I have some very brief opening comments.

Mr. Mac Harb (Ottawa Centre, Lib.): There is the understanding that it will be deemed as read and will go on the record of the committee as such.

The Chair: Yes, we normally try to do that, except getting it on the record is a bit of a technical thing. That's why we say, on the record, it is lodged with the clerk. Therefore, anybody who wants the verbatim can ask the clerk and it will be supplied to them.

Mr. Rob Wright: That's fine, Mr. Chairman.

I will just start by thanking you very much for that introduction. It's a pleasure to be here with some key members of my management team to respond to some of the observations Mr. Desautels has just made.

I won't comment in great detail; I'll just say up front that we recognize that this is an extremely important subject. SR and ED is probably the most important science program for Canadian business and for Canada.

I want to thank Mr. Desautels, the Auditor General, for his report. It definitely will help us improve the administration of this program. We acknowledge that and welcome it.

As Mr. Desautels has pointed out in his comments, the starting point for this issue really is 1994 when we inherited, in Mr. Desautels' terms, an administrative nightmare.

It was proper, in our view, that the legislation was changed. It dealt with a real problem, but the extent of the administrative challenge from bulge claims that were created by this was really underestimated.

I think the most powerful point, in Denis' assessment, is that if we had started with much clearer guidelines, in administrative terms, we could have managed that bulge much better. We agree with that in hindsight, but there was no quick fix to this problem in 1994, and that's the key issue. It was a period of severe restraint and we did not have a lot of resources to throw at it. There was a huge bulge of complex and poorly documented applications.

There were really only three options facing the Revenue Canada of that day: to approve all documented claims, which we did not do; to reject the vast bulk of these claims as being less than fully documented, which we did not do; or to have a more deliberate process to sort this out over time. I believe we chose the right path, on something that was this important to the government and to the industry of the day.

The process also reduced—I think importantly—court time and expense, and reflected our overall approach to collaboration and fairness on important issues.

But there is no doubt we could have managed this huge bulge in 1994 much better, and there's no doubt it created much greater problems for us than we originally envisaged in 1994.

Mr. Desautels' report will definitely help us further improve the program and learn from this experience.

The only key point I want to make up front and emphasize for you, Mr. Chairman, from what would otherwise be a very long intervention, is that we did not wait for this report to start improving this program. We knew we had an administrative nightmare in 1994 because we were living in it. Again, inspired in part by the report from the AG, we worked with our colleagues in the Department of Finance in 1995 and 1996 and released that detailed evaluation in 1997, which talked about some of the administrative challenges we faced. This report clearly marked the need for administrative improvements. It also flagged the real value of this program.

In June 1998, our minister of the day had a conference with stakeholders, who were also very concerned about the overall administrative flexibilities in the program. There was a very strong consensus that one of the key observations in Denis' report today was valid then—that there was an urgent need to clarify those rules. So by November 1998 we released an action plan, a public document committing ourselves to real change to improve the efficiency of this program, and we formed an action plan steering committee with industry stakeholders to start making these improvements. But it does take time.

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Now since November of 1998,

[Translation]

the current minister, Mr. Martin Cauchon, has had other meeting with industry officials and all government partners.

[English]

He endorsed very much the action plan that was announced in 1998 and committed us to fully implementing that action plan this year.

So I do thank the AG for his report. It will contribute in important ways to our improvement, but it really does not fully reflect the tremendous progress we feel we've made in improving the program, and we'll be happy to talk about that as we go along, sir.

Thank you.

The Chair: Thank you very much, Mr. Wright. I appreciate very much your cooperation in delivering a verbatim summary of your report. Again, for the record, it will be deposited with the clerk, and anyone who needs a copy of the transcript can obtain a copy of your actual report at the same time.

I understand Mr. Farber is going to present on behalf of finance.

Mr. Len L. Farber (Director General, Legislation, Tax Policy Branch, Department of Finance): Yes, thank you very much, Mr. Chairman.

Once again, I'm pleased to be here before the members of this committee.

Mr. Munir Sheikh, the assistant deputy minister for tax policy, is unfortunately not able to be here with you this afternoon. He's with the minister in the committee meeting that's taking place next door, just on the other side of the partitions. But he has submitted his comments to the clerk, and hopefully, members of the committee have had an opportunity to review them.

So Mr. Chairman, I don't intend to read his comments into the record, but I would take it that his report, like Mr. Wright's report, will form part of the record. It's a fairly in-depth discussion of a number of different areas that were raised in the Auditor General's report.

Mr. Chairman, first I want to say that the Auditor General's report is a comprehensive review of Canada's tax assistance program for research and development, and from that perspective it provides a very useful tool in reviewing the merits of the program.

Let me briefly touch on three key issues that were addressed in the report that I believe warrant emphasis.

First, the Auditor General refers to the finance department's 1997 SR and ED evaluation report, which Mr. Wright referred to as well, and raises questions about the validity of some of the assumptions and whether the survey conducted was conducted in a reasonable fashion.

The objective, Mr. Chairman, of any tax assistance program is clearly to increase or encourage effort and economy. It therefore stands to reason that if indeed an SR and ED program were generating benefits to the economy, its elimination would lower economic output. This was the experiment the department indicated in its evaluation report—whether eliminating Canada's SR and ED tax incentives would increase or decrease economic growth.

Two critical assumptions were set for this evaluation. First, every penny saved from abolishing the program would go to lower taxes. Second, no value would be assigned to the dynamic gains in undertaking this evaluation that are inherent in SR and ED. That is, those gains are natural and accrue over time because of accumulations of new knowledge and scientific advances resulting from SR and ED.

As Mr. Sheikh points out in his comments, this analysis is no different from that of any businessman setting up a business plan for a new venture and looking at a worst-case scenario. If the business can succeed under the worst of circumstances, then clearly it can safely be assumed it can succeed under normal circumstances.

The study estimated that every dollar of government assistance led to $1.38 of increased spending in R and D. Under the SR and ED program the ratio of SR and ED to assistance is not just one to one, but it would mean a success of sorts if it were just one to one. But where every penny of assistance actually generates $1.38 per dollar, clearly it's beneficial to the economy.

The AG asks whether this survey was conducted in a reasonable fashion.

Mr. Chairman, interviews were conducted with CEOs of a number of different companies, directors of taxation or equivalent positions within the firms, and it was refereed by several academics. No one at any time expressed concern about the methodology, nor the results.

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The Auditor General's report suggests that the benefits are not very large—$20 million to $55 million. I'm sure we all wish for them to be larger, under any set of circumstances. Now, the fact is the program does contribute to Canada's economic growth even under the most adverse assumptions.

However, clearly, Mr. Chairman, any program can be improved, and that is where the focus on the various aspects of the program is worthwhile, because it draws our attention to it, and together with the CCRA, we can work on improving it.

Second, Mr. Chairman, let me turn to the Income Tax Act and the law and deal with a concept of R and D that is far easier to talk about than to translate into a legal framework. SR and ED, or scientific research and experimental development, are not overly precise concepts. What may well qualify as SR and ED in one context may not qualify in another.

Given this imprecision in concept and the difficulties in drawing a precise line between eligible and ineligible R and D, it was important for the government to lay out guidelines that were as clear as possible. We at finance and the agency have done our best to do that.

The key criteria that were developed and referred to by the Auditor General for SR and ED to qualify for tax assistance are the following: there must be technological advancement, scientific or technological uncertainty, and scientific and technical content. These criteria have worked reasonably well over the last several years. What is important to recognize in these criteria is that they are not necessarily present in an endeavour that happens to be new to the taxpayer.

Last, Mr. Chairman, let me make a few comments on the administration. As the commissioner for the agency has indicated, and the Auditor General has set forth in his report, the administration of the program has come under increasing pressure in the use of management information systems and internal-use computer software. We recognize this and have been working with the agency very closely to align the administration with the policy intent. As the Auditor General has indicated and the February budget clearly stated, we recognize the backlog of claims, and they will be dealt with. As indicated in the budget papers, Mr. Chairman, and I quote, “The Government is committed to rigorously applying the existing well established three basic criteria”—which I just referred to—“to address the backlog of SR&ED claims related to information technology”.

We will consult with the industry and R and D experts with a view to determining whether within the existing criteria there are clear ways to both facilitate compliance and ease administration. Again, the budget document spells that out very clearly, Mr. Chairman, and that consultative process has already begun. We are in the midst of preparing an internal paper, which is in draft form at the present time. We intend to use this document to consult with stakeholders, scientific experts, and the industry with a view to determining what needs to be tweaked within the law to ensure the taxpayers can have ease of compliance and the administration can be facilitated in a way that would make sense to both parties to it.

So it's a real challenge for the program to keep up in a world in which advancements and developments in technology are occurring at a very rapid pace. What is a technological breakthrough today quickly becomes a well-known standard practice tomorrow. The laws work fine in most of the situations that have come to the CCRA, but the difficulties that have been discussed here this afternoon are difficulties we recognize and will deal with.

I just want to make one last comment with regard to the bulge or the increased number of R and D claims that came about as a result of a change in law in 1994.

At that point in time, Mr. Chairman, the idea behind that, which was touched on in the Auditor General's report, was to ensure that backlogs of claims would not just all of a sudden come to the fore after many, many years.

The SR and ED deduction is a very special type of deduction that doesn't necessarily have to be claimed in a particular year. It's a pooling system that is aggregated and can be claimed at any point in time. Different cases that come up before the courts and whatnot could give clear indications to taxpayers that what they never expected to get R and D claims for could all of a sudden be judged by the court to be eligible for claims.

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At that point in time the law was changed to ensure that within the normal filing time for a corporation, which is the following year plus another six months, an 18-month timeframe, any claims that were expected for research and development, including tax credits, would be claimed in that context.

It's quite understandable that taxpayers would at that point in time, given the cut-off date, put forward a large number of claims, and they did do that. But the criteria are there, they will be applied, and we support the agency in their efforts to deal with that backlog. On a go-forward basis into the future the law is now clear, and that kind of situation ought not to present itself again.

In conclusion, Mr. Chairman, the Auditor General's report is helpful in highlighting in a public way the issues that were being addressed, and commitments were being made in the budget to respond to these legitimate concerns.

Mr. Chairman, any questions on that, my colleague, Mr. Paul Berg-Dick, and I would be very happy to take.

The Chair: Thank you, Mr. Farber.

For the record, the full written text of the opening statement that had been prepared by Mr. Munir Sheikh, ADM of the tax policy branch, will be deposited with the clerk and available for anyone who needs a copy.

Before we go to the first round of questions, I should perhaps point out that, by and large—and I think I'm correct in saying this—the finance department sets tax policy and CCRA handles tax administration, collection, and processing and so on. Since we have a large array of witnesses today, perhaps members could specify to which witnesses the questions are directed.

Mr. Mayfield, eight minutes, please.

Mr. Philip Mayfield (Cariboo—Chilcotin, Canadian Alliance): Thank you very much, Mr. Chairman.

It's a pleasure to meet with the Auditor General and his staff and officials from the agency and the Department of Finance.

This is an interesting topic we're discussing today, and a number of questions arise in my mind. I'm not sure who to direct these to, but perhaps I could direct them to the Auditor General and then other comments would follow from that.

As I've read and listened, I've heard about how well we're doing with, say, the 1:1.38 ratio. The actual numbers are not that much, $20 million to $55 million. I would like to have some clarification on what these numbers mean, how well we're doing—or how well we're not doing. What do these numbers really mean?

It strikes me that we're in a very big operation here, that clients or companies seeking these tax credits are involved in some pretty big numbers, it would appear to me. I'm wondering how much of this amount is generated simply to apply for these grants, to administer them, to seek the refunds. How much actually goes into the kind of research or development we're talking about?

I would like to know also, I guess, if we were going to discuss it further.... I'm certainly not suggesting that we shouldn't be involved in this kind of research, but it strikes me that we also have a highways program that could do with a few billion dollars, and I wonder how much return there would be on that. As we talk about these numbers, then, I'm wondering if there could be some comparison of how this money could be used to effectively generate wealth within our economy.

Mr. Chairman, perhaps the Auditor General and the other officials could respond to that.

The Chair: As I mentioned, Mr. Mayfield, the finance department handles policy and CCRA handles administration.

Mr. Philip Mayfield: I'll let you sort that out.

The Chair: Then we'll start off with Mr. Desautels.

Mr. Denis Desautels: The evaluation of such programs is a complex matter, and I'm the first one to acknowledge that. The evaluators have to take into account the various alternatives taxpayers may have in terms of what they do, or how they behave, if the incentive is not there or whatever the issue is.

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In this case, the evaluation shows that there is indeed additional spending on SR and ED as a result of the incentive. The figure of $1.38 to $1 has been mentioned a few times. That seems to be a fairly solid figure, and in itself seems to be a good result when compared with the success of other countries.

When we look at the other conclusion of the evaluation, which is the overall impact on the economy, the picture is not as positive, or at least the picture given by the evaluation is not as positive. Indeed, the results are not as impressive as the first result I mentioned. That particular evaluation has been sitting out there for a couple of years.

We believe, and that's why we brought it out and included it in this report, it deserves a bit of discussion, a discussion that could lead to ways in which the program could be improved in order to get better results for the tax money that is forgone.

Now, in terms of Mr. Mayfield's specific question with regard to how much of the benefits go into actual administration and how much go into actual research, there are some administrative costs to running a program like that, to both the taxpayers and Revenue Canada. They are not insignificant, but they would not, in my view, change the first result significantly of $1.38 to $1.

Mr. Philip Mayfield: Perhaps I could interrupt at that point, sir. When we're talking about the cost of this, I'm wondering about the cost to those companies, first, and second, are the costs of the Department of Finance and the agency included in this? It gets to be a lot of.... Well, I was going to say “churn”, but I don't think that's quite the right word. It gets to be a lot of investment in this particular program, and I'm wondering if that's reflected in the rate of return.

Mr. Denis Desautels: I think the finance department in particular is probably the best place to respond to that particular concern of Mr. Mayfield's.

The Chair: Do you want Mr. Berg-Dick to respond as well?

Mr. Philip Mayfield: Okay.

Mr. Paul Berg-Dick (Director, Business Income Tax Division, Tax Policy Branch, Department of Finance): I'd be happy to respond, Mr. Chairman.

I think it's important to put the evaluation, both aspects of the evaluation, in context. First off, in terms of looking at that first figure, $1.38 to $1, if one takes the overall spending of about $1.5 billion in R and D, that 38% of additional R and D comes out to over $500 million of R and D—$500 million in addition to what the government is putting out through tax credits, or over $2 billion worth of R and D that would not be done in this country in the absence of this particular program.

Mr. Mac Harb: Could you repeat that, please? Did you say $500 million wouldn't have taken place if it weren't for this program?

Mr. Paul Berg-Dick: Yes.

Mr. Mac Harb: Thank you.

Mr. Paul Berg-Dick: Furthermore, the program itself is putting out about $1.5 billion in credits. So the combination of the credits themselves, in addition to this incentive to increase the R and D...because for every dollar the government puts in, industry does $1.38 of additional spending. Taking $1.5 billion, then, that turns into $2 billion worth of R and D.

That's a lot of R and D in this country. If you think of the overall total, just under $9 billion being done by business, that's a very significant portion of the overall R and D that's being done by businesses in Canada.

I think there's been a lot of confusion about the second figure, the $20 million to $50 million. Mr. Farber in his opening comments framed it a bit in terms of what the second test was looking at. That's looking at what are all the additional benefits of R and D coming from that $2 billion. It's also recognizing that the $1.5 billion of money that's going into the credit has to be financed by other taxpayers. So there's a cost to that.

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That's the question being asked in the second part: What are the benefits of R and D versus the additional costs of the taxes being imposed to pay for that credit?

The Chair: I think we'll have to stop there.

Do you have another brief question, Mr. Mayfield?

Mr. Philip Mayfield: Yes.

You've related this to “in Canada” and “out of Canada”. One of the concerns I have had is that with regard to research that's done in Canada, by the time it gets down to the manufacturing and the marketing stage, sometimes, if not frequently, it leaves the country for better labour costs and cheaper manufacturing costs.

Are you able to track how much of the technological development, the research benefits, actually stay in Canada, not going out of the country for production and marketing?

The Chair: A brief response, Mr. Berg-Dick.

Mr. Paul Berg-Dick: Certainly if one looks at where the R and D is being done, even in this local area, there is a direct link between the R and D facilities and the manufacturing facilities located here. If you look at the large companies—like Nortel, like Newbridge, like Alcatel—they all have manufacturing facilities together with their R and D facilities.

So I think there is a clear connection—

Mr. Philip Mayfield: I'm aware of that, but I'm also aware of components that come in from Mexico and Korea and other parts of the world.

Mr. Paul Berg-Dick: Sure, and companies have to find the most efficient way to do that, but I think in terms of the most advanced technologies there is a direct benefit in having manufacturing and R and D done in the same country.

The Chair: Thank you, Mr. Mayfield.

[Translation]

You have eight minutes, Mr. Perron.

Mr. Gilles-A. Perron (Rivière-des-Milles-Iles, BQ): Good afternoon, Mr. Chairman. I'm not certain whether to ask a question or make a serious comment. However, I think I would need an hour, not eight minutes, to talk about R&D.

The Chair: You can start with eight minutes.

Mr. Gilles Perron: Fine. I'd like to recount to our witnesses certain R&D situations that I have experienced first hand.

R&D works very well in the case of multinationals like Nortel, as you mentioned, and Noranda Mines. However, the outcome is far less positive in the case of SMEs. Such was the case of an SME in Mr. Assad's riding of Gatineau which was involved in R&D with scientists from Carleton University in Ottawa. All hell broke loose when the time came to get a tax credit and to have the project approved by science reviewers.

Another company in Laval which is owned by Italians preferred to relocate to Plattsburgh, New York, rather than continue to fight with the Canada Customs and Revenue Agency.

I met with Martin Cauchon on several occasions to try and find some solutions, because it is important to look to the future. The problem is the shortage of qualified personnel. Decisions vary, depending on the reviewer who may either accept or reject the claim. The reviewer is the one who establishes the amount of the tax credit.

It would be such a simple matter to resolve the problems that SMEs encounter. All you would need to do is submit a draft proposal to the Agency, which could then determine the tax credit percentage. Then nothing else would matter. However, that's not what happens. SMEs are allowed to hope that they will receive certain tax credits. The science reviewer who receives and validates the initial business proposal will claim that it's a good project and that the company should go forward with it. However, once the project has been carried out and the entrepreneur sets out to claim a tax credit, then the science reviewer tells him that things have changed and that the company is only entitled to a smaller tax credit, perhaps 30 per cent less than expected. As Mr. Farber was saying, in order to extricate itself from a difficult situation, the SME will have no choice but to hire a lawyer and do battle in the courts.

It's impossible to meet with anyone intelligent at Revenue Canada who will listen to both parties and rule that one party is right, while the other is wrong. SMEs have to be prepared to do battle. They don't have the clout that Nortel has or the means to wage a battle in the courts for two or three years.

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That's how things are for SMEs when it comes to the Department of Revenue and R&D claims. Thank you very much. That's all I wanted to say.

The Chair: Did you have a question, Mr. Perron?

Mr. Gilles Perron: What do you intend to do to improve the situation? When we last met, Mr. Cauchon said that you could go back to the drawing board. Do you share that view?

[English]

The Chair: Mr. Wright.

Mr. Rob Wright: Generally speaking, one of the key issues that arrived as a result of this backlog of claims from 1994 was that it did affect our overall administration for current files as well. Again, as a measure of....

[Translation]

I apologize, Mr. Perron, for speaking in English, but it would be difficult for me to explain this to you in French.

Mr. Gilles Perron: That's alright. I can listen to the interpreters.

Mr. Rob Wright: Thank you. That's very kind of you.

[English]

In terms of the overall effectiveness of this program, we are coming out of the wilderness in terms of some of the challenges we have. Just two years ago....

There are two parts to the program. For the smaller enterprises, which you spoke of, there's a refundable tax credit. In that, we have a target of getting an answer to those companies within 120 days, which is very good.

Mr. Gilles Perron: Target.

Mr. Rob Wright: That's a target. Two years ago we were reaching that target only 40% of the time. Currently it's over 80% of the time. So we are starting to really see the improvements in the program and getting the answers when needed.

There still are large and small companies that put in claims that were not properly documented and that took us a while to sort through.

[Translation]

Mr. Cauchon took part in a conference in Montreal and agreed on some important steps with our private sector partners so that we can work together to improve our work systems significantly.

[English]

guidelines and objectives.

Perhaps I can turn to Mr. Baker to talk a little bit more about the types of issues that are leading to these better results. They're not perfect. In fact, part of the progress we're making is that we do have to say no in some instances.

[Translation]

Mr. Gilles Perron: I'd like to comment briefly before you turn the floor over to Mr. Baker. Although I did mention two cases, I could nip back to my office which is located in this very building, the West Block, and provide you with information on 60 to 70 entrepreneurs who have decided to no longer do business with your Agency because it's just too complicated.

Problems arise, not during the initial presentation stages, but during the final stages. The Agency claims that a document is missing, or that the document submitted is not up to date. It claims to not have the information it needs.

Depending on which science reviewer has been assigned to the file, how the legislation is applied varies, along with the decisions reached by the reviewer. There is no set R&D strategy. There is no training provided. A decision should be rendered at the start of the process.

Mr. Rob Wright: That's not entirely accurate.

Mr. William V. Baker (Assistant Commissioner, Verification, Enforcement and Compliance Research Branch, Canada Customs and Revenue Agency): You've raised some very important questions, sir, which go directly to the heart of our effort to improve our program.

[English]

For instance, when it comes to small business, that is an important target area. You may be aware that our minister, Mr. Cauchon, when speaking in Montreal in January, made it clear that it was a priority of his that we are acting upon to ensure that the program reaches small business.

There are two initiatives I just want to speak to in order to address your concerns. One, as indicated in the report, we receive an awful lot of claims, and many claims are relating to smaller businesses. In fact, with companies under $1 million of SR and ED expenses, we received about 10,000 claims, looking at amounts that are quite significant in terms of the credits allowed. The large part of the credit does go to the bigger companies, by definition, because they're in larger enterprises.

There is an administrative burden. There has to be a certain administrative burden. We've tried to mitigate that. We've recently introduced a short form for small business to help them out. We have put in place mechanisms to help them sort through the problems they may have in terms of additional redress mechanisms and additional support and services that are available. It's worthwhile knowing that 90% of the claims we receive are approved in whole or in part. That is, 90% of the claims are allowed in whole or in part, and 70% of the amount that's being sought is ultimately approved by the Canada Customs and Revenue Agency.

• 1625

So while there is an administrative burden, we are achieving results; the credit is being received by the small and medium sector. There is more we can do. In particular we've been working on some outreach programs to ensure that we can identify small and medium businesses that can perhaps benefit from that program, because it is one of our responsibilities.

Mr. Rob Wright: Mr. Chairman, could I mention one of the issues concerning Plattsburgh. Not every application is guaranteed success, of course, but vis-à-vis the timetable, these are the most attractive tax incentives in the world vis-à-vis scientific and experimental development.

Our administration compares very favourably with the U.S. administration of incentives such as this. So we feel that although there's been frustration, and I think the bulge has affected this—Denis has made the point very effectively in terms of the way we've managed it—we still, as we stand now, have made great progress and really feel we're very competitive with our colleagues in the U.S.

The Chair: Thank you, Mr. Wright.

Did you have something to say, Mr. Desautels?

Mr. Denis Desautels: Very briefly, Mr. Chair.

[Translation]

I'd like to comment on the problem raised by Mr. Perron, one that is to a large degree an administrative problem. In our chapter, we emphasize the importance of clarifying as much as possible eligibility rules and criteria so that there is as little uncertainty as possible for the people who may claim these tax credits. Therefore, it's important for everyone, and in particular for SMEs, to have relatively clear rules to avoid uncertainty over program administration procedures.

Thank you, Mr. Chairman.

[English]

The Chair: Thank you, Mr. Desautels.

We're going to turn to Mr. Richardson, but I understand the first one or two minutes are going to be used by Ms. Phinney.

Ms. Beth Phinney (Hamilton Mountain, Lib.): Yes. This question was answered right near the end, but I'd like it to be repeated because I didn't get it all down.

In speaking of the percentage of the applications, you referred to 90% and 70%. Could you just repeat that part of your answer, please?

Mr. William Baker: Sure. In a given year we receive 11,000 or 12,000. Of the claims we receive, 90% are for tax credits—this is altogether—and are approved in whole or in part. Just to put the “in part” in focus, when you look at the total amounts that are being requested under the SR and ED tax credit, after we've completed our analysis, scientific and financial, we end up allowing 70% of the amounts that are requested.

This is not only an indication of the amount of money that's going out, but it's a pretty good indication of the progress we've made in achieving compliance on the part of claimants with the requirements of the program.

Ms. Beth Phinney: Thank you very much.

The Chair: Mr. Richardson.

Mr. John Richardson (Perth—Middlesex, Lib.): Thank you very much, Mr. Chairman.

I found it a very interesting combination here today of the Auditor General and the Canada Customs and Revenue Agency. Today is the first time I've faced the group, and it's quite a broad description of the operation, so I was pleased to get that at this stage in our work on the committee.

I was struck by a couple of the figures that were put forward that showed rather impressive results in the CCRA over the past year. I wondered whether that was a blip in its improvement, or was this an on-track improvement that was planned and executed by the CCRA? Could you answer that question?

Mr. Rob Wright: Can I talk about that for a half-hour? No.

The Chair: A yes or no would be fine.

Mr. Rob Wright: No, obviously we were very challenged in 1994. As I mentioned earlier, following the AG's report in 1994 we, with Finance, worked on a full assessment of the program and identified some problems. It was our minister of the day, the Honourable Herb Dhaliwal, who organized a conference with stakeholders, who were also demanding administrative improvements for clarity in the guidelines, which was raised by Mr. Perron.

So we had this conference, people determined that we had to make some improvements urgently, and there was a strong consensus to work together. We actually agreed to work this joint action committee, which is co-chaired with Norine here.

Who's the private sector participant?

• 1630

Ms. Norine Heselton (Director General, Scientific Research and Experimental Development Directorate, Verification, Enforcement and Compliance Research Branch, Canada Customs and Revenue Agency): The private sector co-chair is John Mann, the director of engineering for DaimlerChrysler.

Mr. Rob Wright: So they agreed on a specific plan of action, a 13-point plan that we must carry out to improve the administration of this program, to get over the hump of that bulge of activities and get going. We're making good progress. The numbers reflect that, and I'm really encouraged when Phil Feely talks about the mood of our people across the country as well. We're sensing we're getting over this. We're starting to make some real results; we're seeing some good results.

It's a product of a collaborative effort with the private sector, but it's not a quick fix. It takes sustained effort and hard work and great cooperation with the private sector.

Mr. John Richardson: You can certainly see that. For our public accounts committee, this would be a major focus because this is a major play you have before us today; it's probably the biggest play we have. It started out where we were and where you are, and that part showed some real growth and improvement in the operations.

I would just say we appreciate that kind of work, that you have to sweat to get something out of it, and that this does not come overnight with an organization as big as yours. This is a huge organization by any standard. I would just say that kind of work and that accountability, the matrix that goes with it, certainly put a little polish on the image of CCRA, and I want to congratulate you for that.

Other than that, I just look forward to hearing you when you come back again, and I hope the improvement is there. If it's sustainable, the Canadian public will be the winners in all of this, and I thank you very much.

The Chair: Thank you, Mr. Richardson. Of course, if they come back again, it may be because there's another problem, but we'll leave that for another day.

Ms. Phinney, I understand there are just over three minutes left of Mr. Richardson's time. Do you want to use that?

Ms. Beth Phinney: Yes. You mentioned you had a conference with the stakeholders in 1998, and I think this is an ongoing process. I just wondered how the industry has reacted to the comments by the Auditor General in his criticism of the SR and ED credits, and do they feel it's a fair assessment or not?

Mr. Rob Wright: Thank you, Ms. Phinney. I think they think the AG gave us a fair assessment on 1994, that they themselves were highly critical of our administration and really wanted us to get our act together with them and improve it. I guess where they would differ with the AG, and I don't know if they've talked to him directly, is that we have, as I pointed out at the outset, been working on this with the industry for two years.

I think the best way for me to respond to you, Ms. Phinney, is to turn it over to Norine Heselton, who's with us on executive interchange from the private sector and is co-chairing this action implementation group. She can talk about the collaboration we're getting there with industry.

Perhaps I should let you say a few words about that, Norine.

Ms. Norine Heselton: I would be happy to. Thank you.

As a result of the June 1998 conference, an action plan was released in November and that's the action plan we've committed to implementing by the end of December 2000. Very quickly on the heels of that conference, in fact in September of 1998, an action plan steering committee was struck. This is a partnership of people like myself and my management team from the CCRA, as well as technical people familiar with the SR and ED program in industry, like the chair, John Mann, who has hands-on experience.

That committee's been meeting regularly—in fact, over the course of time since I've been with the agency, since January 1999, on a monthly basis. These are all people with day jobs, but they're prepared to invest a great deal of valuable time in helping us fix the administration of the program. I'd also like to have on the record my gratitude to them for the effort they're putting into this. It's showing real results. You can see from the statistics that Mr. Wright and Mr. Baker were talking about, we are making progress, and we're doing it through that partnership.

Ms. Beth Phinney: Could you answer the question about how they reacted to the Auditor General's report?

• 1635

Ms. Norine Heselton: As Mr. Wright said, they recognize that the Auditor General's report focused on a period several years ago and do not agree with the findings if you extrapolate them to what they see is happening today and the work they know we're doing.

Ms. Beth Phinney: Thank you.

The Chair: Mr. Desautels, you wanted to say something?

Mr. Denis Desautels: Yes, Mr. Chairman.

We ourselves had a look at the submission to the committee from the industry, from CATA, and I might characterize the reaction of the industry as saying they agreed with most of the points we raised. They did take exception to two or three of our remarks. They also said we looked at the past and not the future, and I do take exception to that, because—

A voice: I agree with you.

Mr. Denis Desautels: —we carried out our work up until the very last moment when we finalized this report in early 2000. So the facts and figures we report in here are indeed quite reflective of the situation as we knew it just a few months ago. So it's not something that reflects 1994, but in our view it reflects the end of 1999 and early 2000.

The industry did make some other comments about the desirability of clarifying the legislation, which I personally find a little surprising, because I think it's better to bring about more clarification of the rules and regulations around these incentives, as opposed to having a system where you have to rely on different independent opinions to negotiate the final merits of a particular project.

But if you wish, Mr. Chairman, Mr. Minto could elaborate a little bit on the currency of the information we have in our chapter, particularly on the backlog and so on.

The Chair: Make it a brief comment, Mr. Minto.

Mr. Shahid Minto (Assistant Auditor General, Office of the Auditor General of Canada): Thank you, Mr. Chairman.

It's true that a lot of the work dealt with the past, but our recommendations dealt with the future, and we brought it right up to date. Just to put in context the past that we're talking about, in the last five years the CCRA has granted over $6 billion in tax credits to 11,000 corporations. So the past is not insignificant. It's a huge past.

When we looked at it on March 31, 1999, the agency had an inventory of 7,680 outstanding claims dating back to 1985. I'm referring to paragraph 6.59 of the English version of the report. This involved backlog for $5 billion of claims. This is today. This is the audit of March 31, 1999, we're looking at.

When we looked at how far back they had gone in doing their audits, we looked at 25 claims of the 100 biggest corporations, and we found the audits they had done were for 1988 to 1993. So how people are filing today we can't say, because they haven't been audited.

There's a backlog. There are disputes that have been carried forward. A lot of people in telecommunications, as we say in the chapter, are still filing as is. This is not the past we're talking about.

The Chair: If I could just interject, what you're saying is CCRA are taking these basically on a first come, first served basis. They're still trying to deal with the backlog, so the current applications still aren't even being looked at.

Mr. Shahid Minto: No. In fairness, not at all, sir, no. That's not what we're saying. What we're saying is the past is still part of the problem for the present and for the future, because a lot of the files are termed unworkable, awaiting decisions on the past.

The Chair: Oh, they're unworkable today because you haven't decided on the previous files?

Mr. Shahid Minto: That's right.

Mr. Rob Wright: I think we may have a real discussion here, Mr. Chairman, because I do take exception to that.

I don't support everything the private sector says in their comments on us, or Denis, but I think the way I posited it was correct. The focus of this analysis was on how we didn't handle as well as we should have the bulge. There are lessons in that for what we're doing today that we can apply. We have accepted these recommendations. They will make us better. But I do not think this report fairly reflects the tremendous progress that has been made in the last couple of years. We had 16,000 bulge claims from 1994 that we've wrestled with for the last several years. There are 250 left that are in a formal process of appeal or questioned, which is appropriate.

• 1640

As to the raw numbers on what comes into our system, 80% of refundable claims from small and medium businesses are now approved or dealt with within the 120-day timeline we have set. That's up. That's twice as good as it was only two years ago. It's up that well because we've been focused on results.

Finally, even for the larger investments from non-refundable claims, we're up to almost 70% that are done within the targets we've set. So we have made strides.

I don't dispute the observations on the problems we've had. I do not dispute that we have not finished the job we have started. But what this report does not fully recognize, and perhaps wasn't intended to, is the dimension of the work we have underway with the private sector, the progress we are making, and our determination to see it through.

Again, I can understand some of the concerns Mr. Desautels may have about some comments, but that is one aspect. While we accept this report, I think it's fair to say it does not fully reflect that we are getting improved results in our collaborative efforts, sir.

The Chair: Okay. Thank you, Mr. Wright.

Mr. Mayfield for four minutes, please. We're on the second round, so it will be four minutes.

Mr. Philip Mayfield: Thank you very much, Mr. Chairman.

I'd just like to continue discussing the value of this program, and I'm not discrediting the value of the program. It would seem this tax credit program is extremely generous when compared to other developed countries, and yet when you look at the total spending on research and development in relation to our GDP, it is pretty low. I'm wondering if you have an explanation for that. This would be to the Finance people.

Mr. Paul Berg-Dick: Again, it's important to put those numbers into context. Our economy is somewhat different from other countries' economies, which may explain part of that.

Rather than just looking at the level in terms of our percentage of the GNP that is invested in R and D, it's also important to look at the trend. In other words, have we been increasing R and D slower or faster than our counterparts? When we look at it on that basis, we see that vis-à-vis all of the other G-7 countries, we've been growing our R and D effort faster than they have. So in some sense that's an indication that the program that's been in place here is having some results. That doesn't mean it's not going to take some time, but it does mean at least the direction is appropriate.

Mr. Philip Mayfield: Could you explain what you meant by saying we're growing our research and development faster? It seems to me in the total context, if you get a tax credit, you'll probably get on with it, but if you don't get a tax credit, it may lie fallow.

I was thinking of Mr. Perron's comment that people have given up because of the administrative difficulties of getting the claims through. Is there a problem here where perhaps you not only encourage some, but you discourage others? What would be the reason for the discrepancy between the high numbers of tax credits and the low numbers compared to the GDP, compared to other countries?

Mr. Paul Berg-Dick: Just to put it another way, what's happening is we're starting to close the gap between, let's say, us and the United States. Ten years ago or even fourteen years ago, in 1986, the U.S. did about twice as much R and D as a percentage of GNP as Canada. That's been dropping, and it's now dropped to 1.7. So if that trend continues, we'll start to see in relative terms.... We're still below, and we understand that, but we're starting to make some progress.

At the same time, it's important to see what our overall corporate tax structure looks like. It's a combination of not only R and D incentives but also corporate tax structure. Some of the changes that were introduced in the budget, coupled with the R and D credits, bode very well for Canada to increase its R and D as well as other activities.

There are particular issues, as Mr. Perron has said, but they also have to be put into the context, as Mr. Wright has indicated, of how we can improve the administration, how we can work with small businesses in the special programs to make sure they know beforehand what qualifies and what doesn't qualify. There's a role for the policymakers to make sure, in the context of the law and the regulations, that is also as clear as possible.

• 1645

Mr. Philip Mayfield: What would be the effect of research done by universities or supported by foundations or other things, instead of by businesses themselves, or through stimulation by tax credits from the government? Is there a potential there that's not being used?

Mr. Paul Berg-Dick: I think that forms a very important counterpart to the tax credits for industrial research and some of the programs that are in place to help the infrastructure at universities, to provide better research facilities. In other words, it's a combination of providing assistance to industry and working with industry together with universities in a partnership that can best develop the synergy required to build the overall level of R and D in Canada.

Certainly, vis-à-vis the U.S. government, we do a lot less R and D directly funded, so that's one reason why our numbers are below. So that overall level is a combination of what universities do, what industry does, and what governments do in the context of the National Research Council, say.

Mr. Philip Mayfield: It's not only the U.S., but most other G-7 countries too.

The Chair: Thank you very much, Mr. Berg-Dick.

Mr. Harb is next for four minutes, please.

Mr. Mac Harb: I think it is fair to say we are still playing catch-up with the United States, as well as with other countries. Unless we're all on a level playing field, we still have a role, as the government, to continue with the program.

I think we have two issues here: whether the program is a valid one, a good one, a needed one; and the administration of it. So on the issue of whether the program is a good and valid one, I think facts speak louder than words. Our private sector does not invest in research and development as much as other private sectors and other G-7 countries.

Second, other G-7 countries give more incentives than we do, so as a result we need a program like the one we have here. Is that correct? Then we can catch up and provide the incentives so our private sector can invest more in the future.

The Chair: Are you addressing your question to Mr. Berg-Dick?

Mr. Mac Harb: Yes.

Mr. Paul Berg-Dick: Again to clarify, in terms of the actual tax incentives, Canada has the most generous regime within the G-7 and among the OECD countries. Other countries have research programs of the government funded by industry, but that's very different because they're directed in a particular area, as opposed to allowing industry to determine exactly what kinds of activities in their research programs would most benefit their particular enterprise.

Mr. Mac Harb: Thank you very much.

I don't think we have a disagreement here, at least from what I've heard from Mr. Wright and Mr. Desautels. I think both of you are saying the same thing. The problem happened in 1994, and at the very same time we cut every government department program. It was also the time when the department of revenue was looking at moving from a department to an agency. Is that correct, Mr. Wright?

Mr. Rob Wright: It was actually before that, sir. I'd like to think it was not really associated with that. It was a problem and we're a large organization, so when there's a problem it's a large problem. It was a huge challenge.

Mr. Mac Harb: How long did it take you to deal with the 16,000 applications and bring them down to 250?

Mr. Rob Wright: It took us this long; it took five years.

Mr. William Baker: That's right.

Mr. Mac Harb: Now that you're on top of it, you are confident there will be no problems because you won't have the kind of backlog you had before.

Mr. Rob Wright: We are confident we will fully implement this action plan that the industry and our ministers have fully endorsed. In fact, Mr. Cauchon has committed himself to getting that done and is regularly urging us to make sure we get it done.

With that, we feel we'll be able to deal with some of the very important points Mr. Desautels has made and get the results on a regularized basis. Again, this is a very important incentive program for Canadian business, and it's only going to be fully effective if we administer it properly. There's a lot for us to improve on.

• 1650

Mr. Mac Harb: But for as long as we have the program, we are going to have the challenge of determining whether or not this is research that will qualify or not.

Norine is probably in a good position to tell us about the different challenges you are facing in trying to determine whether or not an application really qualifies. It's not absolutely a perfect science, even though it is research in the science area. Are those some of the challenges the agencies face from time to time?

Ms. Norine Heselton: From time to time, yes, certainly.

Mr. Mac Harb: Is that the biggest challenge?

Ms. Norine Heselton: It's not black and white. But through the partnership we have with industry, we're coming to a better understanding—we in headquarters and our people across the country—of what it means to do research and development in an industrial context. That's where a lot of the raging debate had its origins. It's a matter of understanding how industry goes about its business, and they're helping us with that.

Mr. Mac Harb: I guess it would be very difficult, for example, for an ABC Canada Inc. to go first to Revenue Canada and say, “Look, I'm planning to do research and development of this product. Do I quality or not?” It's almost as if you are approving something before you proceed. If you tell them they qualify, then you're almost giving them a carte blanche and you have no control over what takes place—whether or not all of those components are met and complied with.

Is that one of the difficulties you are faced with? What do you do in a situation like that? Is that something you look at?

Ms. Norine Heselton: You've just given a very good summary description of a service we just introduced called pre-claim project review, where a company of any size can come to the Canada Customs and Revenue Agency, the SR and ED program, whether they've started the research and development, it's in process, or they just haven't filed their claim yet. They can sit down with our technical experts and say, “I am doing or thinking of doing this. If I do, what does it mean in terms of whether or not the work is eligible?” We will give a preliminary opinion. Then when the claim is filed, it will do a couple of things. It will expedite the process because the conversation will have happened much earlier in the process. Additionally, if the claim is reviewed, the nature of the review should change, because we already know what the claimant was planning to do. As long as that is conducted, it should be axiomatic.

The Chair: Thank you very much, Ms. Heselton.

[Translation]

You have four minutes, Ms. Jennings.

Ms. Marlene Jennings (Notre-Dame-de-Grâce—Lachine, Lib.): I apologize for missing your presentations. However, I did read the documents you submitted, along with the AG's report. I was quite interested in the action plan put forward by the Agency eighteen months ago, that is in November 1998, and I would like to go over with you each of the action plan's 13 components so that we can get an idea of the measures that have already been taken.

Mr. Rob Wright: Thank you. The first step was to establish a scientific research and experimental development directorate and to hire a dynamic leader from the private sector, Ms. Heselton.

[English]

I'll have her summarize what she has done in implementing this plan at that new job.

Ms. Norine Heselton: It's been an interesting 18 months.

Ms. Marlene Jennings: We only have four minutes and there are 13 points.

Ms. Norine Heselton: Mr. Wright indicated we have a new structure in headquarters in the field. The importance of that is not the organization chart, but the fact that it creates a self-contained national program focused on this incentive program and not doing other things.

The steering committee, as I indicated earlier, has been active since September 1998. We now have 12 sector-specific committees that are working on this business and industrial context for the individual sector.

Ms. Marlene Jennings: Who sits on that steering committee?

Ms. Norine Heselton: The steering committee is populated by 10 representatives from the private sector, my senior management team and me from the CCRA, or subject area experts as we need them.

Ms. Marlene Jennings: What are the sector-specific committees now?

• 1655

Ms. Norine Heselton: Those sector-specific committees are produced by the industry sectors themselves; they're not ones for which names are put forward and the agency says yes or no. They're driven by industry. But there are 12 of them crosscutting the entire Canadian economy, and, as I say, dealing with issues that are specific to the individual sectors to resolve the clarity challenges and so on.

In terms of the fourth action, which deals with an audit process, we in fact—

Ms. Marlene Jennings: No, it's about the communications package covering the audit process. Has the communications package been developed, and is it in use?

Ms. Norine Heselton: There are two pieces to that. One is a guide to conducting an SR and ED review, and that's operationalized and reflects the culture of an incentive program and the way we will address the claimants.

The other piece is a claim review process letter, which is soon going to be accompanying every claim as we indicate that we're going to review it. That's just a hair's breadth from being operationalized.

Ms. Marlene Jennings: What about action 5, which is to develop a code of rights, obligations, and responsibilities for stakeholders?

Ms. Norine Heselton: That in fact has become part of action 4, where we've incorporated those statements into the review process letter so everybody understands.

Ms. Marlene Jennings: Can you send copies of that package to the committee, please?

Ms. Norine Heselton: I'd be happy to do so.

Ms. Marlene Jennings: Okay. Let's get to establishing a standard mechanism for dealing with informal disputes.

Ms. Norine Heselton: We've undertaken a couple of initiatives there. One is to further institutionalize something we call a “second review process”, where as early as possible in the review of the claims we will have the intervention of management to make sure the proper process is being followed and resolve any issues that arise. We want, especially in the case of small clients, to make sure they don't have to go the expensive route of lawyers and appeals and so on.

Additionally, further in the claims process, at the time the opinion has been virtually rendered, we have a pilot called “dispute resolution”, which is going to be piloted in a couple of our major centres starting in September, to, again, mitigate the need to go to the more onerous appeals process and resolve the disputes as the claim is being reviewed.

Ms. Marlene Jennings: I have one last point. It appears that most of this is in the process of being implemented or has been implemented.

Paragraph 11 of the Auditor General's presentation says:

[Translation]

11. Our first concern is the inconsistencies in the handling of the retroactive claims, which raised questions of fairness.

[English]

It appears some files received all kinds of assistance in ensuring they were in fact made eligible. The idea may have been eligible, but the documentation that accompanied the claim did not make that clear. Those companies received assistance, whereas other companies did not receive any assistance whatsoever.

Has the process you've put into place to deal with claims been standardized? It may be a great idea to help everyone, but if that's the case, is it clear to every single company that they can get that assistance?

That's one.

Second, you talked about instituting the second review. By instituting it, have you taken that extra step to ensure that everybody knows they now have the right to a second review? Because that's—

The Chair: Okay, we'll get those two points right there.

Ms. Marlene Jennings: Thank you.

Ms. Norine Heselton: In terms of your first point about people getting assistance, it's a process that has always existed, the second review. For instance—

Ms. Marlene Jennings: But it wasn't uniform.

Ms. Norine Heselton: We haven't done a very good job of promoting the fact that it was there. That's changed.

What we have now is a review process that has been operationalized, as we say. Mr. Feely is going across the country promoting the new services, explaining them, allowing the field to fully understand how they're to be implemented. Additionally, we're working closely with industry associations for a variety of sectors to help them help us get the message out as well. So it is no secret. We use our website increasingly. The second review process is there, as is the guide.

The Chair: Thank you.

Mr. Wright.

• 1700

Mr. Rob Wright: Very briefly, that whole set of actions, Ms. Jennings, deals with the essence of what the Auditor General was saying was lacking in 1994, which was clear guidelines and consistent application available to all. So we are really making progress there. It's fair to say it wasn't properly in place a few years ago. But the essence of that action plan does deal with the essence of the criticisms that we've accepted and want to deal with.

Ms. Marlene Jennings: Thank you.

The Chair: Thank you.

Mr. Minto.

Mr. Shahid Minto: Thank you, Mr. Chairman.

Mr. Chairman, we thought enough of the action plan to publish it in our report. I think the member was reading from our report. So certainly there's a lot of merit to this action plan. And at the time we concluded our audit, a lot of the committees were putting out reports. Their reactions were leading to actions and things, so we could not see any results, and therefore we have not commented on results.

But there were a couple of things of interest, for example, the second reviews you talked about. Because we raised the question in our chapter, we did have discussions with the department. And we have seen documentation that suggests they are actually going out and publicizing that now, which is something that was not done before. So when we do our regular follow-up, obviously we will look at all of these things. But we were impressed with this action plan. There are some parts on which we suggested improvements, but, generally....

The Chair: That's good to hear. Thank you, Mr. Minto.

Mr. Mayfield.

Mr. Philip Mayfield: Thank you, again, Mr. Chairman.

There were a couple of problems that were noted in the report. One of them was that there were different decisions in different parts of the agency. Has that difficulty been overcome so that the agency pretty well speaks with one voice now?

Mr. Rob Wright: Yes, sir. I believe what we have in a program like this is a need for national leadership when we establish a standard process. We have a functional model where we try to coordinate—and we do coordinate very well—in terms of what happens in the field, but we also make sure, in terms of consistent application, that there is an oversight at headquarters that's meaningful.

This does mean that on occasion files are referred to headquarters for review. In some cases, the headquarters' view, because of the expertise and other judgments, overturns the decision in the field. This is the way we work. People understand how we work. We do have established processes to deal with legitimate professional differences of view. There are 16,000 bulge files; there were 100 detailed files examined. One case was identified where, I regret to acknowledge, professional differences grew to an unprofessional extent.

Mr. Baker has given it a very strong order of priority of his own time to make sure that all involved understand who's doing what and what the natural processes are, and can help us get over this. I think we're making progress on that one file, and we are using it as an example to communicate to all of our people how we have to recognize and respect each other's views and follow due process to clear these up.

Bill, do you want to comment in any way?

Mr. William Baker: Just to say that in the nature of the work we do in the agency, and the fact that we hire professionals, we are going to get differences of view on a particular file. I think that's a healthy outcome, frankly. It allows us to compare notes, exchange ideas, with a view to trying to get the best decision at the end of the day. There's toing and froing, and this is par for the course.

In this one case, as the commissioner identified, the toing and froing wasn't resolved in as positive a way as we would have liked. We've been investing a considerable amount of time with the office affected to work through that issue and make sure we've learned from that experience so it doesn't happen again.

I think we should just point out, though, as Mr. Wright pointed out, when you look at all the files we've handled and the number that were examined by the Auditor General, we were heartened that there weren't more cases like this. It's an isolated case, but one is too many.

Mr. Philip Mayfield: Yes. I'm sorry to rush you, but I want to get to the finance people, because there's also a problem with finance and telecommunications industries.

I'm wondering if the dispute with them has been resolved. What strategies are being developed or are in place for resolving this? Could you comment on that, please?

Mr. Len Farber: I think, as indicated in my opening comments, the strategy is really one that was originally identified as a problem in the Auditor General's report. We certainly mentioned it in the budget papers in the context of issues with regard to internal-use computer software and management information systems. We are in the process of developing a paper that we will use for consultation across the country with both technical experts in the R and D field as well as with a number of different companies, to see whether or not there is some legislative framework that can better be developed, other than what is there now, in terms of the guidelines that are being applied in order to ensure that there's ease of compliance, in order to ensure, as we heard earlier about some of the problems that certain taxpayers are facing, that there's some clear delineation as to what would and would not qualify.

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I think the essence is that for a large number of companies whose main function is research and development, there are not a lot of problems. Companies that have a track record have an easier ability to get their claims filed and have an easier ability to receive the refundable credits because of that track record, and as we've heard from Revenue Canada, those are turned around fairly quickly.

For those companies whose core business is not research and development, it's that aspect of what they are doing in terms of the research that they have more difficulty with. That is where we want to concentrate some effort, to see whether a consultative process across the country can come up with a better approach or some better wording that would provide the necessary guidelines to facilitate what we're talking about.

Mr. Philip Mayfield: Thank you, sir.

The Chair: Thank you, Mr. Farber and Mr. Mayfield.

Mr. Harb, you said you wanted some more time.

Mr. Mac Harb: Actually, my question is a little bit removed from the subject. It's to Mr. Wright.

You have gone through reorganization now, and you've been in operation as an agency for over a year. Maybe you can provide an overview in terms of the staffing in particular, because I know you had a major problem with professionals. Like the Auditor General, like the people in the financial institutions or the Department of Finance, you hire the professionals and a few months later somebody from the private sector snaps them up. Here we go; they're gone. Could you give a little bit of an overview in terms of what's happening now and how that is going?

Mr. Rob Wright: Sure. It has been actually seven months, Mr. Harb, and it has been a challenge.

We've made some very important changes. We have a board of management, which is fully engaged. It's an excellent board. It's focusing on the management policies that can help us be more effective, and one of the things they approved on day one was withdrawal from the broader government staffing system, a system that the Auditor General is outside of as well and has had some very sound observations on, on some of the challenges in that system.

We have yet to implement fully an operational system for ourselves, but anecdotally, as one of the things we've done to try to deal with the problem we've had on accounts receivable, we've hired 400 additional collectors this year. In a process that would have taken a year, we had, from notice to having bums on chairs, 33 days, which is extraordinary. We've had tremendous success in our staffing programs for temporary hirings in the field, and we're really pleased with how it's going. We're not there yet, but we're really pleased with that.

As to other things we've been working on, our board is engaged, and again, as the chairman was warming us up before this session started, the importance is not just what's examined but knowing that there is an examination.

So our board is providing a lot of rigour in our planning. We have a much better planning process with our minister and our board, and we're seeing some real results. We've also been able to focus on some real achievements in our program this year. There are major changes in the framework affecting our customs program. We've really turned around the client service program this year, but I must say I can't say the agency has credit for that. It has been a four-year struggle.

I was mentioning to the chairman at the outset that when I arrived to this job from New Zealand, it was a terrifying year. We were answering about 25% of the calls made, and even less than that in the height of tax time. The Auditor General remarked on some of the progress we've been making, but it's so slow. You put on some more resources, some more technology, and more calls come in. We have 30 million phone calls a year seeking assistance on matters of some complexity. But this year, finally, after four hard years, we're answering over 95% of the phone call inquiries to our offices, thanks to the men and women across the country.

I think the thing that encourages me about this SR and ED program where we've taken our lumps is the determination to make a difference. We're already getting some feedback from the field that it's a better place to work because you're working with clients who know they're going to get served more appropriately, and we want to stay on that track. The agency will help us do that, but overall it's too early to claim big wins there.

Mr. Mac Harb: My second and final question is very small. You can take your time in telling us about it, but I can take only a couple of seconds to ask you.

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Part of your mandate was to try to see if you could do some collections or some joint effort with the provincial government, as well as with some of the other agencies in Canada. How far have you gone on that front, and what sort of cooperation are you getting at that level?

Mr. Rob Wright: There's a great deal of interest among provincial governments for the service we provide. We already collect over 70% of provincial revenues, and up to 95% of revenues certainly in Atlantic Canada.

Every year, we get asked to do some additional business. This year, we got some additional work from the Nova Scotia Workers' Compensation Board. The B.C. Workers' Compensation Board is interested in us collecting payroll deductions. Again, that saves governments money, but also companies, who only have to deal with one set of taxers. Although we're popular, it's probably better not to have more than two or three around. So that has gone really very well.

The biggest issue for us with the provinces is the tax on income initiative. It's a major tax policy reform that Minister Martin announced about two and a half years ago. We originally thought we would have three or four provinces for tax year 2002. Moving to a tax on income, we now have nine provinces interested in that, and we're doing it this year. So that's a big challenge.

The Chair: Thank you, Mr. Wright.

Mr. Mayfield, you said you had one more question.

Mr. Philip Mayfield: Yes, I do. I hope I haven't cut you off.

The Chair: No. I'm next.

Mr. Philip Mayfield: Good.

Mr. Wright, to you and your officials, I believe you've been working on risk assessment. Can you tell us briefly about the initiatives you've taken with regard to that? Do you have an action plan, an implementation timetable, and that kind of stuff?

Mr. Rob Wright: We do. That's a very good question, sir.

In our business, we have an excellent framework for using risk assessment, and as the Auditor General has pointed out, there's scope to apply it more rigorously. We are making some important strides in this area, and I'll let Mr. Baker talk about that.

Mr. William Baker: We have quite a suite of actions that we have put in place over the last while to address risk.

First of all, I think it's important to realize that we're not starting with nothing. The Income Tax Act defines the type of work that's eligible for the SR and ED tax credit. It's expanded upon in the regulations, and we have information circulars.

We have been making some significant investments in risk management over the last while, because risk management is the core of our business. We have a limited resource and we have to use it wisely.

Through analysis we're undertaking, we're able to focus really on two things. What is it about the claim that should prompt us to take a close look if there are problems? It could be the nature of a sector it's involved in, or whatever. And what is the nature of the claimant? Is it a new claimant? Is there a pattern of compliance or non-compliance? Through this, we develop risk models that we provide to our field staff to allow them to target their energies.

We have a risk research function within the agency as well that develops insight as to what motivates and compels people to comply or not, which we apply here.

Through Norine and her team, we've done some excellent additional training. We've been beefing up both our scientific and financial capacity to manage risk. We believe we have one of the world's best risk management approaches for administering an R and D tax incentive program, and I'm quite confident we can do that well.

Mr. Philip Mayfield: Mr. Baker, I appreciate your knowledge and your enthusiasm in describing that. I wonder if you have any—

The Chair: I thought you had one question, Mr. Mayfield.

Mr. Philip Mayfield: This is a request, not a question.

The Chair: Okay.

Mr. Philip Mayfield: I wonder if you have anything you could send to the committee that would be of interest to our researchers in discussing this program as they put together a report on our discussion here, something of your timetable, your implementation.

Mr. William Baker: Certainly. We'd be pleased to provide additional information on risk management to the committee.

Mr. Philip Mayfield: If you would, that would be lovely.

Mr. William Baker: It would be our pleasure.

Mr. Philip Mayfield: Thank you very much.

Thank you, Mr. Chairman.

The Chair: Thank you, Mr. Mayfield.

I have a question, gentlemen.

I'm referring to paragraph 6.39 of the Auditor General's report, where the staff at the tax services office spent over 10,000 hours on the audit and $300,000 on a science report. They turned the application down, went to the head office, and the agency's head office spent another $300,000 on a second science report.

In the interest of fairness—and the Auditor General raised that in his opening statement in chapter 11, where some cases were almost rejected out of hand, and then you spent $600,000 of outside money, 10,000 hours, getting involved in somebody's claim. Where is the fairness?

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Mr. Rob Wright: I should say that we don't just flip a coin to see whether we do that. Obviously, the whole essence of a science study is making a judgment on what the science is.

The Chair: Yes, but 10,000 hours of internal work plus $300,000 and the answer was no. That's a fairly significant investment. That would have been an intelligent decision, I presume, an informed decision, to come to the answer no. Then you spend another $300,000 to, in essence, reverse it.

Mr. Rob Wright: Again, the $300,000 relates to a science review, and in some cases our science review has given us the confidence to say no and stick to no. In other cases, we do a science review that is disputed quite intensely by someone else and we have to decide who's right. In a number of cases—and this is a point the AG made—we have chosen in some areas that it was appropriate to get a third view. The point you're making is, did we consistently apply that process in 1994? It wasn't a consistent policy. That's a fair point. That's why we're doing it now.

The Chair: And the Auditor General says they denied most of the claim because of the lack of substantiation by the taxpayer. Right, Mr. Desautels? Those are your words?

Mr. Denis Desautels: Yes, that's right.

The Chair: I think about a client, a constituent of mine, who had an SR and ED claim where he wasn't aware that he had to break out the costs. He had his costs, he had his expenses, he had his financial statements, he had his income expense report, but he hadn't broken out his SR and ED so he could clearly identify that he spent that on SR and ED, even though he could prove that he had spent all that money in a normal revenue expenditure. He was denied because he couldn't prove beyond a shadow of a doubt that this, and this amount only, was spent on SR and ED. Now we're saying that through lack of substantiation you're prepared to invest that kind of money?

Mr. Rob Wright: I think that's an unfair extension of the case you're talking about, but perhaps I'll let Mr. Baker respond.

Mr. William Baker: If I might say a couple of things, first of all, the case that is being alluded to in the chapter refers to an extremely large, complex case involving almost a decade of claims. It was one of those that came in during the 1994 timeframe.

We do not establish a budget amount of administrative time that we're going to put into a particular case; it's driven by the merits of the case, the nature of the documentation, and the complexity of the science. We'll make the investments that we think are necessary to try to arrive at a fair outcome.

I think, Mr. Chairman, it would be a mistake to think we would not do exactly the same thing for a smaller claimant. I'm not disputing that you may be aware of a claim where this did not happen, and I'm sure we could find claims where it did happen, and in fact the very first part of the Auditor General's report referred to the fact that it happens in some cases and not in others. We can be more consistent in the nature of the support we provide to companies seeking this SR and ED tax credit, and indeed I think we've already responded to the committee on some of the efforts we're making.

The Chair: It was certainly very disappointing for my constituent, and it was disappointing for me who went to bat for him. And he had gone through old documentation. He had to produce his trial and effort creations that he had thrown away; he dug them out of the garbage as best he could. He had physical evidence of the work he had done, but he couldn't on paper say he spent a hundred hours here, a hundred hours there, and a hundred hours somewhere else. Therefore, his claim was denied. Now we find here, because of lack of substantiation, you're prepared to invest big amounts of money, and because it was a large client, a complex thing and so on, he got the attention that my constituent didn't.

I refer back to the Auditor General's point on fairness, and I can't overemphasize—and I'm sure you'll agree—that fairness is the underpinning of the Income Tax Act, and voluntary compliance. I have one constituent who is not very happy. He doesn't see your agency in a good light. And then we see this.

I want to turn to Mr. Farber. I think it's on the same situation where—and I use the term subcontractor or general contractor—for the exact same SR and ED the subcontractor got the credit. When he sold it upstairs to the general contractor, he was able to claim the same amount. I understand the legislation has since been changed to deny double claiming, but how did it happen in the first place that we allowed double claims?

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Mr. Mac Harb: It was a grey area, John.

The Chair: No, it wasn't grey; it was black and white.

Mr. Len Farber: You're right, Mr. Chairman. That was a loophole within the legislation at that time. It was changed. How did that happen? The whole R and D community has been growing quite exponentially over time, and as we continued to monitor the situation and we saw certain situations that had developed with regard to claims for the same R and D, we moved as quickly as it came to our attention. And we did stop that.

You are right. We took the corrective action as soon as that information came to our attention.

The Chair: This is more for my own edification. This R and D tax credit, is that a refundable or a non-refundable tax credit? Does it come off taxes payable or can a person get a cheque in the mail if they have tax losses? Is it refundable or non-refundable?

Mr. Len Farber: It is refundable, Mr. Chairman. For small business it's 100% refundable with regard to current SR and ED expenditures and it's 40% refundable on capital R and D expenditures. Depending on what the track record is of the particular R and D claimant, that refundability can arise within the timeframes the commissioner and the assistant commissioner indicated to the committee earlier.

The Chair: I presume, and I haven't followed everything up to date, that you have issued clear and specific guidelines, Mr. Wright, to accountants and to any business claiming an SR and ED tax credit, that this is how you have to break out your costs, these are the kinds of records you have to support, and in the absence of being able to support your claim, it will be denied for lack of substantiation. Is that your policy now?

Mr. William Baker: We've done a couple of things, Mr. Chairman. First of all, we have issued clear guidelines for documentation requirements. That's quite recent. In fact, it was tabled in January of 2000 at the conference and it's now in general use. It is intended to be a tool to business so they can get it right the first time.

We recognize the compliance cost this imposes on business and we're trying to make that as simple as possible.

The second thing we've done, which was alluded to earlier, is we've issued guidelines on how a business can go about seeking a second review if they're not satisfied with the outcome of the first process. I should also reinforce in members that in the Canada Customs and Revenue Agency, even after a second review, if one were to take place, any claimant has the right to seek an independent review through our appeals branch. We can handle 93% of disputes administratively. And then of course there's access to the Tax Court of Canada, where you can get further deliberation by the courts. I think we have a very complete process to deal with that.

We still have work to do in getting the communication message out, particularly to smaller agencies. We're involved in a whole range of outreach activities right now to do that.

The Chair: One final question. Can you confirm that you're now into assessing returns rather than assisting people in helping to file returns? Again, while you want to maintain a good rapport with the taxpayer, I don't think you should be helping some fill in a form or make an application, although it may be detailed and complex, while others are left to their own devices to file. I think you clearly have to see yourself as a tax collector assessing applications, and we won't have any more of this participation, helping people to get through the paper work and the hoops and so on. Is that right?

Mr. Rob Wright: I would ask Bill to comment, but first I would say that a key part of what we're doing in partnership with industry is to make sure the stakeholders and the industry themselves help identify the obligations on the stakeholders and help communicate it with us.

Bill, do you want to comment?

Mr. William Baker: For the record, sir, we've never prepared an SR and ED tax claim on behalf of a taxpayer. That would be completely in discordance with our policy. What we will do is assist a claimant, particularly a small claimant who has not very much experience, on how to go about getting it done so that person could benefit from the program, which, we should keep in mind, is intended to be an incentive for those very people.

The Chair: How do you feel about that, Mr. Desautels, where they assist some and not others?

Mr. Denis Desautels: Mr. Chairman, we raised the issue of fairness because we felt that some taxpayers did not get the same degree of cooperation and assistance from the agency. I'm not against the agency facilitating compliance with legislation. I think they have a lot of good programs that are aimed at that. I think they have to be made available and made known to all taxpayers, so that if they wish they can avail themselves of some kind of guidance from Revenue Canada.

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So I think facilitation is a good thing generally and it facilitates compliance. I think we should encourage that, but it should be done in a way that's available and known to be available to everybody.

The Chair: Thank you, everybody. It's getting close to wrap-up time, so we'll now have closing comments by the Auditor General.

Mr. Denis Desautels: Thank you, Mr. Chairman.

I think that both the Customs and Revenue Agency and the Department of Finance are fully aware of the challenges this program faces. They've both stated their intentions for the future. Hopefully, when we revisit this audit in our regular follow-up, these intentions will have been turned into clear results.

I'd like to say three things quickly, Mr. Chairman, about the future. First of all, I think it's truly important that the rules provide taxpayers with as much certainty as possible. In a tax program, which this is, we do not normally evaluate for merit like we do for a grant program. It's essentially a statutory entitlement. If you meet the rules, you receive the benefits.

In principle in a tax program, the taxpayer must be able to self-assess and voluntarily comply. The taxpayer must have a reasonable certainty that he or she will be entitled to the benefits. If that's not the case, the program will not induce as much additional spending as it's intended to.

As the Department of Finance noted in its opening statement, SR and ED are not overly precise concepts. This problem requires that the program be continually monitored and fine-tuned to see that it does not stray from its policy intent. To monitor the program, we need good information. Much of that good information can be obtained from the agency's regular auditing activities.

A second point related to the future is that with respect to the outstanding disputes with financial institutions and the telecommunications companies, there is a huge amount of public money at stake. It's important that the risk in those files be mitigated, that the policy intent of the program be protected. To do otherwise, I think, would run the risk of running a big bill, a huge bill, and repeating what you might recall was the experience of the resource allowance situation that we discussed a few years ago in this committee.

A third point: Because this program, of course, has a certain cost in terms of forgone revenues for Canada that are quite significant, the Department of Finance needs to pursue program evaluations of this program, as is done with other programs. I think that's why we refer to that in our report.

I think there are questions that need to be answered as to whether or not changes can be made to this program to make it more effective and to reflect, in my view, the characteristics of the new economy. The program was initiated in 1985. The way business is carried on nowadays has changed quite a bit from 1985, so I think the occasion is right to ask whether or not the program still responds to the needs of the new economy.

Thank you, Mr. Chairman.

The Chair: Thank you, Mr. Desautels.

Ms. Beth Phinney: Since we have one minute left, maybe Mr. Wright or Mr. Baker could make a comment.

The Chair: We don't normally have it, but we're not that hard and fast on rules here, Mr. Baker, if you have a quick comment, or Mr. Wright.

Mr. Rob Wright: That's very good of you. Thank you, Mr. Chairman. I would simply like to say again that this is a very important program for Canadian industry and for Canada. We acknowledge the problems of the past and take the constructive criticism from this report to improve. I want the record to show how proud I am of the progress we've made in the last couple of years and of our women and men across the country who are really going to help turn this around.

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The Chair: We appreciate that comment, Mr. Wright. We always want to commend the people who work hard on behalf of Canada. We appreciate sometimes they're working under difficult circumstances, sometimes dealing with difficult issues that have to be applied and sometimes the taxpayers don't always see their point of view.

I think you can certainly pass on the recognition of this committee that we appreciate what they do on behalf of all our citizens.

Thank you.

The meeting is adjourned.