Consultation Regarding the Impact of Contingency Fees on the Effectiveness of the SR&ED Tax Incentive Program

Transcription

1 Consultation Regarding the Impact of Contingency Fees on the Effectiveness of the SR&ED Tax Incentive Program Thank you for the opportunity to provide input into the Government's consultation regarding the impact contingency fees may have on the SR&ED Tax Incentive Program (SR&ED Program). My submission focuses on two of the areas for which input is being sought: why firms hire third-party tax preparers on a contingency fee basis; and the impact of this practice on the effectiveness of the SR&ED Program. I recently retired from the CA Profession and at this point I am not in the SR&ED tax preparation business. However, due to my belief and extensive experience in the SR&ED Program I maintain a keen interest in its continued success. In 1986, I became one of the original CRA Headquarters SR&ED Tax Policy Officers, a position I stayed in until 1990 at which time I was seconded to the Ottawa TSO to be the SR&ED Manager for a one year period. From July 1992 until December 1993 I provided SR&ED training to all CRA staff in Canada. In January 1994, I was seconded to the Department of Finance for a two year period where I was the Senior Tax Policy Officer for the SR&ED Program working for Bill Toms and Bob Hamilton. During that time, under their direction, I led the Finance SR&ED consultations on software and contract SR&ED. In 1999, I returned to the SR&ED Program, first as the Headquarters SR&ED Manager of Operations and then as CRA's SR&ED Director of Program Administration from , reporting directly to the CRA's SR&ED Director General. In early 2004, I left the CRA to work for Ernst&Young as a Senior Manager in their National SR&ED Practice working out of Ottawa. In late 2004 I moved to Toronto to work for KPMG as a Senior Manager in KPMG's Toronto SR&ED Practice. Finally, in 2006 I returned to Ernst&Young to be the Senior Manager SR&ED in their Halifax office, a position I stayed in until 2009 at which time I retired from public practice. I trust that this summary of some of my SR&ED employment history, as well as this submission, in some way shows both my experience and belief in the SR&ED Program. As you are probably aware, this is not the first time contingency fees for the preparation of SR&ED claims have been raised as a potential issue. In fact, I believe that the first time occurred while I was on secondment to Finance. Thank you for formally addressing SR&ED contingency fees at this time. I believe that SR&ED claim preparers have been necessary to the success of the SR&ED Program. I trust you will receive significant input from others as to why these tax preparers charge contingency fees, the prevalence of this practice and the amounts charged. As stated above this submission focuses on why firms hire tax preparers and the impact of this practice on the SR&ED Program's effectiveness.. Why firms hire third-party tax preparers on a contingency fee basis? In m opinion, each of the following three Stakeholders; Claimants, Tax/Claim Preparers and the CRA play a distinct role as to why the use of contingency fees is prevalent in the SR&ED Program. Claimants

2 Once claimants decide that they may want to utilize external assistance (maybe due to; lack of expertise, lack of internal resources, to learn, bad experience in a prior claim...) they are faced with potential fee options including; fixed, hourly or contingency. Each of the fee options can appear quite imposing when you consider the hourly rates or flat fees that tax preparers have charged. In my opinion, fixed fees are the least used of these three fee structure and a topic I have not discussed further in this submission. Hourly fees can be quite significant especially when the potential audit defense is factored in. Therefore, informed claimants who chose hourly fees, basically have to be in a financially secure situation (strong cash position) and have to be fairly confident of the outcome should a CRA review occur. So if one is financially strong and believes that a CRA review/audit will be quick and conclude successfully then hourly fees may make sense. As we know there are many claimants that are not financially strong (isn't that one of the reason for these incentives?). In addition, while CRA does do many things well, providing claimants with confidence as to what a science decision might be is unfortunately not one of the them, especially where tax preparers have assisted claimants. So if a claimant is not financially strong and has decided to use external assistance, given the risk associated with a CRA review, the use of contingency fees may be almost necessary for the claimant to claim. Tax/Claim Preparers Like any service business there is a need to have clients, generate revenue and earn a profit. So first of all in this business, contingency fees is an option that is necessary to be competitive. In other words, if an SR&ED claim preparer does not offer the option of contingency fees then the number of potential clients may be significantly reduced from a business perspective.. There is no question that contingency fee rates have a very significant on the profitability of an engagement. I believe that rates should be reviewed as part of these consultations. However, contingency fee engagements have a lot more risk in terms of ever being paid so where there is the potential of increased risk should there not also be potential of higher profits? While I see the above as positive reasons to offer contingency fees there is obviously some not so positive reasons. Like someone exploring for gold, claim preparers can sell their services, roll the dice and hope that they find enough companies that result in sufficient credits being allowed to make the business viable. For example, find 100 companies to claim regardless of their eligibility, and if 50% of the amount claimed is allowed, then they will profit and thrive. It is here where I believe a concerted effort is required from CRA to focus on these situations and take the necessary punitive steps. For those claim preparers that are running a legitimate business, many of which are governed by rules of Professional Conduct, they, for the most part, will not artificially inflate claims due to the business and professional risk and because they are honest Canadian taxpayers themselves. CRA There is no doubt that the CRA does a great job of delivering many aspects of the SR&ED Program, particularly those aspect that are consistent with other programs that the CRA delivers. For this CRA should be commended and thanked for a job well done. One aspect where delivery could be better is working with claims where the taxpayer claimant has decided to exercise their rights and have taxpayer representation. In my opinion, in recent years a significant number of RTAs did not like working with external claim preparers. There is at least a perception that, as a result, many RTAs conducted a more negative CRA review process, in many

3 cases. (to be clear I lived the experience many times both while I worked for the CRA and more recently ( ) working in Industry) In situations where taxpayer claimants have decided to utilize external claim preparers I believe that CRA has contributed to the level of contingency fee engagements because of the uncertainty that will occur if a review takes place. This uncertainty is good where the claim has been inflated to generate fees but is potentially harmful in the majority of cases. The impact of this practice on the effectiveness of the SR&ED Program? One very important fact that, in my opinion, should be given significant consideration in these consultations is that many of CRA's Research and Technology Advisors (RTA's) do not like it when claimants utilize tax/claim preparers. Over the years, notwithstanding all taxpayers have the right to representation, it was not uncommon, at the commencement of a CRA SR&ED review to have heard the RTAs say something to the effect I do not want to hear from the tax preparers in the room, I only want to hear from the taxpayer and their employees. I am not going to belabour this point but I do urge that this significant problem be addressed. Another important consideration is that, in my opinion, the knowledge and expertise in industry is on par with that of the CRA, a fact that CRA S&ED staff, particularly on the science side seem to neither agree with nor even acknowledge the possibility. Therefore, in my opinion, many of the disagreements on eligibility, sometimes referred to as inflated claims, may stem from incorrect CRA science decisions. Please do not take this to think that I am saying that there are no inflated claims. I readily acknowledge that there are inflated claims, either due to a deliberate decision to claim beyond what the claim preparer knows is eligible (is this fraud?), or due to a misunderstanding and /or misinterpretation of the SR&ED Program requirements or simply due to error. Deliberate decisions to inflate claims need to be dealt with in a coordinated approach with harsh consequences something that the SR&ED Program probably has never done well. At the same time I think care needs to be exercised not to generally include disagreements between CRA and very knowledgeable claimants/preparers in the category of inflated claims. Hand in hand with contingency fees comes the perception that the result will be inflated claims because either preparers inflate to increase their potential fees or claimants want the claim inflated to increase their net payout. I acknowledge that this will be true in some cases but again these are situations where individuals make deliberate decisions to misrepresent and these situations, in my opinion, need to be dealt with accordingly in a coordinated fashion. Contingency fee engagements mean that payment for services rendered is not received from the claimant/client until the claim is accepted by CRA. An inflated claim has the distinct possibility of (i) payment never being received if CRA disallows, or (ii) payment not being received for a year or years. How long would many businesses survive if payment for services rendered is generally not received for a year, more than a year, or never? Notwithstanding the existence of fraud or misrepresentation, from a logical perspective does the inflation of claims by legitimate preparers make good business sense? Perhaps the bigger issue regarding contingency fees is the rate. I do know that a lot of time is spent in deciding on the rate to charge. The factors in the decision making process include; (i) profit, (ii) what will competitors charge, (iii) size of the claim, (iv) should their be a fee cap, (v) what can the client accept, and (vi) risk of success/failure. Personally, I am more concerned with the rate charged in

4 contingency fee arrangements than the use of said fees. However, I do wonder if there is a similar concern with engagements where there may be potentially exorbitant fees that are not contingency fees? This may seem a little out there but I truly believe that the SR&ED Program could benefit if the CRA decided to work with claim preparers, including situations where there is a contingency fee. A lot of informed thought goes into many contingency fee engagements. By informed thought I mean knowledgeable people applying the legislation in new ways. In my opinion, CRA could be looking to industry expertise to help augment the SR&ED Program. Wouldn't a good place to do that be working together to better understand and implement the legislation going forward? It is unfortunate that when a good claim is prepared there is an underlying concern that the RTA will not agree and may not work together to resolve. Unfortunately, no matter how good CRA is in its overall delivery of the SR&ED Program, in my opinion, the fact that when a RTA, one a case by case basis, makes a wrong decision the SR&ED Program fails in its ability to resolve. The second review process and the Appeals process are not appropriately designed to resolve a science matter in an SR&ED file and as result these processes have not worked particularly well from a SR&ED Program delivery perspective. I suggest that when there is significant disagreement on science matters that there be an independent body to resolve and have the final decision. In my opinion, the CRA should not be expected to deliver this program alone. It is clear to me that CRA's compliance role is key to all discussions. Perhaps one of the reasons that coordinated inflated claims remains a problem is that the SR&ED Program does not have a specialized system such as Investigations, Tax Avoidance or Contract Payment Reporting to assist in addressing the extreme cases. I am not disagreeing that problems exist and believe that compliance initiatives are part of the solutions. For discussion purposes please consider the following: CRA certification requirement or a Contract Payment Reporting system for contingency fee engagements (when rates are over say 15%?) An independent oversee committee that has the final decision before the assessment action in certain situations The establishment if a specialized team for potential fraud or misrepresentation cases I admit that while recognizing the CRA's job well done, which includes the RTAs, I have been critical of the RTAs. I fully recognize that the RTAs have a difficult job to do which I believe could be better supported by the CRA. The decisions rendered by the RTAs have more of a subjective content that most CRA decisions which in my opinion, is a big part of the problem. The Income Tax Act is administered by a system that is focused on the law based on legal rationale/discussion/conclusion. CRA SR&ED science eligibility decisions sometimes may not based in legal rationale/discussion/conclusion because of the subjectivity involved. This is perhaps the main reason why I recommend the consideration of a pre assessment action Science Dispute Resolution Oversight Committee Thank you for providing me the opportunity to once again be involved in an SR&ED Program consultation. There is no no doubt that the Consultation is on point. There are issues to address and

5 new directions to be found. I believe that most of the people that work in the SR&ED Program, both internally and externally, are working with good intentions. In my opinion, the majority of the issues, that specifically relate to this Consultation, are caused by a relatively small group. Let's not have the majority painted with the same brush. I remain passionate about the SR&ED Program and welcome opportunities to discuss and support. Thanks again! Phil Feely