Working Papers

No. 6: Measuring the Compliance Cost of Tax Expenditures: The Case of Reasearch and Development Incentives

by Sally Gunz, University of Waterloo, Alan Macnaughton, University of Waterloo, and Karen Wensley, Ernst & Young, Toronto, January 1996

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Summary

This study quantifies the compliance costs associated with the tax incentives for scientific research and experimental development (SR&ED) through a survey of companies. The main finding is that, despite the reputedly extensive financial and technical record keeping required to support an SR&ED claim, the compliance costs of SR&ED credits are quite low in aggregate — 0.7 percent of the credits claimed. Thus, it appears that the perceived low level of research and development (R&D) activity in Canada is not a result of high compliance costs associated with the SR&ED program. However, there could be some discouragement effect on R&D activity for firms with relatively low SR&ED credit claims. While the average compliance cost of SR&ED claims is less than 1 percent of the claim, firms with claims under $200 have compliance costs of 15 percent or more.

Since a large portion of federal R&D spending is also delivered through grants (24 percent for tax credits versus 17 percent for grants), this study also investigates, although to a more limited extent, the compliance costs of grants, which were also low (2 percent). In fact, for those firms receiving both grants and SR&ED credits, grants had a lower compliance cost per dollar received. However, this figure does not take into account the costs borne by unsuccessful applicants.

Since this appears to be the first study to examine the compliance costs associated with a particular tax expenditure, two findings may be of broader interest.

• While past studies have found that smaller firms incur disproportionately high compliance costs, this study suggests that, for tax expenditures, the size of the claim may be more important. Firms with small claims incur high costs, even if the firm is large.
• For some tax expenditures, compliance costs may result mainly from work required from technical and scientific employees rather than from accounting employees. In this study, about two thirds of the compliance costs are of this type. This could be a problem for smaller firms because much of the scarce time of the company principals may be diverted from the actual R&D work to tax compliance.

Working Papers