Are SR&ED tax changes another punch in the teeth for Canada’s tech sector?

Canadian governments are fond of making grand pronouncements that “technology innovation and the jobs it brings are key to future economic prosperity,” yet conversely their actions are punishing small tech companies.

How can they do this and in the next breath say that “small business is the driver of economic growth”?

Finance Minister Bill Morneau’s recent announcement that he is going to remove tax advantages for small corporations shows it’s happening again. We haven’t seen the details, but technology companies have a reason to be very nervous indeed. Governments often make flowery speeches about “small tech businesses” as the engines of innovation and job creation at the same time as their legislation, policies, and their day-to-day practices placed obstacles in the way of those same businesses. A pat on the back is followed by a punch in the teeth.

The tech sector in Canada has thousands and thousands of small corporations. They often go unnoticed, but in total they generate billions of dollars of economic activity, they develop amazing innovations and above all else, provide tens of thousands of jobs.

Last week the finance minister proposed changes, ostensibly to prevent individuals from using the corporate taxation regimes to shelter income or income split with family members. To the average member of the public, this might seem like something to applaud. If, however, you have a small tech business, it could send a shiver down your spine. What if these changes couldn’t distinguish between tax avoidance by individuals and the real needs of legitimate small businesses. Governments have a track record in this country of saying nice things about small tech businesses and doing things that cause immense damage.

For example, the Ontario government recently decided they would actively push out small providers in their procurement process. Only the largest companies could become “vendors of record” – essential for most sales to government and agencies. Those smaller providers had managed, against all odds, to win places on the previous vendor of record contracts we cut off.

Before I came to IT World Canada I left a job heading a worldwide practice for a large consulting firm. With a mortgage on my house, all my savings, and some credit card debt, I built a company that did excellent work. Despite the odds, we won a spot as a vendor of record. That alone took almost a year of work and had months of delays. That was just the start. We had to fund a massive (for our size) marketing effort just to get shortlisted by the many departments in the government. Against all odds, and with another year of hard work, we won some government work and had excellent references. But no matter how hard we worked, it was always an uphill battle.

I was constantly amazed at how blatant this prejudice against smaller firms was. On one occasion, after we had beaten a large consulting company for a contract with a ministry, the CIO candidly told me she was dismayed that her preferred choice – a large firm – had not won. Another time, we built a system for an office of one provincial agency in eight weeks and to rave reviews. Despite the support from that office, when the contract to supply all offices was announced, we didn’t even get considered. The contract was granted to a large vendor instead.

And so it went. Eventually, we just walked away from government work and stuck with the private sector. Long after I’d stepped down as head of that company, it continues to grow, create jobs and pay taxes to governments whose seeming accomplishment is to put barriers in its way.

We were lucky. We could plan our exit. I expect that many that stayed in the game and believed the government’s statement that small business was the “engine of innovation” will fold as a result. Years of hard work lost and personal investment could be lost at the stroke of a pen. Yet, you will hear certainly hear politicians in the next election extolling the virtues of the sector they just devastated.

At the federal level, the situation is equally bleak. The government proclaims the need for innovation while cutting back on programs like the Scientific Research and Experimental Development program (SR&ED). Under the previous government, the SR&ED program budget was quietly cut. Suddenly, claims that would have been once sailed through were squashed in audits. Canadian Advanced Technology Alliance (CATA) representative Russ Roberts made the case, covered by ITWC, that the government had taken more than $5 billion out of the system in the past years with little, if any public debate and certainly no legislative changes. Instead of admitting that they supported the previous government’s cuts, the new government announced an “innovation fund” that represents only a quarter of what was lost as a result of these changes, according to Roberts. Businesses that invested in good faith found themselves denied claims that, in prior years, would have been paid.

The finance minister’s recent announcement on tax changes takes the punishment to a new level.

The government is ostensibly pursuing “abuses” of the corporate tax laws which allow companies to retain earnings, distribute income amongst family members and in some cases replace direct income with capital gains taxed a lower rate. If these changes are applied in the ham-handed way that we’ve come to expect from past history, they could be more devastating than the Ontario government’s recent death blow to small tech services businesses or the stealth cuts in the SR&ED program.

One target is a practice called “dribbling” where a corporation pays out income to family members. Sounds innocuous until you realize that when we started our company, we employed my wife and two of my children at various points. For many small firms, this isn’t an option, it is a necessity The finance minister should know that. He started in his father’s firm and I presume he earned his salary.

In addition, the government is making noises about taxation of earnings retained in the business. As a small firm, we struggled to build-up reserves. In a downturn or the loss of a large customer, we could not, like a large company, turn to banks or bondholders. Nor could we simply dump our employees into the government EI system without severance or concern as large companies like Sears has recently done. In a small company loyal staff are like family. Morality aside, in a small business, it’s not just a slogan – people really are your best asset. It can take months, sometimes years to build up that asset. You don’t want to have to destroy all that work because of a short term setback in revenue. Even those firms who are doing well find it tough to borrow to expand – they need to be prudent and retain profits in the company.

These “advantages” could easily take away from small tech companies in a swift and arbitrary way that governments would never do to larger companies. But this is not a “big company versus small company” story. Large players realize that small technology companies are essential to their success. They work collaboratively with them on a day-to-day basis in a system that most Canadians don’t even know exists. It’s called the “channel.”

This invisible sector is worth billions of dollars a year in economic activity and creates tens of thousands of high-tech jobs. These companies are agile and innovative. Today’s services startup is tomorrow’s Shopify.

Governments talk a good game, but when it comes to action, they just don’t seem to get it. Despite the billions of dollars in economic activity that we create annually, the channel is often invisible to politicians and to voters. They need to realize support for this sector is a “win-win” for economic activity and for the innovation which is so integral to our future.

Take a minute. Write a note to Bill Morneau and let him know we need government to be a partner, not an unwitting opponent of innovation. Educate him on the needs of the tech sector and the channel. Tell him — we need innovation and growth. We don’t need another punch in the teeth.

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Jim Love, Chief Content Officer, IT World Canada

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Jim Love
Jim Love
I've been in IT and business for over 30 years. I worked my way up, literally from the mail room and I've done every job from mail clerk to CEO. Today I'm CIO of a great company - IT World Canada - Canada's leading ICT publisher.

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