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If you were a 
kid in the 1980’s you watched “the Racoons” on @CBC
If you were starting a company in the 1980’s you used “Scientific Research Tax Credits”.
Come learn the story of the program before SR&ED, that gave us the Racoons and cost the Government over $3B
kid in the 1980’s you watched “the Racoons” on @CBCIf you were starting a company in the 1980’s you used “Scientific Research Tax Credits”.
Come learn the story of the program before SR&ED, that gave us the Racoons and cost the
Government over $3B
In 1983, 1st Trudeau, was worried about the lack of investment in R&D in Canada. The country had just exited a recession and the deficit was growing.
But increasing R&D spending was a key plank of his strategy. The gov’t was broke, so decided to encourage private investors.
But increasing R&D spending was a key plank of his strategy. The gov’t was broke, so decided to encourage private investors.
To encourage investors they instituted “Scientific Research Tax Credit” (SRTC) which would be instituted on Jan 1 1984.
It would allow startups engaged in R&D to pass back to investors 50% of their investment as a tax credit.
It would allow startups engaged in R&D to pass back to investors 50% of their investment as a tax credit.
i.e.
You buy a share,
the company which was doing R&D, could take 50% of what you invested, as a tax loss to you - to put against your income taxes. They just need enough R&D tax losses.
Or if they didn’t, all the money raised had to be towards R&D.
You buy a share,
the company which was doing R&D, could take 50% of what you invested, as a tax loss to you - to put against your income taxes. They just need enough R&D tax losses.
Or if they didn’t, all the money raised had to be towards R&D.
It started innocently enough.
Companies like Mitel issued a preferred share that that would dividend out tax credits - but they didn’t sell well.
People were mystified as to why?
The problem was that enterprising Tax Accountants discovered a better deal for investors.
Companies like Mitel issued a preferred share that that would dividend out tax credits - but they didn’t sell well.
People were mystified as to why?
The problem was that enterprising Tax Accountants discovered a better deal for investors.
In the startup world. Things went a bit different.
People started issuing shares with a redemption right.
ie
Investor: Invests 80K
Company then Issues Tax Losses worth 40K
Investor Redeems the Shares for 50K.
Investor has 40K tax free. 50K $ = Net 10K
Startup keeps 30K
People started issuing shares with a redemption right.
ie
Investor: Invests 80K
Company then Issues Tax Losses worth 40K
Investor Redeems the Shares for 50K.
Investor has 40K tax free. 50K $ = Net 10K
Startup keeps 30K
And the Government?
They just lost 40K of Tax revenue. But that was the plan correct?
So the company still has to do 80K of R&D but now with only 30K of cash…
So how do you that?
3 ways: Creative Accounting or Fraud or Sales.
Lots just did the first 2.
They just lost 40K of Tax revenue. But that was the plan correct?
So the company still has to do 80K of R&D but now with only 30K of cash…
So how do you that?
3 ways: Creative Accounting or Fraud or Sales.
Lots just did the first 2.
And this is where things went wrong.
You see the government got independent accountants and bookkeepers to send them a letter attesting to the veracity of the R&D Spend.
And the government didn’t have people to check.
Equipment was bought for $500K having a ‘receipt’ for$2M
You see the government got independent accountants and bookkeepers to send them a letter attesting to the veracity of the R&D Spend.
And the government didn’t have people to check.
Equipment was bought for $500K having a ‘receipt’ for$2M
Salary’s started rising inexplicably.
Expenses that may or may not have been R&D related were accepted.
There was a lot of interest to invest to get Credits
But not enough companies.
So ‘Enterprising’ people got involved.
Research companies were being founded daily.
Expenses that may or may not have been R&D related were accepted.
There was a lot of interest to invest to get Credits
But not enough companies.
So ‘Enterprising’ people got involved.
Research companies were being founded daily.
One Guy decided to start a company to test a new high speed stabilizer. In other words he bought Sports Cars… and put spoilers on them.
This cost the government $13M.
I assume it looked like this.
This cost the government $13M.
I assume it looked like this.
A 29 yr old, Ed Fitch described as - "a very dynamic, bright and personable young fellow," Sold $30M in tax credits in BC.
He disappeared a few month after CRA asked about his R&D claims.
The king tho was a guy named Howard White. He “raised” 100M and sold 45M of Tax Credits
He disappeared a few month after CRA asked about his R&D claims.
The king tho was a guy named Howard White. He “raised” 100M and sold 45M of Tax Credits
Then he asked the the provincial government to give him money, so he could meet his R&D spend requirements. Nova Scotia Desperate to build something, anything in Cape Breton agreed.
Who was buying these credit?
People who need to reduce their taxes
Rich ppl and companies.
Who was buying these credit?
People who need to reduce their taxes
Rich ppl and companies.
Oil and Gas Companies started buy tax credits.
Esso avoided $393 million in taxes
In 1985 other Oil and Gas companies saved an additional $180M in taxes.
Was this a problem?
Well… You see this wasn’t expected to cost to much.
Esso avoided $393 million in taxes
In 1985 other Oil and Gas companies saved an additional $180M in taxes.
Was this a problem?
Well… You see this wasn’t expected to cost to much.
The SRTC program was projected to cost only $200M in 1984.
But by November the government had issued $1.8B in tax credits.
That is a lot.
The Mulroney Gov’t had taken charge and they were worried.
And so in early 1985 they phased SRTC out.
But it didn’t end…
But by November the government had issued $1.8B in tax credits.
That is a lot.
The Mulroney Gov’t had taken charge and they were worried.
And so in early 1985 they phased SRTC out.
But it didn’t end…
You see, the government couldn’t just turn it off. To many companies where in the middle of raising money.
So they allowed a grandfathering clause for existing investors….
And then the lawyers arrived -Savvy lawyers continued to “grandfather” deals for years afterwards.
So they allowed a grandfathering clause for existing investors….
And then the lawyers arrived -Savvy lawyers continued to “grandfather” deals for years afterwards.
Hoping to turn the page.
In 1985 the Conservatives instituted a $500K lifetime capital tax emption and said investors could not get a flow through R&D tax credits.
But owners could.
And owners could now use a capital gains tax emption…
Soo……
In 1985 the Conservatives instituted a $500K lifetime capital tax emption and said investors could not get a flow through R&D tax credits.
But owners could.
And owners could now use a capital gains tax emption…
Soo……
This didn’t fix the problem.
Savvy Lawyers started creating GP/LP structures.
Suddenly you would be an owner in a company, get your 50% tax free flow through and demand a redemption on you ownership.
But now you didn’t have to pay any taxes for up to 500K.
Life was good.
Savvy Lawyers started creating GP/LP structures.
Suddenly you would be an owner in a company, get your 50% tax free flow through and demand a redemption on you ownership.
But now you didn’t have to pay any taxes for up to 500K.
Life was good.
And this was how “the Racoons” got funded in 1986 with no fraud but a year after SRTC was supposedly canceled..
The estimated cost of the program by 1986 was $3.8B over 15 times the expected cost.
There was so much fraud, the SRTC became a byword for government ineptitude
The estimated cost of the program by 1986 was $3.8B over 15 times the expected cost.
There was so much fraud, the SRTC became a byword for government ineptitude
The fraud lawsuits went on for years.
Remember that Howard White guy in Cape Breton - they arrested him in 1996. (10 years later)
It became clear that about 40% of the program was criminal, 20% questionable. And the balance hard to tell.
And what was the result?
SR&ED
Remember that Howard White guy in Cape Breton - they arrested him in 1996. (10 years later)
It became clear that about 40% of the program was criminal, 20% questionable. And the balance hard to tell.
And what was the result?
SR&ED
SR&ED was instituted in 1988 as result of this fiasco.
The goal was to make sure the alignment of risk capital was clearly there.
An Investors money goes further in a tech company because the company can now apply for SR&ED credits but they have to stay inside the company.
The goal was to make sure the alignment of risk capital was clearly there.
An Investors money goes further in a tech company because the company can now apply for SR&ED credits but they have to stay inside the company.
This contributes to the likelihood of success as they can develop their products with R&D subsidies.
We can argue on whether this is the best thing to subsidize but I’d say Fraud in SRED is pretty minimal.
Investors have to wait to get repaid…
you know, like an investment.
We can argue on whether this is the best thing to subsidize but I’d say Fraud in SRED is pretty minimal.
Investors have to wait to get repaid…
you know, like an investment.
So SRTC came before SR&ED.
So who cares?
You might wonder. Why am I bringing up this boring story about Tax Credits?
So who cares?
You might wonder. Why am I bringing up this boring story about Tax Credits?
Well every year or so someone thinks we should use flow through tax incentives to increase R&D and startup capital in our ecosystem.
It does after all work in Mining.
Here’s some examples:
https://calgaryherald.com/business/local-business/government-exploring-flow-through-shares-for-tech-sector-in-absence-of-cancelled-tax-credits
https://saskatoonchamber.com/wp-content/uploads/2019/02/2009-Using-Flow-Through-Shares-to-Encourage-Innovation.pdf
https://www.sorbaralaw.com/resources/articles/publication/flow-through-shares-for-canada-s-innovation-sector
It does after all work in Mining.
Here’s some examples:
https://calgaryherald.com/business/local-business/government-exploring-flow-through-shares-for-tech-sector-in-absence-of-cancelled-tax-credits
https://saskatoonchamber.com/wp-content/uploads/2019/02/2009-Using-Flow-Through-Shares-to-Encourage-Innovation.pdf
https://www.sorbaralaw.com/resources/articles/publication/flow-through-shares-for-canada-s-innovation-sector
This one is from two weeks ago.
There’s many many more…. https://www.thestar.com/business/personal_finance/2021/01/23/canadas-tech-sector-badly-needs-more-capital-tech-itself-has-a-solution-the-blockchain.html?rf
There’s many many more…. https://www.thestar.com/business/personal_finance/2021/01/23/canadas-tech-sector-badly-needs-more-capital-tech-itself-has-a-solution-the-blockchain.html?rf
I’m not saying we don’t need innovation in the system.
But all of these articles above and the people in them who are advocating for Flow Through Shares …
NEVER mention the SRTC program… wonder why?
But now you can, and share the story of how “the Racoons” Studio funded.
But all of these articles above and the people in them who are advocating for Flow Through Shares …
NEVER mention the SRTC program… wonder why?
But now you can, and share the story of how “the Racoons” Studio funded.
These aren't the easiest to write for twitter.
And I left out a lot of great tidbits and details.
I'm going to start sharing some of the more in-depth stuff I write on Substack - yes another newsletter.
Feel free to subscribe. https://mattroberts.substack.com/p/coming-soon
And I left out a lot of great tidbits and details.
I'm going to start sharing some of the more in-depth stuff I write on Substack - yes another newsletter.
Feel free to subscribe. https://mattroberts.substack.com/p/coming-soon
Also if you’re looking for more. See some of last months tweets. https://twitter.com/mattroberts/status/1356275472645152772
