Posts by wdorfmann

2011: The year insanity trumped innovation.

2011 might be remembered for a lot of things, but to me it’s the year that the world finally woke up to the mess with the US patent system — to which many of the other country’s patent systems are of secondary importance.  (And when I say “woke up”, I don’t mean “woke up and solved“. ) Anyway, here’s the problem:  Granting patents for questionable & intangible ideas to people/organizations that didn’t really “invent” those ideas, combined with a legal system that is way in over its head trying to assess the validity of such patents has led to an economy based on faux-IP rather than true innovation.   It means that we’re not manufacturing as much and we’re not creating as much value from real and important innovation.  This is all just the opposite of what patents are supposed to do.

Gary Yurkovich recently posted the following comment on LinkedIn:  ”Remember when Apple was innovative with good products? Now it competes best in courtroom. http://zd.net/pcGm0j“.  True, but while patent-litigation over innovation seems to be the trend (see http://www.economist.com/node/21525096 ), I don’t blame Apple. The patent system is broken, not Apple. It’s the ease with which one can now patent things like blatantly obvious software implementations that is the problem (i.e. vague “innovations” that should never be patentable), and Apple is just reacting rationally.

Apple actually innovates better than most: Eg.where’s the competition for ipad when the likes of HP quit at the 1st sign of heavy sailing? That’s Leo Apotheker trying to turn HP into the next SAP and is a very sad development (whither manufacturing?). It truly angers me, having cut my teeth on DEC which was eventually bought Compaq, which was eventually bought by HP, which … has given up the fight.

 

 

 

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SR&ED: Flawed, but worthwhile

I read with interest Saturday’s story in the Globe and Mail entitled “Flawed R&D scheme costs taxpayers billions” by Barry McKenna (see http://www.theglobeandmail.com/report-on-business/flawed-rd-scheme-costs-taxpayers-billions/article1939418/).  One of the things my company does is SR&ED consulting — helping companies determine if they have SR&ED-eligible projects, helping them document their projects in order to apply for SR&ED credits, and helping them establish processes to tap into SR&ED tax credits when SR&ED-eligible work is performed in the future.

The funny thing is, I agree with much of what Mr. McKenna says in Saturday’s article, but I still believe the SR&ED program is worthwhile.  Is it flawed?  Yes.  Show me a tax program that isn’t.   Interestingly, it is not uncommon to question government incentive  programs like SR&ED, no matter what country you’re in.  Yesterday’s Oregonian newspaper, for instance, had an article questioning Oregon’s green energy incentives (see http://blog.oregonlive.com/politics_impact/print.html?entry=/2011/03/how_many_jobs_from_oregons_gre.html).

 

I don’t know if SR&ED fully meets its implied social objective of increasing R&D in Canada.  But I do know it helps retain and increase employment in the technology sector.  One of my clients,for instance, was doing really innovative R&D, but he was using offshore resources to do much of it.  I explained that if he used employees here instead, he would be able to tap into SR&ED tax credits that might enable him to grow the business entirely within Canada.  As a result he has hired two new employees in Canada and has opened an office here as well.  He expects to hire three more in Canada — changing his mix so that instead of having 1 or 2 employees here and 4 overseas, he will have six in Canada and one or two overseas.

Another client would almost certainly have closed their doors in 2009 due to the recent financial crisis.  Most of their customers were in the US and their business virtually dried up by the beginning of 2009.  Instead, they downsized a bit, focused on R&D, obtained SR&ED credits as a result, and are coming out of the recession with a stronger product portfolio.  They are a stronger company now.  They and their employees are thriving in Canada and are paying taxes.  The alternative?  I hate to think about it:  All of those jobs overseas?  Many of the employees on EI?  Loss of a truly innovative technology company?

Oh, and please note that other countries are using R&D tax credits to create or retain industries and jobs.   The USA, Mexico, Australia, France, China, India and others all provide generous credits.  (See http://www.scitax.com/pdf/Scitax.International.RD.Tax.Credit.Survey.Table.pdf).  Just to state the obvious here:  It’s hard enough to compete in the global economy, and I appreciate the fact that our government helps us do that.

So, what’s the problem?  I think that Mr. McKenna’s article was correct about the unscrupulous use of SR&ED credits by companies that don’t deserve them.  They are taking advantage of the subjectiveness of the assessment process and of the lack of resources at the CRA to more thoroughly examine every case.

There is little I can do about that other than to make sure that I only assist companies that have valid claims and who are willing to do the work needed to fully document them.  When they do that, I’ll go to the mat with the CRA for them to make sure their legitimate claims succeed.

 

 

 

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SR&ED Creativity… Just Be Careful

I came across the following blog post recently: “SREDing Sweat Equity”.   It describes a maneuver to use SR&ED to enable paying yourself a salary during the early stages of your company’s development.  Part of my work at Axxiton Consulting involves helping companies to maximize SR&ED claims by identifying eligible projects & activities, analyzing and documenting projects & activities to claim for SR&ED, and establishing processes to help assure repeatable success.  So I found the aforementioned blog post interesting.  But I have the following observations:

The proposed maneuver is quite interesting.  SR&ED is a great program, and I’ve seen some companies survive the economic downturn solely due to SR&ED — it literally kept the lights on so that the companies survived until the the economy recovered.  However, companies need to make sure they don’t see SR&ED as an entitlement.  They still need to demonstrate technological advancement.  It must be credible and documented. And they need to be aware of the rules – both for claiming SR&ED credits and for paying their employees.

SR&ED can help keep the lights on during an economic downturn

The first problem I see with the proposed maneuver is this:  Specified employees (i.e. a person who owns 10% or more of company or who does not deal at arm’s length w/the company) can only claim up to 75% of the time (and presumably salary) for which they were directly involved in SR&ED for the Prescribed Proxy Amount (PPA) top-up when computing SR&ED.   That reduces the SR&ED-eligible expenditures in the example from $70K to $52.5K for the PPA.  Max SR&ED credits for the $70K salary will therefore be about $43K in Ontario.

Steve & Steve

Another problem is that an entrepreneur is unlikely to expend 100% of their time on SR&ED activities.  In fact, companies that claim all of their principals’ time as being for SR&ED might trigger increased scrutiny of their SR&ED claim as a result. If you do so one year, you can’t count on getting away with it every year.  Be careful here:  If you mysteriously claim exactly 100% on SR&ED activities year after year, someone’s going to decide to take a more careful look (even if you claim 90% and deem it to be 100% under the “all or substantially all” rule).   Be realistic.  As a founder, some of the time you spend on your company will be for bizdev, financing, admin, etc..

Another important point is this:  Suppose you do pay yourself with an IOU, the company must still withhold and pay remittances for personal tax, CPP and EI.  In the blog’s example, using 2011 tax rates, that would be $15,180 in tax and $6,323 for EI and CPP.  That’s $21,503 you need to come up with in cold, hard cash to pay the government while you’re waiting for the SR&ED cheque to arrive.  I believe you can wait up to 180 days into the subsequent fiscal year to pay the salary if it is a bonus, but there are two problems here:  First, bonuses to specified employees will be scrutinized by the CRA to make sure they are not based on profits.  Bonuses paid on profits to specified employees can’t be included in your SR&ED claim.  Second, you don’t know how long it will take to process your SR&ED claim, nor do you know how much of your SR&ED claim will be accepted by the CRA.

IOU

So… now you’re in a situation where you’ve paid salary via an IOU of $70K.  You’ll net about $21.5K in cash (SR&ED claim = $43K, Remittances paid to Receiver General = $21.5K).  That assumes that the entire SR&ED claim will be approved.  And you hope it will be approved in a timely manner so that you aren’t out of pocket $21.5K while you wait for the $43K cheque to arrive.

Just be aware of the risks.  Don’t file frivolous SR&ED claims.  Claim legitimate SR&ED.  Document, document, document!  The best damned thing you can do is to methodically record your time spent each day, and that of your employees.  Always have supporting documents for your claim. (See http://bit.ly/aSsSh6 for my thoughts on this point).

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Danger Will Robinson: National “Infrastructure as a Service”

Danger Will RobinsonI was in New Zealand recently, and saw the following article in the New Zealand Herald: “Govt in $2b shake-up of data systems”.  As I read the article, the hairs on the back of my neck went up.  New Zealand hopes to move a significant portion of their Information and Communications Technology (ICT) infrastructure into the cloud.  They call it “Infrastructure as a Service.”  It’s supposed to save money.

New Zealand is a wonderful country, and they have much to be proud of.  They dug themselves out of a significant fiscal crisis in the 1980s – and are not afraid to take innovative and/or draconian measures to address their problems.  The article points out that “Once it is up and running, the Government would be one of the first in the world to adopt an Infrastructure as a Service model.”  Bad, bad idea.

The first time I visited there, I took a picture similar to the one shown above of a geothermal power generation plant and told people that it proved NZ was where the clouds were made!  This is ironic, because one of NZ’s big failures in my opinion was their privatization of the electricity grid.  It is my understanding that Kiwis pay more than 3 times what we pay for electricity, despite having an abundance of hydroelectric and geothermal power available.  The irony today is that a national government-wide cloud strategy may not save money (as the electricity-grid-privatization was supposed to do), but may cost far more than expected.  Furthermore, there is a very real danger that it could cripple the ability of the government to deliver services, and could even threaten NZ’s national sovereignty.

I love cloud computing.  It works.  It saves money.  The promise is that the costs of cloud-based services grow only as the organization’s needs grow and don’t require significant capital investment up front.  You don’t need a large IT staff.  There is protection against obsolescence.  Etc., etc..  But Cloud Computing is not for every organization, and those that adopt it need to understand the risks and true costs involved.

False Economies

I believe that there are often false economies with moving services into the cloud.   If not done correctly, cloud based computing can be like payday loans or rent-to-own services.  I saw one medium-sized organization replace its far-from-perfect time keeping system with a cloud-based CRM system:  $50/month per seat – they replaced a suboptimal system that cost them almost nothing with a different suboptimal solution that cost them about $75K per year.  Then they needed to purchase data conversion services, consulting services and training services from the vendor before it was all up and running.  Those up-front costs were in the $75K-$100K range.

Another thing to keep in mind is that IT projects of any sort typically run over budget and over schedule.  This problem seems to be worse the larger the organization involved.  Governments are notoriously bad about this (probably because they’re spending other peoples’ money).  I’m sure the vendors who bid on this project will spin a pretty good yarn, but for some reason I don’t trust Microsoft, Oracle, IBM, Google, SAP, NetSuite, Amazon, or others to necessarily get it right the first time.  After all, New Zealand would be the first country in the world to attempt to put virtually their entire government IT infrastructure into the cloud.  There is no precedent.

Continuity of Services

Someone once said “the bigger they are, the harder they fall.”  I think that was meant to encourage a small competitor to take on a large competitor.  But in the context of enterprise-wide, or nation-wide cloud computing it takes on a whole new meaning:  Imagine if no government employee could use email, access word-processing documents or spreadsheets.  If that happened for even just a few minutes, it would be devastating.  If it happened for an hour, a day or a week, it would be akin to an earthquake shutting down the entire federal government.

The security of a single ICT cloud-based provider (as opposed to the patchwork of relatively independent systems that probably exists today) should be considered.  A single undiversified system will be more vulnerable to malicious attacks or systemic failures.  Cloud-based systems can be accessed via the global internet, and don’t require physical access to the systems.  This can be addressed via technologies like geolocation and by using sophisticated authorization, access, and directory services – but such technologies create management and user headaches all their own, and often create incentives for employees or external users to short-circuit them. (Think of users that write-down their passwords because the system forced them to change them frequently, or people who install free VPN solutions like hotspotshield to work around geographical internet restrictions).

The problem is that the host system (i.e. the cloud-based ICT) is enormous and a vulnerability can affect the entire infrastructure.  Conventional (non-cloud-based) systems are inherently compartmentalized and heterogeneous.  This isn’t always good, but does help to prevent system-wide failures.  For some reason, the picture of a virtual “Death Star” comes to mind when I think of a nation-wide cloud solution… The bigger they are, the harder they fall.

Sovereignty and Security

New Zealand is not generally in the rest of the world’s crosshairs, but its government does have a duty to protect the country’s sovereignty and to protect its citizens against terrorists, enemy governments and industrial espionage.  Clearly, a system that can be accessed relatively easily via the global internet poses a problem in this respect.  I’m sure that New Zealand will take precautions, but I’m skeptical that they will ever be sufficient with a cloud-based solution – especially for the first country in the world to put virtually their entire government IT infrastructure into the cloud.

This is no idle concern:  Recently it appears that Israel, the US, Germany and Britain colluded to prevent Iran from developing nuclear weapons by using the Stuxnet worm to damage Iran’s centrifuges used for refining nuclear material.  There is evidence that China hijacked about 15% of the world’s internet traffic last April.  There is also suspicion that North Korea has launched a series of experimental cyber-attacks in the past few years against South Korea and the US (interestingly this an asymmetric capability on North Korea’s part, since they have little infrastructure of their own that can be cyber-attacked).  Russia, or at least organized crime based in Russia, is well known for conducting denial of service attacks against other countries that get in its way.  Every country should take this type of threat seriously for its economic, military and civil security.

Another problem with sovereignty is where the data is kept.  I’m sure that New Zealand will take measures to keep the cloud-based data within their own borders.  But if they don’t, the data might be subject to eavesdropping by the US under the Patriot Act, or under similar legal regimens in other countries.  If data is stored in other countries, or even transits other countries as part of the global internet, it will be subject to such snooping and there will be little New Zealand can do about it.  I don’t hesitate for a second to think that China, the US, Russia, Israel, Britain and other countries will use such data for industrial and national espionage activities.

Privacy,  Data Security, Government Abuse

By definition, data is stored outside of the organization when using a cloud-based infrastructure.  New Zealand has strict privacy laws, and I submit that a cloud-based infrastructure will endanger the privacy of peoples’ data:  Economic data, financial data, taxation data, medical data, legal data, vital statistics data, military data, and many other types of data are gathered and controlled by governments.  Part of the unexpected costs of developing a cloud-based infrastructure will be related to protecting the privacy and security of data.  I believe that no matter how hard they try, the government will not succeed in protecting the privacy of citizens’ data in a cloud-based infrastructure of this magnitude.  There will not be physical compartmentalization of data as you get with conventional IT infrastructures.  The cloud-based infrastructure will be a Wikileaks delight!  I wasn’t born yesterday:  I know that there are many safeguards that can be used – but I’ve also been on the inside of many organizations and have seen the damage that disgruntled or greedy employees can wreak, or the danger of unforeseen technological threats.

A final concern I have is that of government abuse.  I believe that the New Zealand government is benevolent, and does not intend to exploit the centrality of the data for any nefarious purpose.  But governments, politicians, law enforcement agents and civil servants sometimes yield to temptation and use powers given to them for unethical and amoral purposes.  Or they “extend” their powers after data is centralized or gathered for seemingly innocent purposes (think of the possible abuses of the Patriot Act in the US for instance).  I think it was Otter from the movie Animal House who put it best:  “You f—ed up, you trusted us!”.Animal House

Use common sense:  Don’t do it

New Zealand currently has an RFP out for its $2b “Infrastructure as a Service” project (see http://www.gets.govt.nz, GETS Ref #31944).  It’s a great country, and I really hope they demonstrate common sense and avoid this debacle.  I don’t have a dog in the fight, but would really like them to perform euthanasia on the idea now.  If they don’t, they should try it on one or two departments first.  Isn’t that the idea behind cloud computing anyway:  Only bite off as much as you can chew?

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Purchase new computer equipment before February!

I’m planning to purchase some new computer equipment this year for our company (Axxiton Consulting Inc.) — and I’m going to do so before February 1st!  Canadian tax rules provide a strong incentive to do so. In Canada, depreciation for tax purposes, or the rate at which you can expense capital purchases for tax purposes, is prescribed by the Canadian Income Tax Act.  The amount which you can expense in any given year is called the “Capital Cost Allowance”, or just “CCA”.  For a given capital purchase, you can ordinarily expense a prescribed percentage of its book value for tax purposes (known as the Undepreciated Capital Cost, or “UCC”) in any given year, except for the first year when you are only allowed to expense half that amount.  For instance, the CCA rate for furniture is 20% per year.  So if you purchase a piece of furniture for $1,000, you can expense half of 20% in the first year ($100), then 20% of the remaining amount in the second year ($180 = [$1,000-$100]*20%), and so on. The reason I’m buying computer equipment before February, 2011 is that there is a temporary rule for CCA Class 52 which will allow us to expense 100% of the cost of new computer equipment in the current fiscal year if I purchase it before February.   Specifically, the Income Tax Act says:

“Include in Class 52 with a CCA rate of 100% (with no half year rule) general purpose electronic data processing equipment (commonly called computer hardware) and systems software for that equipment, including ancillary data processing equipment if acquired after January 27, 2009, and before February 2011.”

(See “Classes of depreciable property” on the Canada Revenue Agency web site)

This is big!  It means that if I purchase a piece of “general purpose electronic data processing equipment”, say that costs $1,000, I can expense the entire $1,000 amount as a Capital Cost Allowance in the current fiscal year. We’re trying to minimize our tax expenses, so if we are planning to purchase the equipment this year anyway, it makes sense to purchase it before February. This is important regardless of whether or not the company is profitable this year:  In Canada, we can carry losses back 3 years or forward 20 years to minimize taxes payable.

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