The Jenkins Report

by gord Jans

PosItIvely sHaPIng tHe Future

On October 17, 2011 the report, “Innovation Canada: A Call to Action,” was released by the Independent Panel on Federal Support to Research and Development, commonly known as the Jenkins report.

Figure 1: What do you believe are the most important actions that government can take to improve Canada’s ability to compete globally in the life sciences industry? (respondents were asked to select top 3 choices)

Create incentives for risk capital NA NA

Create more favourable tax incentives

Research grants to companies 78% 75%

63% 62% 67%

84%

49% 38% 51% 45%

37% 37% 40% 42%

2011 2009 2007 2006

However, unlike many of its predecessors, it appears the Jenkins report will result in some fundamental policy shifts at the federal level that will likely have significant consequences for the entire innovation ecosystem in Canada. As of the date of submitting this article, the 2012 federal budget has not yet been released. However, the federal government has made strong suggestions that the time for action (rather than more study) is finally over, starting with the 2012 budget. This article examines the Jenkins report and provides suggestions for implementation that could positively shape the future of Canada’s life sciences sector.

baCKgrounD

The Jenkins panel was commissioned to address the following three questions: 1.What federal incentives are most effective in increasing business

R&D and facilitating commercially relevant R&D partnerships? 2.Is the current mix and design of tax incentives and direct support for business R&D and business-focussed R&D appropriate? 3.What, if any, gaps are evident from the current suite of programming, and what might be done to fill the gaps?

To aid its analysis, the panel invited interested parties to comment on 15 specific questions relating to R&D and innovation. PwC submitted its response to these questions on February 18, 2011 . In our executive summary, we encouraged the panel to establish priority areas for Canada and review and revise policies and programs (including procurement policies) to focus on areas of strategic priorities. In my view, life sciences is one of these priority areas.

As noted in our report, Inflection Point: Canadian Life Sciences Industry Forecast 2011, “For a nation as rich in knowledge and resources, Canada holds a unique opportunity to grow the value of its bio-economy into a key driver of its economic growth. Alignment of public policy into a fully enabling ecosystem supporting the full life

cycle of development from discovery into the marketplace is critical to our global competitiveness.”

The question is whether the government’s response to the Jenkins report will be aligned with these views so a better ecosystem for life sciences in Canada can be created. Let’s hope so, since this sector is uniquely positioned to help address Canada’s pending demographic challenges in managing health care delivery and costs as well as providing opportunities for greater economic wealth.

WelCoMe InItIatIves

On the positive side, the Jenkins panel recognized that government procurement can play a critical role in stimulating innovation and this is a welcome message. Procurement can be a very powerful tool for life sciences if the provinces adopt a co-ordinated approach aligned with the Jenkins report recommendations within their respective health and economic development ministries. The federal government may have a unique opportunity to empower the provinces to head in this direction as part of the 2014 health accord negotiations.

In addition, the endorsement of a Small Business Innovation Research (SBIR) type of program that exists in the United States could represent a significant source of new funding for the Canadian life sciences sector. In the U.S. there has been extensive debate over the fact that so-called “majority investor owned” small businesses were not eligible for SBIR funding. These rules essentially prevented venture capital (VC) backed companies from participating in the program. In late 2011, the U.S. repealed this limitation and will now permit VC and other majority investor owned companies to apply for some SBIR funds (up to 25 per cent of the SBIR budget for the National Institutes of Health and up to 15 per cent for all other agencies).

Also positive in the Jenkins report is the recommendation for increasing access to risk capital for high-growth innovative companies. Our report, Inflection Point: Canadian Life Sciences Industry Forecast 2011 confirmed there is strong demand from industry for government to implement incentives to increase risk capital (see figure 1). The significant assumption here is that life sciences are included in the definition of high-growth innovative sectors when this recommendation is implemented. While the Jenkins panel called on the Business Development Bank of Canada (BDC) to solve this problem by disbursing additional funds, there are other solutions such as creating new tax incentives to foster a better ecosystem for risk taking.

Of course, there are many within the life sciences community who are concerned with the proposal to remove the refundable R&D tax credit for small and medium size enterprises (SME’s). Currently SME’s can receive more than $1,000,000 annually from the federal program and, when combined with provincial incentives, R&D tax credits have been a significant source of non-dilutive funding for many life science companies. Although 2011 was an improvement over 2010, it is no secret that the funding environment in Canada has been very challenging for several years. Therefore the potential loss of R&D refunds could have a severe impact for the sector. Let’s hope the recommendation to redeploy “savings” from R&D program changes into new incentives to support the growth and profitability of SME’s provides an equal or greater benefit for the life sciences sector. Without any details, it is difficult to know. Nevertheless, there should not be any gap in time between the phase out of the existing R&D program and the phase in of any new programs.

More to ConsIDer

Several recommendations of the Jenkins panel could be tweaked to maximize the positive impact on the life sciences sector. These include: • Supplement the BDC direct investment model with a flow-through share regime for life sciences, since tax policy can be a much more powerful tool than direct funding. For example, a $200 million

“investment” by the federal government in flow-through shares can

yield far more capital for the sector than $200 million of direct funding. The reason is that in order to provide $200 million of tax relief, the flow-through investors must invest $800 million if their average tax rate is 25 per cent. Since federal corporate tax rates (15 per cent) are much lower than top marginal personal tax rates (29 per cent), a flow-through share regime that includes corporations in the definition of eligible investors may generate even more capital than one focused on individual investors. This type of program may also provide a significant catalyst to increase the demand for partnering with

Canadian life science companies by large pharmaceutical, biotech and medtech players. As a reference point, in 2010 PwC prepared an economic impact study for BIOTECanada and we estimated that a mature flow-through share mechanism for life sciences could generate nearly $1 billion of economic output in Canada. • The proposed phase out of the refundable R&D tax credit should take into account the lengthy development and regulatory approval cycles. The Jenkins panel recommends the R&D tax credit be targeted at growing and profitable SME’s. Life science SME’s need time to meet the growth and profitability criteria. Imposing an annual profits test for refund eligibility would exclude the majority of Canadian life science SME’s. A more palatable approach would be to consider profitability over, say, a 10 year period and include any deferred revenues existing at the end of year 10 to account for licensing or partnering deals that may have occurred but are not yet included in profit. For example, in the first 10 years, a company would continue to be entitled to receive refundable R&D tax credits. However, if the profitability criterion is not met at the end of 10 years, the company would become liable to repay some or all of the R&D credits. • The types of organizations eligible to receive funding from an SBIRtype program in Canada should include all VC backed, publicly listed and other majority-owned companies. Given the current state of funding within the Canadian life sciences sector and recognizing that there are strong scientific capabilities in both public and private companies, all types of organizations should be eligible for

SBIR funds. This would maximize the potential benefit to the sector and maximize the potential return for the government. In addition, unlike the U.S., there should not be any limit on how much of the

SBIR budget each federal agency can allocate to different types of organizations. From a practical perspective, if companies with VC investors and public companies are excluded or otherwise limited, there would be relatively few eligible Canadian headquartered applicants within the life sciences sector. Accordingly, the criteria to receive the funding should be based on the merits of each applicant rather than the identity of the applicant’s investors.

a Cataylst

In closing, the Jenkins report can become a catalyst for positive change within the Canadian life sciences sector. However, the implementation of the recommendations must take into account the unique features of the industry in order for this positive change to occur.

Supporting the life sciences sector is an important piece of the puzzle in achieving a more innovative economy. This sector is uniquely positioned to improve the long term health and wealth of Canadians. Despite a bumpy road for investors over the last 30 years, the global race to lead in life sciences continues since the prize of understanding how disease and the human body functions on a molecular level is huge from both a societal and economic benefit perspective.

Many other countries continue to link success in life sciences to economic success despite the challenging times. For example, since the global economic crisis began in 2008, a number of established and emerging economies have announced significant programs which in whole or in part were designed to increase financial support for the life sciences sector. These include Australia, France, Norway, the United Kingdom and the United States as well as emerging economies in China, India, Singapore and Taiwan. Innovation in life sciences cannot occur without investment. Canada should seize the opportunity to leverage the Jenkins panel recommendations and our success in weathering the global economic crisis and invest in 21st century innovative sectors such as life sciences.

The Jenkins report can become a catalyst for positive change within the Canadian life sciences sector. However, the implementation of the recommendations must take into account the unique features of the industry in order for this positive change to occur.

For more JenKIns rePort information visit our best PraCtICes Web Portal at www.bioscienceworld.ca