Tax Support for R&D and Intellectual Property: Time for Some Bold Moves

Abstract

The federal budget announcement of a review of the Scientific Research and Experimental Development (SR&ED) investment tax credit suggests that the review will be focused on issues that will have, at best, a minor impact on the effectiveness of the credit.

The announcement raises the issue of the program’s effectiveness in encouraging research and development (R&D) that benefits Canada, presumably by encouraging more commercialization activity at home. The SR&ED program is not the right instrument for achieving this objective. A better approach is to implement policies, such as an intellectual property box or targeted subsidies, that act more directly on the incentive to commercialize R&D in Canada.

The announcement also highlights the need to simplify the SR&ED program. This is a worthy goal, but before embarking on another round of simplification, the Canada Revenue Agency should gather evidence on the costs firms incur in applying for a SR&ED tax credit.

Bold changes are needed to improve the effectiveness of the SR&ED investment tax credit:
• Support for R&D performed by large firms should be increased and support for smaller firms should be reduced. This rebalancing would leave smaller firms with substantial subsidies while increasing support where the social benefits from R&D are greater.
• Credit rates should vary by the type of R&D performed. The social benefits from basic and applied R&D are higher than the social benefits from experimental development. The credit rates should reflect this difference.

The budget also announced that the government will consider the merits of taxing income from intellectual property (IP) at a special low rate. Implementing an IP Box as a complement to the SR&ED tax credit would be good public policy.

Keywords: Fiscal and Tax Policy; Business Subsidies and Preferences; Research and Development

JEL Classification: O38; H25