SR&ED program requires major reforms to stimulate business R&D: policy brief

Significant changes are needed to Canada’s largest funding program for incentivizing R&D by the private sector if the country wants to compete internationally in innovation, says a policy brief by Robert Asselin.

The existing Scientific Research & Experimental Development (SR&ED) program, which provides R&D tax credits to Canadian companies and cost about $3 billion in 2022, has failed to increase business investment in R&D, Asselin, senior vice-president, policy, at the Business Council of Canada, said in a policy note published by the C.D. Howe Institute.

Canada is doing poorly, trailing Mexico on total production and global market shares, and our relative performance is declining, Asselin said in an open letter to Finance Minister Chrystia Freeland that accompanied his brief.

“Our capacity to do industrial research at scale is almost non-existent and our technology transfer mechanisms have not kept pace with developments in knowledge creation,” Asselin wrote to Freeland. “There is still an overreliance on incremental innovation or safe bets.”

“The tools we have used so far have not worked and we have to change that,” Asselin, who’s also a fellow at the Munk School of Global Affairs & Public Policy, told Research Money.

“Absolutely we need to pick winners,” he said. “We need to pick sectors, industries where R&D is intensive and where we can scale.”

His brief recommends that the government “fix the imbalance” in SR&ED between small and large companies, including by providing a preferential tax rate to advanced industries with high concentration of R&D.

Currently, the SR&ED program provides a tax credit equal to 15 per cent of current expenditures on R&D by large firms, and 35 per cent for current R&D expenditures by Canadian-controlled small and medium-sized private corporations.

However, small firms get a 35-per-cent subsidy on up to $3 million in R&D investment, notes Asselin’s brief. While SR&ED is refundable for small firms, large firms must use the credit to reduce taxes otherwise payable.

“The problem with SR&ED right now is it almost serves as a universal tax cred for SMEs, and I think that’s wrong,” Asselin said.

His brief recommends increasing the SR&ED tax credits available to large, R&D-intensive companies, because research shows there are greater R&D spillovers with large firms and the return on public investment is significantly higher.

Currently, Canada’s advanced industries are either small or aren’t performing at scale, which is why the country lags many nations in productivity, Asselin noted.

Canada’s advanced industries, according to a metric used by the Brookings Institution, have R&D spending above the 80^th percentile of Canadian industry intensity and a higher-than-average number of STEM (science, technology, engineering and mathematics) workers.

Examples of Canadian advanced industries include information technologies, the clean tech and biotech sectors, cyber-security, and the information components of artificial intelligence, Asselin said. “These industries should be prioritized in SR&ED allocation.”

Canada should create an “IP box”

Creating an “IP box,” as recommended in a separate report, by John Lester, an executive fellow at the School of Public Policy at the University of Calgary, and published by the C.D. Howe Institute, would be a better way to incentivize commercialization of R&D than the SR&ED program, Asselin said.

An IP box (also called a patent box) taxes business income earned from IP at a rate below the statutory corporate income tax rate, to encourage local R&D. This would nurture the creation of Canadian IP and its retention in Canada, Asselin said.

In addition, an OECD agreement on a global minimum corporate tax rate also needs to be implemented, Asselin’s brief says. This would prevent the erosion of Canada’s tax base and ensure that income taxed at a preferential rate would originate from R&D performed in the implementing jurisdiction, according to his brief.

“It would also make sure that we have a level playing field vis-à-vis other countries, that we’re not penalizing our companies by having a differential tax treatment in Canada,” he said.

The global minimum tax was agreed to in October 2021 between 136 (now 137) of the 147 countries that are members of the OECD/G20 inclusive framework on tax base erosion and profit sharing.

The long-anticipated deal is designed to ensure that multinational enterprises will be subject to a minimum 15-per-cent tax rate in every country of operation starting in 2023, thus preventing multinationals from taking advantage of different tax regimes between countries and effectively avoid paying tax.

Ottawa committed to reviewing SR&ED program

As for the SR&ED program, innovation advocates, business groups and other organizations have called for years for a major overhaul or even to eliminate the program.

In Federal Budget 2022, which described SR&ED as “a cornerstone of Canada’s innovation strategy,” the government committed to do a review of the program to ensure it’s effective in encouraging R&D that benefits Canadians.

The government said its review also will consider whether the tax system can play a role in encouraging the development and retention of IP created by R&D conducted in Canada. As part of the review, Ottawa said it would consider creating a patent box.

Asselin said he gives the government credit for acknowledging that a review would help and be a positive step.

However, given the increasing technology competition in the world, there seems to be a lack of urgency on government’s part to reform the SR&ED program, he said. He pointed to other countries, including the U.S., Germany, the Netherlands, Japan and Singapore, that he said are reviewing their innovation policies and making bold moves.

“What I would be afraid of is they [government] have promised to show movement, but at the end they would deliver very little reform – only small tweaks,” Asselin said.

Finance Canada, which is responsible for delivering SR&ED, didn’t respond by publication time to Research Money’s questions about whether the review of the program has started or its response to Asselin’s proposed reforms.

However, in a 2021 report on federal tax expenditures, Finance Canada said existing studies “suggest that the SR&ED [tax credit] is effective in stimulating additional business spending on R&D in Canada, in particular among small firms.”

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