Canada’s research and development (R&D) tax credit, known as the Scientific Research and Experimental Development (SR&ED) program, is one of the most generous in the world, providing over $3.5 billion in tax incentives annually to over 22,000 businesses. However, many experts argue that the program is outdated, complex, and ineffective, and that it needs to be reformed to better support innovation and intellectual property (IP) creation in Canada.
The Challenges of the Current SR&ED Program
The SR&ED program was introduced in 1948 to encourage Canadian businesses to conduct R&D and to enhance Canada’s competitiveness and productivity. The program allows businesses to claim a tax deduction and an investment tax credit (ITC) for eligible R&D expenditures, such as wages, materials, equipment, and contracts.
However, the program has been criticized for several reasons, such as:
- The program is too complicated and costly to administer and comply with, requiring extensive documentation, audits, and reviews. According to a 2017 report by the Canada Revenue Agency (CRA), the administrative cost of the program was $191 million, or 5.4% of the total tax expenditure.
- The program is not well-targeted and does not distinguish between different types of R&D activities, such as basic research, applied research, and experimental development. The program also does not account for the spillover effects of R&D, such as the social and economic benefits that result from knowledge diffusion and collaboration.
- The program is not effective in stimulating R&D and IP creation in Canada, as evidenced by the low and declining rates of R&D spending and patenting in Canada. According to the Organisation for Economic Co-operation and Development (OECD), Canada’s gross domestic expenditure on R&D (GERD) as a percentage of GDP was 1.6% in 2019, below the OECD average of 2.4%. Canada’s patent applications per million population were 184 in 2019, below the OECD average of 295.
The Recommendations for Reforming the SR&ED Program
Many experts and stakeholders have proposed various suggestions and recommendations for reforming the SR&ED program, such as:
- Simplifying and streamlining the program by reducing the administrative burden, improving the clarity and consistency of the eligibility criteria, and enhancing the transparency and timeliness of the claim process. For example, the Canadian Chamber of Commerce has recommended that the CRA should adopt a risk-based approach to auditing, provide more guidance and feedback to claimants, and expedite the processing of claims.
- Refining and improving the program by adjusting the tax credit rates, introducing a refundable component, and expanding the eligible expenditures. For example, the Canadian Advanced Technology Alliance (CATA) has recommended that the federal government should increase the ITC rate from 15% to 20% for all businesses, make the ITC fully refundable for small and medium-sized enterprises (SMEs), and include overhead and capital costs as eligible expenditures.
- Supplementing and complementing the program by introducing other tax measures or incentives to support R&D and IP creation in Canada, such as a patent box regime, an innovation box regime, or an R&D super-deduction. For example, the Innovation Economy Council (IEC) has recommended that the federal government should create a patent box regime that would provide a lower tax rate on income derived from patents and other forms of IP that are developed and retained in Canada.
The Government’s Response and Consultation
The federal government has acknowledged the need to review and modernize the SR&ED program, and has committed to undertaking a consultation on the program in Budget 2022. The government has stated that it will explore opportunities to improve the program in cost-neutral ways, and to consider whether the tax system can play a role in encouraging the development and retention of IP in Canada.
The Department of Finance has launched a consultation paper on the SR&ED program, seeking feedback from Canadians and stakeholders on various issues and questions, such as:
- How to improve the support for R&D-intensive Canadian businesses;
- How to improve the eligibility criteria and the overall structure of the SR&ED program;
- How the SR&ED program can better complement other R&D support initiatives; and
- Whether there are more effective ways to provide assistance through the SR&ED program.
The consultation paper also includes a separate section on the suitability of creating a patent box regime in Canada, and the potential design and implementation issues of such a regime.
The consultation period will end on April 15, 2024, and the feedback received will inform the government’s decision-making on the SR&ED program and the tax system’s role in supporting R&D and IP in Canada.