Government of Canada finally launches consultations on SR&ED modernization

As promised late last month, the federal government has now launched consultations on its Scientific Research and Experimental Development (SR&ED) tax incentive program.

These consultations will focus on how to revamp the key research and development (R&D) tax credit to boost the creation and retention of intellectual property (IP) in Canada, per the announcement and as first reported by The Globe and Mail.

The Department of Finance is seeking feedback on how to modernize and improve SR&ED in “cost-neutral ways” and the suitability of adopting a patent box regime by April 15, as it considers whether to give firms that develop and keep IP in Canada a tax break on sales of their inventions globally.

The feds are seeking feedback on how to modernize SR&ED and whether to adopt a patent box regime.

Other questions posed by the Finance Department include: how to improve support for R&D-heavy Canadian firms; how to improve SR&ED’s eligibility criteria and overall structure; how it might better complement other R&D support initiatives; and whether there are more effective ways to provide assistance via SR&ED.

A Department of Finance spokesperson told BetaKit that the focus of these efforts is on “how to better target SR&ED to the broader goals of ensuring that support effectively benefits Canada and positions the country as a research and development leader.”

The feds first committed to a review of SR&ED in Budget 2022 to measure the program’s effectiveness and “explore opportunities to modernize and simplify it.” As part of this evaluation, Canada said at the time it planned to consider whether the tax system can support “the development and retention of [IP],” including the viability of a patent box approach.

As BetaKit previously reported, responses to this announcement were mixed. Some industry stakeholders have emphasized the need to overhaul SR&ED, while others have wondered what a review would achieve. Now, two budgets and nearly two years later, that SR&ED review is finally happening.

“We have long believed that this tax credit should be adjusted to prioritize Canadian firms and expand eligibility criteria to cover [IP] costs related to R&D,” wrote the Canadian Council of Innovators (CCI) in a statement responding to the announcement.

CCI, which represents Canadian scaleups, said it sees “plenty of cause for optimism” in the Department of Finance’s initial documentation about the consultation process, and described the government’s study of a patent box policy as a mechanism to spur IP generation and commercialization in Canada as “encouraging news.”

As Canada navigates a challenging fiscal and broader economic environment, the government has stated its intention to make any SR&ED changes “cost-neutral.”

Administered by the Canada Revenue Agency, SR&ED represents Canada’s largest federal program for business R&D. Introduced in 1948, the initiative provides over $3.5 billion in tax incentives annually to encourage Canadian tech companies and other firms to engage in R&D.

The Government of Canada has described SR&ED as “a cornerstone” of the country’s innovation strategy.

But the feds have largely struggled to implement that broader innovation agenda—punting the launch of the Canada Innovation Corporation and the rollout of open banking, among other things—and faced difficulty parlaying it into meaningful economic growth for Canada.

The country’s productivity woes are well documented, and Canada has long ranked below its peers in business R&D spending and IP generation. Overhauling SR&ED could help address these issues.

CCI has previously shared recommendations on how to modernize the SR&ED program, calling on the feds to: broaden eligible expenditures to include more IP-related activities; ensure SR&ED explicitly covers commercialization; restructure spending thresholds for claims; and come up with new evaluation metrics.

CCI and other organizations have also called on the feds to simplify the lengthy, complex SR&ED application process and streamline funding disbursement.

Senator Colin Deacon hailed the review’s IP focus as “an important shift in priorities.” In an interview with BetaKit, Deacon described IP as key to Canada’s prosperity, citing a 2023 Senate report which found that implementing a “globally competitive” IP regime would stimulate more business investment in Canada.

“We need to own—have Canadian companies exploiting Canadian [IP] for the benefit of Canadians—creating opportunities, jobs and wealth in Canada,” argued Deacon, who believes SR&ED is ripe for an overhaul. “I think we really do need to revamp it, make it simpler, make sure that it’s generating IP that is owned and exploited in Canada, and that we’re getting the best out of every dollar in the program.”

Others were more skeptical of these efforts, including Munk School senior fellow Graeme Moffat, who called it “lipstick on a pig,” arguing that an IP-related tax break “won’t fix SR&ED or innovation: it will create jobs for IP specialists inside SR&ED consultancies.”

Currently, SR&ED allows Canadian-controlled private companies to earn tax credits of 35 percent for up to $3 million in eligible R&D expenses, and 15 percent beyond that. The program also permits public and foreign companies to receive 15 percent tax credits for qualified expenditures in Canada. According to a 2018 analysis by The Logic, large firms, including foreign subsidiaries, have benefitted the most from SR&ED.

“We really do need to revamp it, make it simpler, make sure that it’s generating IP that is owned and exploited in Canada, and that we’re getting the best out of every dollar in the program.”

In a recent blog post, CCI argued that maintaining the refundable SR&ED rate of 35 percent for smaller businesses makes sense as they “are capital-hungry and often have little revenue.” But CCI suggested that as companies scale, it would be worth reducing the rate available and using the savings to finance a commercialization and IP incentive, like a patent box structure.

Patent boxes reduce taxes on profits resulting from domestic IP commercialization. European countries like Britain, France, Spain, and Switzerland have already implemented such regimes.

“De-emphasizing research subsidies and incentivizing seeking new revenues linked to research, development, and IP rights would put the focus of public support where it should be—on outcomes instead of inputs,” argued CCI director of policy and research Laurent Carbonneau in the post. “This is probably the most bang for buck that Canada could get with a cost-neutral approach.”

Others, including Robert Asselin, senior vice president of policy at the Business Council of Canada, and Technation—two lobby groups that represent both domestic and foreign firms—have previously argued that greater SR&ED benefits should flow through to large companies to encourage innovative businesses to scale up and reward them for their impact.

With files from Bianca Bharti.

UPDATE (02/01/24): This story has been updated to include additional comments from CCI.

Feature image courtesy Justin Trudeau via Flickr.