An International Comparison of Tax Assistance for R&D: 2017 Update and Extension to Patent Boxes

Abstract

Business investment in research and development (R&D) is widely recognized as providing benefits to the broader economy that exceed the benefits to the firms that perform the R&D. As a result of this externality or spillover, most governments provide support for R&D in order to encourage more of it. In 2017, 29 of the 35 members of the Organisation for Economic Co-operation and Development (OECD) provided tax incentives for spending on R&D. That’s up slightly since 2014, when we last prepared an international comparison of tax assistance for R&D. On the other hand, average support levels edged down from 2014 to 2017. In addition to these expenditure-based measures, 15 OECD countries provide preferential tax treatment for the income generated by commercializing R&D and other innovative activities. These income-based measures are often described as patent boxes, since they first applied to income realized from patented products and processes. In most cases, the qualifying patents did not have to be based on R&D performed in the country offering the incentive, so patent boxes were criticized for creating an incentive to shift taxable income without encouraging additional R&D. Recently, however, most countries have accepted the OECD recommendation that both the R&D and the income from its commercialization must be located in the same jurisdiction before an income-based incentive can be provided. With this linkage, income-based incentives can be a useful policy tool, particularly for large firms. Income- and expenditure-based incentives are likely to have similar impacts on the amount of R&D undertaken by large firms, but income-based measures have the advantage of providing a greater incentive to commercialize R&D in the implementing jurisdiction. They also blunt the incentive to shift the taxable income generated by commercializing R&D to lower-tax jurisdictions. However, smaller firms, who are more likely to be cashflow constrained, will respond less strongly to income-based measures since the subsidy is available with a delay. Further, small firms have limited opportunities to shift taxable income across international borders. Should the federal government implement an income-based tax incentive for R&D performed by large firms? A key consideration is what happens to tax revenue on income from commercialization of R&D. If a lower tax rate results in higher revenue as a result of tax base shifting effects, income-based measures have a clear advantage over their expenditure-based counterparts. Some competing jurisdictions have very low corporate income tax rates, so feasible reductions in federal tax rates may not generate tax base shifting effects large enough to make the policy a success. More information on how multi-national enterprises shift intellectual-property income out of Canada is required before proceeding with income-based tax incentives for R&D.