Rewarding innovation: Improving federal tax support for business R&D in Canada

Business innovation is key to a creating a highly productive Canadian economy. One concern is that Canadian businesses have relatively low levels of business research and development (R&D), despite access to some of the world's most generous R&D tax subsidies. This doesn't mean that tax credits do not stimulate R&D; indeed, research suggests they do. Rather, low business R&D appears to be rooted in structural aspects of the economy and, more importantly, a lack of demand-related pressure to pursue innovation as a business strategy. This paper looks at the impact of the federal R&D tax credit, and proposes tax options aimed at improving Canada's innovation performance. It argues that Canada's best bet is to focus on creating a competitive tax system across the entire innovation value chain. The current system is mainly designed to " push " firms to undertake R&D through generous upfront subsidies. Meanwhile, the rewards of innovation—income from intellectual property and new products and services—are taxed at rates that are far less competitive. The federal government should focus its efforts on addressing market " pull " factors by keeping taxes on the rewards of innovation at internationally competitive levels. It should also consider options to reduce tax disincentives for small, innovative firms to grow into larger, globally competitive companies.