Work Smarter, Not Harder: Cost-neutral ideas for reforming SR&ED

By Laurent Carbonneau

CCI Director of Policy and Research

The venerable Scientific Research and Experimental Development (SR&ED) tax credit is Canada’s innovation policy workhorse. It will cost the public purse nearly $4 billion in foregone revenues this coming year.  

By way of comparison, Canada’s federal science and engineering research council, NSERC, disbursed $1.3 billion over the most recent fiscal year. Adding in health research funded through CIHR effectively doubles that number, but still leaves SR&ED as the single biggest source of federal dollars for research and development. Even direct support measures like the (oft-rebranded) Global Innovation Clusters or the (very-punted) Canadian Innovation Corporation represent comparatively small investments.  

Late last December, the federal government announced that it would be undertaking the review of SR&ED promised in Budget 2022 – with the added twist that they are looking to make changes cost-neutral in a challenging fiscal environment. The stakes are high, and it’ll be important to get it right.

We’ve touched on Canada’s historic weakness in R&D and innovation here at Mooseworks before, and CCI’s Chair, Jim Balsillie, recently wrote a piece in the National Post that helps frame what doesn’t work right now about SR&ED. Fundamentally, Canadian businesses will invest in R&D when they can ensure that they have freedom to operate. Otherwise, they are doing scientific philanthropy, not investing in new intangible assets that they can commercialize.

In a globalized economy, countries struggle just as companies do to capture the benefits of their investments in R&D. Subsidizing R&D in one jurisdiction doesn’t guarantee that the benefits will accrue in the same place. Our policies should recognize that reality. Canada should be looking to get the greatest economic return possible from the tax dollars we invest into SR&ED.  

We currently have one of the most generous R&D tax regimes in the developed world, but don’t rank as highly in innovation outcomes.  

We could and should be more deliberate about maximizing that return. In recent years, our Pan-Canadian AI Strategy, to take one example, has seen three-quarters of valuable IP rights whose development the strategy supported shipped out to other jurisdictions. Similarly, a considerable fraction of SR&ED dollars is going to large, foreign-headquartered corporations who will repatriate valuable IP and sell us back the resulting products and services. With the exception of well-compensated jobs for researchers, engineers and designers – who don’t exactly struggle to find work in any case – Canada ends up not seeing much of the value of its investment.

As we learned in looking at Quebec’s video game production tax credit (CTMM), big claimants (and consultants) do well out of generous tax credit structures like SR&ED and the CTMM – and French-headquartered Ubisoft captured $100 million of that incentive’s $350 million bottom line.

Similarly, analysis from The Logic found that in the case of SR&ED, large firms got the most benefit (compared to small and medium firms) and foreign subsidiaries received about a quarter of all large-firm dollars. CCI has also called for making who benefits from SRED more transparent, and certainly continue to think that should be part of any reform package.

So, what can we do to shift SR&ED in a cost-neutral way? We can look once again to the research done on the Quebec tax credit and think about what we are actually incentivizing companies to do. The authors of that study argued that the CTMM credit should focus less on subsidizing production inputs and more on activities likely to generate more sales and revenues – things that lead directly to growth.

Maintaining the refundable SR&ED rate of 35% for smaller businesses makes sense – they are capital-hungry and often have little revenue. But as companies scale and become more sophisticated and grow their revenues, it would make sense to tune down the SR&ED non-refundable rate that all businesses can access, and the government could use the savings to create a commercialization and IP incentive akin to a patent box structure. We could call it the Canadian Commercialization Incentive – we think CCI has a nice ring to it.

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.

This is probably the most bang for buck that Canada could get with a cost-neutral approach. As innovation policy continues to evolve in a more cost-constrained fiscal environment, we have to think hard about the kinds of trade-offs we will have to make in making sure Canadians see real value for their investments in future growth and productivity.

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