April 5, 2022 – Canada needs to create an Intellectual Property (IP) Box to improve its lacklustre innovation performance, according to a new study from the C.D. Howe Institute. An IP Box would tax income from patents and other intellectual property at a special low rate. This initiative would boost Canada’s flagging business investment in R&D, raise our low commercialization rate, and stem an outflow of IP profits to tax havens.
In “An Intellectual Property Box for Canada: Why and How,” author John Lester examines Canada’s case for an IP Box, and describes how it could be designed and implemented.
The key argument for this measure is that it defends against “poaching” of highly mobile IP income by low tax jurisdictions, particularly tax havens, writes Lester. The standard counterargument is that IP Boxes trigger competition for mobile IP income, which will eventually drive the preferential tax rate down to zero. However, this criticism has lost its force due to two developments. The first is an OECD-inspired international agreement that income taxed at a preferential rate must be derived from R&D performed in the implementing jurisdiction. The second is the tentative agreement on a global minimum tax rate. With these two developments, an IP Box can protect Canada’s tax base without engendering competition for highly mobile IP income.
If the tentative agreement on a global minimum rate is ratified by most countries, setting the IP Box rate at, or slightly above, the 15 percent minimum rate could eliminate outbound shifting of IP profits, substantially reducing its fiscal cost.
An IP Box also has two other advantages: encouraging additional investment in R&D by raising the after-tax return on successful R&D projects, and promoting more commercialization activity in Canada.
“An IP Box is a cost effective way to boost R&D and commercialization in Canada because it is partly financed by tax revenue recovered from tax havens,” says Lester.
In addition to aligning the preferential rate with the global minimum tax rate, Lester says the cost effectiveness of an IP Box will be maximized if: (i) the preferential rate applies to income from all IP created from R&D in Canada, not just patents; and (ii) qualifying income includes not only explicit royalties and licensing fees, but also implicit IP income embedded in products sold or in production processes developed from R&D performed in Canada.
A carefully designed IP Box is likely to be a more cost-effective way of promoting innovation by large firms than an increase of equivalent value in the regular Scientific Research and Experimental Development (SR&ED) investment tax credit. The impacts on R&D are likely to be similar, but the fiscal cost would be smaller because more IP profits will be taxed in Canada.
With R&D performed by large firms below its optimal level, Lester suggests it would be good public policy to maintain the SR&ED tax credit at its current level when implementing an IP Box.
Lester also argues for Ottawa to create a national program in order to keep administration and compliance costs low. Further, since provincial governments would receive a windfall revenue gain from repatriation of IP income from tax havens, Lester says there is a strong case for the federal program to implement an IP Box using a tax deduction, rather than a tax credit. A deduction would reduce the tax base of provinces that have signed a tax collection agreement, so these provinces would share in both the costs and the benefits of an IP Box.
Participation by Quebec and Alberta, which have not signed such tax collection agreements, would be at their discretion. Quebec already has a preferential IP regime. A federal deduction would reduce the overall IP income tax rate for firms operating in Quebec below the global minimum rate of 15 percent, giving Quebec an incentive to increase its preferential rate.
For more information contact: John Lester, Executive Fellow at the School of Public Policy, University of Calgary; or Lauren Malyk, Communications Officer, 416-865-1904 Ext. 0247, lmalyk@cdhowe.org
The C.D. Howe Institute is an independent not-for-profit research institute whose mission is to raise living standards by fostering economically sound public policies. Widely considered to be Canada's most influential think tank, the Institute is a trusted source of essential policy intelligence, distinguished by research that is nonpartisan, evidence-based and subject to definitive expert review.