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Patent Box: Will Canada Lag Behind?

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Patent Box: Will Canada Lag Behind?
November 17, 2015

For the past 15 years, the Canadian economy has been plagued by a decreasing level of private innovation spending.

In its November 2014 report on science and technology policy, the Organisation for Economic Co-operation and Development (OECD) revealed that Canada is not keeping up with its global competitors in research and development: Canada dropped out of the top 10 R&D spenders to 12th overall[i]. Earlier, in September 2014, The World Economic Forum (WEF) ranked Canada 15th out of 144 countries (down by one spot vs. 2013) in its annual world competitive index[ii], due in part to Canada’s lower performance in innovation.

Research shows that sustained business enterprise expenditure on R&D is key to productivity and GDP growth. Even though Canada’s economy is weighted more toward resource-related companies (compared to its peers), and the resource sector tends to spend less on R&D, analysis conducted by the Expert Panel on Business Innovation suggests that Canada’s R&D spending tends to lag on a sector by sector basis, compared to the U.S[iii]. Going beyond the direct/indirect funding balance!

The federal government of Canada has been watching the R&D expenditure issue since 2007. In the 2012 budget, the government introduced several changes, generally consistent with the recommendations of the Jenkins Report on federal support for R&D. Issued in October 2011, the Jenkins Report timidly supported a shift in R&D support from indirect funding (indirect support for R&D delivered via the SR&ED tax credit system) to direct R&D support via increased government grants, additional funding allocated for venture capital initiatives, and improved government procurement practices to favour innovative suppliers[iv].

However, a mere shift in the direct/indirect funding balance might not be enough to cut it in a context where globalization and intensifying competition between countries not only involves R&D and innovation funding, but business-friendlier tax schemes as well. Both the Canadian Advanced Technology Alliance (CATA) in 2012[v] and the Canadian Manufacturers and Exporters (CME) in 2014[vi], requested the adoption of a patent box regime on income generated from certain types of qualifying intellectual property (IP), particularly patents. Patent box principle and evolution in Europe Patent boxes are tax mechanisms that encourage domestic innovation and the commercialization of innovative new products by generally lowering the tax rates on profits derived from intellectual property assets, such as patents, trademarks, brands and copyrights.

Though introduced in Europe in the 70s by Ireland, patent box regimes (named as such from one having to tick a box on the tax form that indicates this type of revenue) have been massively adopted by no less than 13 European countries since 2000 (Italy being the latest, in 2015). China also has such a regime. In Europe, however, the patent box regimes have received much criticism over the past couple of years because they support corporate tax practices that artificially shift profits to tax-favourable countries. A notable example was the UK Patent Box regime which took effect in April 2013. It proposed a very low 10% corporate tax rate with respect to profits derived from patent-protected products, regardless of where the research leading to the patent had been performed. Consequently, under pressure from Germany and scrutiny by the OECD Forum on Harmful Tax Practices, the EU countries agreed to move to a system (“modified nexus approach”) which links the advantages of “patent boxes” to a requirement for real research activity in the country of the patent.

Another study, issued in June 2015 by the European Commission[vii], confirmed concerns that the “patent box” regimes merely incentivized the multinationals to shift the location of their patents without a corresponding growth in the number of inventors or a shift of research activities. The study, therefore, reinforced the need for the “modified nexus approach” moving forward.

US Congress is considering a patent box regime After two failed attempts to implement a patent box tax in the U.S. Congress (in 2012 by Sen. Dianne Feinstein and in 2013 by Reps. Charles Boustany and Allyson Schwartz), the regime came back as a major topic of the Congress Tax Reform discussion last week. Sens. Rob Portman and Chuck Schumer, the bipartisan co-chairmen of a working group on international taxation[viii], released on Wednesday July 8th an outline of a plan to create a special low-tax rate for income from intellectual property. A patent box regime is also being currently advocated by private groups in Australia to better realise the full economic benefit from its investment in innovation.

Hence, as more and more OEDC countries adopt favourable measures when it comes to the commercialization of the later phases of R&D effort (i.e., IP, patents, licensing), the pressure increases on Canada to follow suit to avoid a further widening in its innovation gap due to the lack of a competitive innovation tax system. In addition, a Canadian patent box regime, if properly designed, would effectively complement the existing SR&ED Investment Tax Credit program, and therefore have the potential to incentivize companies both to locate their R&D activities and commercialize them in Canada.

[i] Science, Technology and Industry Outlook 2014, OECD

[ii] The Global Competitiveness Report 2014–2015, The World Economic Forum

[iii] Running on Empty: Canada’s Persistent Business R&D Weakness, The Conference Board of Canada, May 29, 2015 [iv] The Big And The Small Of Tax Support For R&D In Canada, K.J. McKenzie, July 2012, Introduction

[v] “A Canadian Version of the Patent Box: Will Canada say yes, or risk falling further behind […]”,CATA Advocacy campaign, December 2012

[vi] 2015 Federal Budget Recommendations, Canadian Manufacturers & Exporters, August 2014 [vii] Patent Boxes Design, Patents Location and Local R&D, European Commission, June 2015 [viii] The International Tax Bipartisan Tax Working Group Report, U.S. Senate Finance Committee, July 2015

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