Tax assistance for R&D: Canada stands out, but not for the right reasons

Canada, like many other nations, supports business R&D through the tax system; but Canada stands out in being unusually generous to small and medium-sized enterprises (SMEs). An international comparison of tax assistance for R&D showed that:

• SMEs undertaking R&D in Canada receive a subsidy through the tax system of just over 40%, the highest in the 38 countries in the comparison.
• Other firms in Canada receive a subsidy of approximately 21%, giving Canada an 11th place ranking internationally.
• Canada is one of only six countries that provides an extra incentive for R&D undertaken by SMEs; the extra support amounts to almost 20% of R&D expenses, compared to an average of about 6% for the other five countries.

The comparison group consists of most OECD member countries along with the BRIC group of countries (Brazil, Russia, India and China), Singapore and Hong Kong. Canada’s remarkably different approach to subsidizing R&D should make Canadians wonder if other countries know something we don’t.

The most common reason advanced for providing extra support for R&D undertaken by SMEs is that they have difficulty accessing external financing. Extra support is also justified by the observation that SMEs are the large firms of tomorrow, and extra support allows more SMEs to make the transition to large, successful firms. I have argued elsewhere that the extra support is a poor investment of taxpayer dollars; the fact that Canada stands out internationally in its treatment of R&D by SMEs reinforces this conclusion.

Unfortunately, Canada is headed in the wrong direction. Changes announced in the 2012 federal budget reduced the amount of tax support for all firms in Canada but widened the gap between SMEs and other firms. The smarter policy approach would be for the federal government to provide the same level of support to all firms through the tax system and use part of the savings to provide additional support for innovative startups through direct spending programs. With that policy change, taxpayers are much more likely to see a positive return on their investment in small firms.