Improving the Tax Treatment of Intellectual Property Income in Canada

Policymakers are concerned that Canadian businesses invest too little in innovative processes, on the view that this inhibits productivity, growth, and incomes. The evidence can be found in Canada’s low rate of growth in patent registrations and low rates of commercialization of new products and services vis-a-vis other member countries of the Organisation for Economic Co-operation and Development (OECD) and developing economies such as Brazil, China, and India. Some observers express concern over a presumed “innovation gap,” and the share of Canadian patents that are held abroad. Canada’s apparently lagging performance presents a puzzle with respect to research and development, because its federal and provincial tax systems treat business R&D spending quite generously, as compared with international peers. In this report, we address one policy aspect of these issues: the taxation of the fruits of innovation. In discussing the preferential treatment of income associated with business investment in research and development (R&D) and its commercialization and adoption, we pursue what are sometimes referred to as “pull” factors, which encourage firms to adopt innovative processes. In contrast, “push” factors encourage firms to invest in R&D irrespective of its link to innovation or the adoption of new technologies or processes, as is the current case in Canada. We present an option for modifying – by way of a new incentive model, known as a “patent box” or “innovation box” – Canada’s current tax treatment of the income derived from exploiting the fruits of R&D. This would complement and in part refocus the tax preferences that business expenditures on R&D now receive. Under our suggestion, businesses possibly would receive less tax relief for conducting R&D, and more for adopting, commercializing, or otherwise exploiting the output of the R&D process – in short, a pull, rather than a push, into R&D activity.