R&D Credits: Reducing the Cost of Innovation

• Author: Ken Murray & Natan Aronshtam
• Pages: 225-244

225

Chapter 10

R&D Credits: Reducing the Cost

of Innovation

ken murray & natan aronshtam

A. INTRODUCTION

Government i ncentives for performing research and development (R&D)

come i n a variet y of forms, includin g grants, ta x credits and tax deduc-

tions, and offsets against a corporation’s payroll taxes. Tax credits reduce a

taxpayer’s taxes payable directly while additional deductions in computing

a taxpayer’s ta xable income indirect ly reduce the taxpayer’s tax liability. In

some cases, these tax incentives are refundable in cash to the R &D per-

former, even if the t axpayer has no corporate taxes payable. T hese incen-

tives can materially reduce the cost of a taxpayer’s developmental activities.

In this chapter, we will focus on the incentives that are available through

the tax system

Currently, over thirty countries offer various tax incentives to R&D per-

formers. Over the past few years, a number of countries, such as South

Africa, New Zealand, and the United States, have introduced tax incentives

for R&D; a number of ot her countr ies, such as Austria and France, have

enhanced their systems. The def‌inition of activities that qua lify as R&D

are remarkably similar bet ween these various tax incentive regimes. Many

countries use the def‌inition contained in the Frascati Manual1 as a basis

for their legislation. Even the United States, which does not use the def‌ini-

1 Organisation for Economic Co -operation and Development , Frascati Manual 2002: P roposed

Standard Prac tice for Surveys on R esearch and Exper imental Developm ent (Paris: OECD,

2002) at 29–45.

226 ken murray & natan aronshtam

tion contained in the Frascati Manual as a basis for criteria, has comparable

def‌initions. However, differences in the regimes arise in a number of areas,

including the rates of the incentives; types of expenditures that qualif y;

refundablity of t he incentives; territorial restrict ions; calculations of credit

(incrementally or volume-based), and so forth.

These incentives are v iewed by governments as either a tool for attract-

ing additional R &D to the country or, at the very least, retaining the same

level of R&D employment. In this chapter, we

explore the rationale for governments offering such incentives,•

examine the Canadian system, •

take a comparative look at other systems around the world; and •

describe opport unities for multinational companies to use these in-•

centives to reduce their overall costs of development.

Finally, the appendix provides a case study of the interrelationships between

the Canadian federal and provincial incentives.

B. RATIONALE FOR GOVERNMENT SUPPORT

The rationale for R&D incentives is that technological innovation is a major

motivator of economic growth. 2 In order to attract f‌ir ms that drive tech-

nological innovation, governments provide support. Otherwise, companies

would refrain from spending an optimum amount on R&D for their eco-

nomic returns do not justify the expenditure. The social benef‌its of R&D

spending, and its spin-offs, exceed those accruing to the f‌i rm that is in-

vesting in R&D. Therefore, government investment t argeted at increasing

private sector R&D is likely to generate external benef‌its to the economy as

a whole that are well in excess of the forgone tax revenues.

Through the var ious incentive programs, governments are try ing to in-

f‌luence R&D performers to either locate their activities in the country, or

to at least stop relocating research jobs out of the country. T herefore, the

availability of R&D incentives becomes one factor in ranking investment

decisions or planning the location of future development activities. Sophis-

ticated R&D performers have systems in place to captu re eligible activi-

ties and the related e xpenditures, and to a llocate the incentives back to the

group that actually performs the work. These groups build the incentives

into the future planning and budget ing process.

2 For a more complete explanat ion, see Canada, Depar tment of Finance, Why and How

Governmen ts Support Research and D evelopment (1997), online: w ww.f‌in.gc.ca/resdev/why_

e.html.