SCIENTIFIC RESEARCH AND EXPERIMENTAL
DEVELOPMENT: TAX POLICY
Revised 31 August 1998
TABLE OF CONTENTS
A. Justification for Government Support of
B. Delivery of SR&ED Tax Incentives
C. Historical Overview
1. From 1944 to 1986
1987 to 1993
D. Comments on Tax Measures Related to SR&ED
AND EXPERIMENTAL DEVELOPMENT:
The role of Scientific Research
and Experimental Development (SR&ED) in strengthening the competitive
position of industry in the medium and long term is well established.
SR&ED activities result in innovation through the creation of new
processes and products, improve the quality of existing ones, enhance
corporate productivity and reduce operating costs, thereby increasing
profitability. Nor are the benefits of SR&ED limited to the industrial
sector; the entire economy benefits from initiatives in this area. In
fact, scientific research is crucial to sustained economic growth and
an improved standard of living.
For these reasons, the federal
government has long been a supporter of research activities in industry.
In addition to providing subsidies and contracts to encourage research,
it supports corporate SR&ED through tax incentives. These differ from
direct financing mechanisms in that they are relatively neutral with respect
to specific SR&ED activities or sectors of production. The industrial
sector is in the best position to decide the type and amount of scientific
research it should undertake and companies are free to decide where to
make SR&ED investments.
Fiscal measures modify the
after-tax cost of SR&ED investments in that businesses incurring SR&ED
expenditures are entitled to tax deductions and credits. These measures
represent a tax expense, or loss of revenue, for the government. Tax measures
may either serve as a substitute for budget expenditures or complement
direct financing methods. They are, however, much more difficult to evaluate
This current issue review
looks at the basis for government action in this area and at how federal
tax measures in respect of SR&ED generally work. The history of tax
incentives for industrial SR&ED in Canada is then examined, and some
observations are made on tax incentives for scientific research.
BACKGROUND AND ANALYSIS
A. Justification for Government
Support of SR&ED
Government funding of industrial
SR&ED is generally considered justifiable because the resulting benefits
to society are greater than the benefits to individual firms. The company
conducting SR&ED activities is not always in a position to take full
advantage of related benefits, but some of the knowledge gained benefits
the community in general. Furthermore, SR&ED results can be copied,
at times even before the innovating company has had the opportunity to
recover all of its costs. Moreover, the degree of financial risk associated
with SR&ED activities may discourage companies from investing in research.
It is argued that unless the government promotes industrial SR&ED,
it is quite likely that companies will not invest sufficiently in SR&ED
activities, since their actions will be guided solely by the returns they
hope to generate.
Even without any kind of
government incentive, some industrial SR&ED research would be carried
out, but this would be only as much as would bring private benefits. Consequently,
any kind of incentive will have a positive impact if it prompts businesses
to make more than this minimum SR&ED effort. That is the goal of the
federal governments industrial innovation policy, which is aimed
at correcting the legendary under investment in SR&ED by Canadian
B. Delivery of SR&ED Tax Incentives
Federal government tax incentives
for SR&ED target three types of research: basic research, work performed
for the advancement of knowledge and science without any practical application
in mind; applied research, carried out for the advancement of science,
but with a specific application in mind; and experimental development,
aimed at achieving technological progress. In experimental development
the results of basic and applied research are used to create new products
or processes, or to improve those that already exist.
To take advantage of tax
incentives for SR&ED, a company must be able to show that it has invested
in one of these types of research. Both current and capital expenditures
qualify for federal SR&ED tax incentives. Current expenditures include
the salaries of research personnel, general SR&ED costs (telephone
and electricity, office equipment and so forth), as well as costs, including
maintenance costs, associated with facilities and equipment used for SR&ED
purposes. Capital expenditures include assets facilities and equipment
but not buildings used for SR&ED purposes.
For the purposes of SR&ED
incentives, corporations are classified according to their size and controlling
interest. In one category are Canadian-controlled private corporations
(CCPCs) established in Canada and controlled neither by government-owned
agencies nor by non-residents; a "small" CCPC is a corporation
with a taxable income of less than $200,000. All remaining corporations
fall into the other category.
SR&ED tax incentives
apply to internal SR&ED and external SR&ED carried out for other
corporations. Most corporations carry out their own SR&ED internally
and are thus themselves the beneficiaries of the tax incentives. Others
contract out all or part of their SR&ED to entrepreneurs. Corporations
that contract out SR&ED are also eligible for SR&ED tax incentives.
Canadian corporations that
incur eligible research expenses may benefit from three federal SR&ED
tax incentives: the deduction, the tax credit and, in some instances,
the tax credit refund. The aim of SR&ED incentives is to compensate
for the high degree of risk involved in investing in research activities
by lowering their real costs; the ultimate goal is to enhance the overall
SR&ED effort in Canada.
The deduction lowers taxable
income and consequently, the tax payable. With the deduction, a business
that spends $1,000 on SR&ED activities and is taxed at the rate of
30% saves $300 ($1,000 * 30%). Thus, its net cost for SR&ED is $700.
The tax credit, which applies
to a percentage of overall SR&ED, serves directly to lower the tax
payable. Suppose that the business in the example above also qualifies
for a tax credit of 20%. The value of the credit is $200 ($1,000 * 20%).
However, for corporate tax purposes, the tax credit amount is considered
income and must be included in the firms taxable income. Thus, the
firms real savings will total $200 * (1-30%) or $140. If the company
owes little or no tax at all, it can even claim a total or partial refund
of this tax credit.
Therefore, tax measures
lower the after-tax cost of SR&ED investment. In the above example,
the real cost of SR&ED is $560, or ($1,000 - $440). In other words,
tax measures allow a firm to recover more than 40% of its initial SR&ED
Such tax measures, which
lower a firms initial SR&ED costs, represent a tax expenditure
or loss of revenue for the federal government (in our example, a loss
of $440). The federal government believes that this loss of revenue leads
to increased SR&ED activities in Canada and ultimately, to positive
spinoffs which outweigh the drop in federal revenues. These spinoffs benefit
not only the industrial sector, but the entire Canadian economy.
C. Historical Overview
The history of federal tax
incentives for SR&ED can be divided into three periods. Between 1944
and 1986, traditional tax measures such as the deduction and the tax credit
were introduced, together with some additional tax measures that were
tested and found wanting. Between 1986 and 1993, the deduction and the
tax credit were fine-tuned to facilitate their use and improve the administration
process. Since 1994, which marked the start of the third period, the focus
has been on broadening and facilitating access to the SR&ED tax system.
1. From 1944 to 1986
The federal government has
for many years been stimulating SR&ED activities through the Income
Tax Act. As early as 1944, companies could, pursuant to this legislation,
deduct immediately from their taxable income an amount equivalent to 100%
of current expenditures in respect of scientific research. Until 1960,
companies could also deduct one-third of capital expenditures incurred
for SR&ED in a taxation year. The legislation was amended in 1961
to make capital expenditures fully deductible in the taxation year in
which they were incurred.
From 1962 to 1966, the federal
government also allowed an incremental tax deduction equivalent to 50%
of current and capital expenditures exceeding the 1961 level. As the name
indicates, the incremental tax deduction allowed companies with higher
SR&ED expenditures to lower their taxable income even further. Companies
claiming the additional deduction reduced their taxes by approximately
$60 million during this period. The measure was replaced in 1967 by cash
grants introduced under the Industrial Research and Development Incentives
Act (IRDIA). These cash grants were equal to 25% of capital expenditures
and 25% of current expenditures in excess of the average for the preceding
five years. Their purpose was to offer the same benefits as the additional
50% deduction, while providing financial support to non-taxable companies
involved in SR&ED, in particular small CCPCs previously unable to
take advantage of federal tax policy. Nearly $290 million was awarded
under the IRDIA, which was repealed in 1975.
The federal government further
amended the Income Tax Act in 1977, introducing a tax credit ranging
from 5% to 10% of current and capital expenditures, depending on the nature
of the firm and the region in Canada where the activities were carried
out. A new legislative provision, whereby the tax credit had to be taken
into account in calculating taxable income was introduced; this provision,
which has decreased the full effect of the tax credit through the companys
rate of taxation, is still in effect today. In addition, in 1978 the basic
tax credit rate was increased to 10%, the exceptions being the Atlantic
provinces and the Gaspé region, where the rate rose to 20%, and small
businesses, where it rose to 25%.
That same year, the federal
government introduced another SR&ED tax incentive in the form of additional
tax relief for scientific research. The deduction is similar to that in
effect between 1962 and 1966. Companies were allowed to deduct from their
taxable income 50% of all SR&ED expenditures exceeding their recorded
average for the three preceding years. Since the goal was to attract venture
capital, companies conducting SR&ED were allowed to waive the tax
deduction and transfer it to outside investors. This measure spawned abuses,
At that time, certain non-taxable
companies could not claim the general deduction or the tax credit, while
others could not claim the full deduction and credit. This encouraged
them to seek out new mechanisms to transfer these tax incentives to those
who could use them. Some people set up limited partnerships to act as
outside investors. A passive outside investor could arrange to have a
research firm conduct SR&ED on his behalf. Investments of this nature
increased the companys research expenditures, thereby qualifying
the investor for the tax deduction and credit. Moreover, SR&ED expenditures
that were not considered "additional" for the research company
were viewed as such for the investor, who had previously incurred no such
expenses at all. The passive investor was thus also able to benefit from
the incremental 50% deduction. It is estimated that claims related to
tax relief cost the federal government more than $2.5 billion.
As a result of reported
abuses, the federal government abolished the 50% incremental deduction
in 1983 and introduced new tax provisions. To begin with, the tax credit
rates were increased by 10 percentage points over their 1978 level. The
basic rate was set at 20%, while the rate in effect in the Atlantic provinces
and the Gaspé region was set at 30% and the rate for small CCPCs was set
at 35%. The government then introduced excellent carry- forward provisions
for the tax deduction and credit. Corporations were allowed to carry forward
their SR&ED deduction indefinitely to offset future taxable income.
Unused tax credits could be combined and either carried back for three
years or forward for seven. The federal government also made certain corporations
eligible to receive tax credits in the form of a cash refund. In the case
of large corporations, the refunds were equal to 20% of the value of the
tax credits, while for small CCPCs, the rate was 100% on the first $2
million of eligible SR&ED expenditures and 40% on capital expenditures
linked to scientific research. The federal government introduced this
refund to ensure that small CCPCs with no tax payable would also benefit
from tax incentives.
The last measure introduced
was the scientific research tax credit. Companies were able to enter into
research contracts on behalf of an outside investor who had acquired shares
or debt securities for SR&ED purposes. To offset this move, companies
were required to waive their tax incentives, while outside investors qualified
for a tax credit of 50% of their investment. This measure also proved
to be an excellent tax loophole. It allowed outside investors to turn
a quick profit by investing in research, without anything to show that
the tax savings thus realized were being poured back into SR&ED activities.
As a result of this mechanism, outside investors benefited from more than
$1.6 billion in tax relief between 1983 and 1985, the year in which the
measure was abolished.
2. 1987 to 1993
In an effort to broaden
its tax base and also probably to limit abuses of the tax system as it
applied to SR&ED, in 1987 the federal government launched a major
reform of tax incentives for scientific research. Its entire focus was
on the traditional tax measures, that is the deduction and tax credit,
and on redefining the meaning of "scientific research and experimental
development" as set out in the Income Tax Act.
The legislation was amended
to ensure that the beneficiary of the tax incentives in respect of SR&ED
was directly associated with the research activities; the effect of this
provision was to limit the number of passive investors. Furthermore, companies
would no longer qualify for tax incentives unless the expenditures incurred
were "all or substantially all attributable" (90% or more) to
SR&ED activities. The government then moved to exclude expenses incurred
for the purchase of buildings from the definition of SR&ED expenditures.
The amount of tax credit that could be claimed for SR&ED was limited
to 75% of federal tax payable (although this limit was eliminated in the
1993 budget). However, carry-forward provisions were enriched so that
unused credits could be carried back for three years or forward for ten.
Finally, the federal government eliminated the refundable tax credit at
the basic rate of 20% for large corporations, but maintained the partial
(40%) or full (100%) refund for small CCPCs.
3. Since 1994
The current tax system as
it applies to SR&ED incorporates part of the components of the 1987
reform and other improvements made to the Income Tax Act since
As in the past, deductibility
of SR&ED expenditures depends on the type of expenditures and where
they were incurred. Both current and capital expenditures incurred in
Canada are deductible; however, of expenditures incurred outside Canada,
only current expenditures are deductible. SR&ED expenditures incurred
in Canada may either be deducted in the taxation year in which they are
incurred, or carried forward and deducted later. Current expenditures
incurred outside Canada must be deducted immediately.
Provisions respecting eligibility
are much broader than before. Under the new system, the deductions of
corporations are no longer limited to expenditures that are all, or substantially
all, attributable to SR&ED activities. Since 1994, the "portion
of expenditures directly attributable" to SR&ED activities has
also been deductible. For example, if 30% of a building is used for SR&ED
and the remaining areas for production or manufacturing purposes, corporations
can claim a deduction for that portion of the costs associated with the
use of the building for SR&ED purposes.
Of course, some companies
may have a hard time pinpointing exact costs and assessing the specific
portion of expenditures directly attributable to SR&ED. Two options
are available under the legislation. Corporations can choose either to
claim a deduction based on a portion of the expenditures that has been
accurately assessed (with supporting evidence), or they can use the "alternative
method," which was introduced in 1994. This involves waiving the
deduction for overhead costs (one of the categories of current expenditures)
and claiming a tax credit for these costs, which is calculated on the
basis of a "proxy amount." This provision will be explained
in greater detail below.
The SR&ED tax credit
currently granted by the federal government is substantially similar to
that offered to Canadian companies since 1987. The general tax credit
rate is set at 20%, 35% for small CCPCs. The 35% rate for small CCPCs
applies only to the first $2 million in eligible SR&ED expenditures.
Unused tax credits can still be carried back three years or forward ten
years. The special 30% tax credit rate for companies involved in SR&ED
activities in the Atlantic and Gaspé regions was eliminated in 1994. The
rates now depend on company size, as elsewhere in Canada. It appears that
the preferential rate did not succeed in attracting new investment to
these regions or alleviating regional disparities. In announcing the change,
however, the Minister of Finance did not say whether more effective and
appropriate measures would be put in place to promote industrial and technological
growth in these regions.
However, four significant
improvements made to the legislation in 1994 distinguish the current tax
credit system from the last. First, a corporation that waives the inclusion
of overhead costs in the calculation of SR&ED expenditures qualifying
for the deduction can now claim a tax credit in respect of these costs.
The latter are estimated according to a proxy amount set by the legislation
at 65% of the salary base directly attributable to SR&ED.
Second, since 1994, a partial
tax credit can be claimed that consists of half the normal credit applicable
to the cost of equipment used for SR&ED between 50% and 90% of the
time (this is multi-purpose equipment or equipment used mainly but not
entirely or nearly entirely for SR&ED). Unlike the full tax credit
(for equipment used for SR&ED purposes 90% to 100% of the time), which
can be claimed for the year of use, the new tax credit must be claimed
in two equal instalments in the two years following the year of acquisition.
Thus the partial credit cannot be carried forward to a future tax year.
Table 1 illustrates how the tax credits on shared equipment use are now
delivered to a company in a 20% tax credit region.
TAX CREDIT ON $100 EXPENDITURE FOR SHARED USE EQUIPMENT
(20% TAX CREDIT)
Percentage of Asset Used for SR&ED
0% - 49%
50% - 89%
90% and More
Source: Government of Canada,
"Modifications to the Scientific Research and Experimental Development
Tax Incentives," News Release, 2 December 1992.
Thirdly, as a result of
the 1994 amendments, CCPCs with taxable earnings of between $200,000 and
$400,000 qualify for the tax credit for small corporations. The one restriction,
however, is that the tax credit decreases as the corporations taxable
income rises. Specifically, the business limit on SR&ED expenditures
(currently set at $2 million) is reduced by $10 for each dollar by which
the taxable income of the corporation exceeds $200,000.
Fourthly, CCPCs with taxable
incomes of between $200,000 and $400,000 also qualify for a tax credit
refund similar to that granted to small businesses. Here again, a business
limit based on taxable income applies.
The federal government also
announced further changes to SR&ED tax incentives in its 22 February
1994 budget. Starting on 31 December 1994, it eliminated the special tax
credit rate of 30% granted to corporations involved in SR&ED in the
Atlantic provinces and the Gaspé region. Rates are now determined on the
basis of the corporations size, as is the case elsewhere in the
country. Evidently the preferential rate failed to attract new investment
to these regions and to alleviate economic disparities. The Minister of
Finance did not specify in his budget speech if other, more effective
and suitable, measures would be introduced to stimulate industrial and
technological growth in these regions.
With respect to the tax
credit for SR&ED available to CCPCs with taxable incomes of between
$200,000 and $400,000, the budget established a ceiling to be calculated
not on taxable income, but on the corporations taxable capital.
According to the Finance Minister, the reason for the proposed change
was to ensure consistency with the changes to the business ceiling with
respect to the general application of the corporate income tax system.
From now on, the ceiling on SR&ED expenditures declines as the corporations
taxable capital in Canada increases from $10 to $15 million. The proposed
measure could reduce the amount of a corporations tax credit or
the refundable portion of the tax credit. Table 2 illustrates the impact
of these changes.
The 1994 budget also
changed the rules governing the tax credit applicable to corporations
most or all of whose income is derived from SR&ED-related activities.
These corporations were exempted from the rules excluding some expenditures
(such as legal fees and interest payments) from expenditures eligible
for SR&ED credits. The result is more standard treatment for all corporations
carrying out research.
The 1994 budget also limited
claims for tax credit adjustments for previous years. There had previously
been no time limit for identifying previous years eligible SR&ED
expenditures. The changes limited eligible expenditures to those declared
by corporations on a form to be returned to Revenue Canada no later than
the tax filing deadline for the year following the year in which the expenditures
were made. These changes were the result of concerns expressed by the
Auditor General of Canada in the 1994 Annual Report. He had noted that
some corporations, realizing that they were eligible for the SR&ED
tax credit, were using the carry-forward provision to claim tax credits
for several years, thereby considerably increasing the federal governments
tax expenditures. The 1994 changes should put an end to the unexpected
influx of claims for this tax credit.
SR&ED TAX CREDIT EARNED BY CORPORATIONS
WITH TAXABLE INCOMES OF BETWEEN $200,000 AND $400,000(1)
Type of Corporation
Total Credit Earned
(1) Assuming current SR&ED
expenditures of $2 million and a tax credit rate of 20%.
Minister of Finance, the Honourable Paul Martin, Tax Measures: Supplementary
Information, 22 February 1994; Minister of Finance, the Honourable
Don Mazankowski, The 1993 Budget, 26 April 1993; Research
Branch, Library of Parliament.
Moreover, Bill C-27, which
received Royal Assent on 15 June 1994, requires companies to identify
expenditures that qualify for the SR&ED tax credits. Formerly, Revenue
Canada had to make adjustments to SR&ED tax credits when they were
not claimed in the taxation year in which the expenditures were incurred.
Under Bill C-27, companies themselves must now calculate the portion of
the expenditures qualifying for a tax credit that they wish to carry forward.
In addition, under the legislation, companies must declare their qualifying
expenditures not later than two years after they are incurred. Since it
is companies that benefit from these tax measures, it seems appropriate
that they should be responsible for calculating the adjustments. These
amendments will greatly simplify the administration of the SR&ED tax
credit program and reduce costs. The amendments should also limit the
number of claims arising from previous fiscal years.
The federal budget brought
down on 27 February 1995 announced additional changes to tax credit provisions.
The budget proposes changes in four specific areas: information technology
R&D, contract R&D and non-arms length transactions; third-party
payments; and unpaid amounts.
The changes concerning information
technology resulted from observations that Canadian chartered banks were
claiming tax advantages for information technology development expenditures
(on software and hardware for gathering, processing and distributing information).
The federal government decided to review this situation and, in the meantime,
temporarily made financial institutions ineligible for SR&ED tax advantages
with respect to information technology. The results of the review were
announced in the 6 March 1996 budget. The government concluded that the
rules governing SR&ED tax incentives must apply to all businesses
investing in information technology, including financial institutions.
The government believes that potential problems can be solved by changing
the administrative directives or broadening audits.
The 1995 budget subsequently
changed some rules governing SR&ED contracts, particularly transactions
between related parties. Companies contracting out SR&ED are eligible
for tax incentives applicable to the amount of the contracts. This amount
usually includes sums that would not be eligible for the tax incentives
if the SR&ED were carried out internally (for example, profits, the
costs of renting buildings, and interest payments). When there is a relationship
of dependence between the payer and the SR&ED contractor (for example,
a parent corporation and a subsidiary), there is clearly greater latitude
for setting (or overestimating) the value of contracts. The 1995 budget
ensured that expenditures eligible for the tax incentives under contracts
with related parties would in future be limited to the costs incurred
by the contractors in carrying out the SR&ED. Formerly, corporations
awarding SR&ED contracts had to provide information on the contractors,
including names and GST registration numbers.
The 1995 budget also made
changes to payments to third parties for SR&ED. SR&ED carried
out under an agreement with a third party is different from other SR&ED
contracts in two ways. Firstly, when SR&ED is contracted out, it is
carried out directly for the payer, which obtains ownership of the SR&ED.
In the case of payment to a third party, the payer obtains the right to
use the results of the SR&ED, but does not have control over the SR&ED
itself. Secondly, and unlike the case for other SR&ED contracts, payments
to third parties become eligible for the tax incentives when payments
are made, not when the SR&ED is carried out. Since the 1995 budget,
third parties must provide information about the nature of the SR&ED
they have carried out and indicate the related expenditures. As well,
payments to third parties are treated like SR&ED contracts: they are
eligible for the tax incentives in the year in which the SR&ED is
Lastly, the federal government
limited the tax credits that may be claimed for SR&ED expenditures
not yet incurred. SR&ED activities, and thus the related expenditures,
often cover a period of several years. Before 1995, corporations claimed
tax credits for amounts not yet paid out. The 1995 budget set out rules
making the tax credit applicable to the year in which payment of the outstanding
amount is made (that is, when the full amount of the SR&ED expenditure
In June 1998, the Minister
of National Revenue announced measures to improve the administration of
tax incentives for SR&ED. An independent national body will be created
to administer the SR&ED program and the application form for the SR&ED
tax credit will be simplified. Furthermore, a review committee, consisting
of industry representatives and officials, has been established to ensure
that the new method of administration is properly implemented. None of
these measures will change anything with respect to the SR&ED tax
D. Comments on Tax Measures Related
The main advantage of these
tax measures is clearly that they are generally applicable, while leaving
companies free to make decisions on their scientific research activities.
The private sector determines for itself the level and type of SR&ED
activities to carry out, basing decisions on cost-effectiveness and marketing
When they form a simple
tax structure, tax incentives can be relatively inexpensive to administer
and apply. However, the frequent changes to federal SR&ED tax incentives
have instead increased the complexity of the taxation system and created
an environment of fiscal uncertainty for businesses planning to invest
The complexity of the SR&ED
tax incentive system has come about partly because of the growing number
of criteria governing the systems application. It is also ties in
partly with the way scientific research is defined for tax purposes. Corporations
are required to explain in detail the nature of the SR&ED activities
and demonstrate the scientific and technological content of their work.
As such, it is difficult at times for them to determine whether a particular
activity can be considered as scientific research or not.
Like all tax expenditures,
SR&ED tax incentives also raise the problem of cost control. Improperly
or inadequately assessed tax incentives can turn out to be attractive
tax loopholes and result in a significant loss of government revenue.
Fortunately, in the 1980s, the federal government took steps to eliminate
potential abuses of the taxation system. This is not to say, however,
that it is completely effective in its control and evaluation of the SR&ED
tax incentives for Canadian companies. In this regard, in his 1994 Report,
the Auditor General was critical of the lack of evaluation, and suggests
that regular and comprehensive control of SR&ED tax measures be exercised
in order to alleviate costs resulting from the federal government shortfall.
It would appear that the federal government has decided to follow up on
the Auditor Generals recommendations. In the 1995 budget speech,
it was announced that the government intended to evaluate SR&ED tax
measures on an ongoing basis and to amend them as required to ensure the
continued efficiency and fairness of the tax system. In the 6 March
1996 budget, the Finance Minister announced that the government had undertaken
an evaluation of the relevance, impact and efficiency of SR&ED tax
Available data on the cost
of SR&ED tax incentives give a general idea of the relative size of
the federal governments indirect funding of private sector research.
According to an Industry Canada resource book (1994), SR&ED tax expenditures
account for nearly 15% of overall direct and indirect federal funding
of science and technology, while the government, which funds nearly 8%
of overall industrial SR&ED, also indirectly funds a further 18% through
tax incentives. In 1997 the federal government awarded $1.3 billion
in tax credits, to more than 11,000 businesses operating in Canada.
In 1986, 4,413 companies claimed a total of $759 million in tax credits.
Thus, tax credits are proving to be attractive to a growing number of
businesses and represent a major cost to the federal government.
Warda found (1990) that
of all industrialized countries, Canada offers the most attractive SR&ED
tax incentives. According to his analysis, the overall federal and provincial
tax incentives available allow Canadian companies to recover, depending
on the province, from 50% to 60% of their initial SR&ED investment.
In other words, because of the tax incentives, companies could double
their SR&ED activities for a given investment. However, it is impossible
to be sure from this study whether the tax incentives are prompting Canadian
companies to incur additional SR&ED expenditures.
In its evaluation report,
Finance Canada tried to assess whether Canadian companies were reacting
to the tax incentives by spending more on SR&ED. The audit showed
that every tax revenue dollar forgone by the federal government generated
$1.38 in additional expenditures. Tax incentives for SR&ED are thus
cost-effective. Even so, the level of SR&ED expenditures by industry
remains relatively low in Canada compared with that of other industrialized
The federal government has
for several years been offering a variety of tax incentives to stimulate
industrial SR&ED. Changes over time have made it possible to increase
the number of beneficiaries eligible for these tax concessions. The most
notable change has certainly been to allow non-taxable corporations to
receive a tax credit refund. The greatest abuses of the system have resulted
from measures allowing the transfer of corporate tax breaks to outside
investors. Although the development of scientific research may be fundamental
to the countrys growth, that development must be promoted within
the framework of an equitable tax system. Amendments to the Income
Tax Act in 1987 appear to give rise to few abuses. The new measures
passed in 1994 have likely increased the number of firms that qualify
for SR&ED tax incentives.
To assess the impact of
SR&ED tax incentives, we have to determine the attendant costs and
benefits. The evaluation of tax expenditures related to scientific research
gives a truer picture of government involvement and facilitates changes
in the orientation of science and technology policy.
15 August 1944
The Act to Amend the Income War Tax Act was proclaimed. Under
these amendments, all current expenditures and one-third of capital
expenditures on scientific research could be deducted to a maximum of
5% of taxable corporate income.
13 July 1961 Amendments
to the Income Tax Act received Royal Assent. Capital expenditures
incurred in Canada for research became fully deductible.
29 November 1962
Parliament passed amendments to the Income Tax Act allowing corporations
to claim an additional tax deduction of 50% for scientific research.
10 March 1967 Coming
into force of the Industrial Research and Development Incentives
Act under which the federal government awarded grants covering 25%
of current and capital expenditures in respect of SR&ED.
30 June 1978 Amendments
to the Income Tax Act enabled corporations to claim an SR&ED
tax credit of between 5% and 10%, depending on the size of the firm
and the location of SR&ED activities.
17 February 1983
Amendments to the Income Tax Act increased tax credit rates by
10 percentage points and provided for credit refunds to non-taxable
19 April 1983 The
Honourable Marc Lalonde, Minister of Finance, presented a paper entitled
"Research and Development Policies: A Paper for Consultation,"
in which he proposed changes to SR&ED tax incentives.
18 June 1987 The
Honourable Michael Wilson, Minister of Finance, tabled the White
Paper: Tax Reform 1987 which called for several changes to SR&ED
22 February 1994
In his budget speech, the Honourable Paul Martin, Minister of Finance,
announced a variety of changes to SR&ED tax incentives.
12 May 1994 Amendments
made to the Income Tax Act (Bill C-9) in 1994 received Royal
15 June 1994 Bill
C-27, which required companies themselves to calculate and identify
expenditures qualifying for the SR&ED tax credit, received Royal
28 June 1994 John
Manley, Minister of Industry, announced a federal science and technology
27 February 1995
In the budget speech, the Honourable Paul Martin, Minister of Finance,
announced additional amendments to SR&ED tax provisions.
6 March 1996
The Minister of Finance announced in his budget that financial institutions
investing in information technologies would also be eligible for a SR&ED
tax credit and that the government would complete its evaluation of
the impact and efficiency of SR&ED tax incentives in 1996.
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de recherche et de développement. Government of Quebec, March 1988.
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A Paper for Consultation. Government of Canada, April 1983.
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Honourable Paul Martin. Tax Measures: Supplementary Information.
Government of Canada, 22 February 1994.
Minister of Finance, the
Honourable Paul Martin. Amendments to the Income Tax Act Explanatory
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This publication is a revised version of the earlier paper Research
Development: Tax Policy first published in October 1989 and
regularly updated since that time.