Canada’s innovation performance is nothing to brag about. In 2012, the country lost its top 10 spot on the Global Innovation Index, ranking 12th. In spite of generous government programs to support R&D, a 2012 OECD report presented Canada as an R&D laggard, with business enterprise research and development (BERD) at 0.99 percent of GDP in 2009, against 2.04 percent for the U.S. and an OECD median of 1.62 percent.
Figure 1 shows Canadian BERD slowly declining since 2007, despite non-financial corporations holding large cash reserves and the federal corporate tax rate having been halved since 2000 (to 15 percent). With a widespread belief that economic conditions will now improve, it is unclear whether businesses will invest in productivity-enhancing activities soon, or simply let future sales expansion drive revenue growth.
A Shift of Approach
Past data indicate that low investment in R&D is structural and chronic in Canada. No one was surprised, therefore, when the finance minister’s March budget speech noted that Canada needs “to promote innovation more effectively,” thereby recognizing Canada’s lackluster performance.
The 2012 federal budget introduced new measures to address Canada’s lack of innovation in the last 30 years with respect to R&D support. This was one of few areas not to face belt-tightening, with the federal government committing CA$1.6 billion to various measures.
The 2012 budget marked a change in philosophy in the way R&D and innovation are supported in Canada. The government took the first steps of moving away from a system of indirect funding, in the form of tax credits, toward a more direct approach using grants, venture capital, and government procurement.
The change was predictable, as the budget announcement was preceded by a series of 2011 reports that were clearly influential. In particular, a federal expert panel’s report recommended moving away from tax credits. The report criticized the very generous (35 percent) tax credit for small Canadian-controlled private corporations and argued that A) it should be reduced to the general rate available to other corporations (20 percent) and B) the latter should be lowered.
Pre-budget rates are shown in Table 1, along with the rates of the refundable tax credit that most provinces offer in addition to federal programs. Foreign companies can benefit from these and other support programs if R&D activities are undertaken in Canada and take an eligible form (e.g., experimental development or applied research).
As part of the new approach, the government committed to support further “traditional” R&D, in the form of advanced research in universities and colleges, by earmarking CA$500 million over five years to the Canada Foundation for Innovation to support new competitions. It also made a clear case for supporting the private sector more vigorously: the Industrial Research Assistance Program saw its budget for supporting companies double to CA$220 million per year; the National Research Council received CA$67 million toward refocusing its activities on business-led, industry-relevant research; and CA$400 million was allocated to “help increase private sector investments in early-stage risk capital, and to support the creation of large-scale venture capital funds led by the private sector.”
These measures came at a cost, and the victim was Canada’s largest R&D support program, the federal Scientific Research and Experimental Development (SR&ED) tax credit. Changes to the SR&ED program were presented as “streamlining and improving” it, but the bottom line is that the program will be less generous starting in 2014. Main changes include a reduction of the rate from 20 percent to 15 percent for larger firms; the elimination of most capital expenditures as eligible expenditures; the reduction of eligible overhead expenditures (the proxy rate being lowered from 65 percent to 55 percent); and the eligibility of only 80 percent of the SR&ED amount paid to an arm’s length contractor.
The shift in ideology, in particular the proposed changes to the SR&ED program, were not welcomed by all, as SR&ED tax incentives seem to have generated a small benefit to Canada. Opponents point to drawbacks of direct funding: potential lack of transparency in the process, funds being given out before projects are undertaken, the threat to Canada’s international competitiveness if funding contravenes WTO rules, and a heavier administrative burden as pointed out in the 2011 expert panel report. They also mention the Technology Partnerships Canada program, canceled in 2006 by the current conservative government after disbursing more than CA$2 billion in public money on controversially selected projects.
A Different Future?
With the changes introduced in the 2012 budget, foreign companies carrying out R&D in Canada will need to keep an eye on how tax credit changes may affect them. Currently, the Canadian tax credit is generous compared to other countries’ equivalents, including that of the United States. Compared to its neighbor and other OECD countries, Canada has indeed promoted R&D largely through a system of tax credits (Figure 2). While the philosophical shift is important per se, changes announced in the 2012 budget will modify the proportions of direct and indirect government support for R&D only slightly. It seems likely, however, that future federal policy will move according to this new paradigm.
 OECD Science, Technology and Industry Outlook 2012, www.oecd.org/sti/oecdsciencetechnologyandindustryoutlook.htm.
 The budget speech is available at www.budget.gc.ca/2012/rd-dc/speech-discours-eng.html.
 The budget announcement was transposed into Bill C-45, which has yet to be adopted by Parliament as of November 8, 2012.
 Innovation Canada: A Call to Action: Review of Federal Support to Research and Development—Expert Panel Report, http://rd-review.ca/eic/site/033.nsf/eng/h_00287.html.
 Mark Parsons, Rewarding Innovation: Improving Federal Tax Support for Business R&D in Canada, C.D. Howe Institute, September 2011, www.cdhowe.org/pdf/Commentary_334.pdf.