At SREDucation, we’re taking the time to document all of the changes that have occurred to the SR&ED program over the years. In our “From the Archives” series, you’ll be able to see how the program has evolved since its inception in 1986. For a timeline of these events, check out the SR&ED Tax Credit page on Facebook. Stay current with the program by understanding the historical context.
In 2009, a paper in Small Business Economics evaluated the effectiveness of tax incentives in Quebec, particularly focusing on the Scientific Research & Experimental Development (SR&ED) tax credit program. In the analysis the authors used manufacturing company data from 1997 to 2003, which included surveys and administrative data.
“We show that there is a deadweight loss associated with level-based R&D tax incentives that is particularly acute for large firms,” the authors wrote.
“For small firms it is not sizeable enough to suppress the R&D additionality, at least not for quite a number of years after the initial tax change. Incremental R&D tax credits do not suffer from this deadweight loss and are from that perspective preferable to level-based tax incentives.”
This article summarizes the report below.
Generosity of Quebec’s Tax Incentives
While Canada is generous with its tax incentives, the authors wrote, the province of Quebec surpasses other provinces in the country. Provincial payments for assistance totalled $538 million in 2005. In Quebec, the province prefers to focus on the type of company that receives the funding rather than individual projects, the authors noted.
“This virtue could also be seen as a weakness, in so far as it might be socially preferable to steer R&D towards projects with high spillovers. Many countries try to focus their support on small- and medium-sized enterprises, which are, more than big firms, plagued by the market failure of financing intangible investment,” they wrote.
The authors’ methodology for determining the effectiveness of tax incentives focuses on R&D tax credits received by every company, rather than looking at factors such as statutory tax rates.
“Indeed, many firms may either not know of the existence of tax incentives (especially small firms) or decide not to apply for R&D tax credits because of administration costs, inexperience or apprehension about dealing with the tax authorities,” the authors noted.
Focusing on SR&ED
The authors called SR&ED “the main R&D fiscal incentive in Quebec”. The early days of the credit in the 1980s saw an emphasis on researcher salaries, but in later years the Quebec government added co-operation and human capital as other factors in determining the credit.
These days, the credit in Quebec focuses on four major components:
- Refundable tax credit for salaries and wages of researchers;
- Refundable tax credit for university research, or research carried out by a public research centre or a research consortium;
- Refundable tax credit for pre-competitive research;
- Dues or contributions paid to a research consortium.
- Super-deductions (1999-2000). “Firms choosing the super-deductions could reduce substantially their net investment cost because the Federal government applied different rules in the treatment of refundable tax credits and super-deductions for R&D,” the authors noted.
- A refundable tax credit based on more R&D spending (1999-2004). It was supposed to increase the performance of R&D with respect to GDP. Small- and medium-sized enterprises (companies with assets below $25 million) were the only ones eligible.
Crunching the Data
A Scenario For Review
Interpreting the Results
- Increasing level-based provincial tax incentives by 10%. They found that for small firms, the ratio of cumulative R&D to cumulative government expenses to support R&D stayed above 1 even after 20 years. More research dollars were being generated than what the government was spending on R&D. This shows that R&D tax incentives do work for small firms, the researchers stated. Large firms, however, don’t benefit.
- Increasing the increment-based provincial R&D tax credit by 10%. In this case, both small and large firms had a ratio that was closer to 3 to 1. “The incremental R&D tax credit is much more effective than the level-based tax credit, and its effectiveness does not vary much by firm size,” the researchers noted.
This article is based upon a Small Business Economics journal article: Effectiveness of R&D tax incentives in small and large enterprises in Québec. The report was written by Rufin Baghana from the Ministère des Finances in Quebec, and Pierre Mohnen, who is with Maastricht University CIRANO, and UNU-MERIT, in the Netherlands.