When Industry Canada changed its name — following the Liberal government’s election victory in October 2015 — to the Ministry of Innovation, Science and Economic Development, the shift in focus was noticeable in the change. The focus now was on innovation, and not so much on industrial research and development. Some may feel that the two are interchangeable, but others will argue there’s a considerable difference between the concepts, as we detail below.
Definition of Research and Development
The Frascati Manual: Proposed Standard Practice for Surveys on Research and Experimental Development, which was written by the Organisation for Economic Co-operation and Development (OECD), is the basis for the current SR&ED program. It has a clearly defined scope and metrics. According to the manual, it defines research and development as three basic activities: basic research, applied research and experimental development.
- Basic research is experimental or theoretical work undertaken to acquire new knowledge of the underlying foundation of phenomena and observable facts, without any particular application or use in view.
- Applied research is the almost the same as basic research, except that it is directed towards a specific practical aim or objective.
- Experimental development is systematic work drawing upon existing knowledge gained from research and/or practical experience, which is directed to producing new materials, products or devices, to installing new processes, systems and services, or to improving substantially those already produced or installed.
Definition of Innovation
The Oslo Manual: Guidelines for Collecting and Interpreting Innovation Data, which was also written by the OECD, discusses the nebulous concept of innovation. It defines innovation thusly:
An innovation is the implementation of a new or significantly improved product (good or service), or process, or a new marketing method, or a new organizational method in business practices, workplace organization or external relations.
The manual itself declines to discuss measuring organizational or marketing innovation, instead focusing on technical product process innovation. According to the manual:
A product innovation is the introduction of a good or service that is new or significantly improved with respect to its characteristics or intended uses. This includes significant improvements in technical specifications, components and materials, incorporated software, user friendliness or other functional characteristics.
Why Do Definitions Matter?
As you can see, the definition of Research and Development is more precise and encompasses more activities that are research-focused. That raises a few questions about the definition of innovation and a potential “innovation tax credit.” How liberally or based on current definitions can innovation be interpreted? Will it broaden what is currently considered to be research and development?
For instance, according to the Oslo Manual’s definition of a product innovation, a new product or service can be innovative if it is simply more user-friendly. How would the federal government ask companies to define “user friendliness”? To that end, one may need to be careful for what we for in calling for a new innovation agenda that may lead to a complete redesign of current tax credit systems.
A New “Digital Innovation” Tax Credit
There have been calls for a new refundable labour-based “digital innovation” tax credit as an alternative to the SR&ED program. Proponents believe this would create new jobs in Canada by reducing both income and payroll taxes for companies that qualify, with the source of funding for this incentive coming from personal income taxes.
This tax credit would be tied together with an “innovation box” (also known as a patent box) incentive to boost commercialization and export. It would apply to innovations that would allow companies to pay lower taxes on products or processes that incorporate intellectual property. These digital innovations would be supported by both the new digital innovation tax credit and the SR&ED program.
The danger in calling for an “innovation tax credit” that is poorly defined is that Canada might wind up with a, say, $20 billion dollar program that will be abandoned in five years thanks to varying kinds of abuses in the tax credit system. The Scientific Research Tax Credits (SRTCs) were discontinued in 1986 for similar issues with a poorly thought-out program – tax incentives were collected not by the actual research and development performer, but instead the individual investors in the company. These incentives were viewed as a disaster in promoting the policy objective of encouraging research and development activities in Canada. Can the same thing happen again? Absolutely, unless they are carefully crafted.
Problems With SR&ED
That’s not to say that there aren’t problems with the current SR&ED tax credit system. The 2012 federal budget saw an overhaul to the system that removed capital expenditures from being claimed, reduced the prescribed proxy amount, contract payments and base tax credit percentages – among other things. Other tax credit programs are still disjointed and difficult to access, with varying mandates and high administration costs. To that end, some groups are calling for the creation of a new independent administrator to look after and overhaul the SR&ED program; however, given the current timelines observed in similar organizations (such as the Ontario Media Development Corporation) this may impede the ultimate goal – funding industrial development.
Whatever the solution, there is a definitive difference between the concepts of innovation and research and development. If Canada is moving away from research and development activities to promote innovation, the distinction between the two must be made clear before any drastic changes are made to the program.