R&D and innovation tax incentives

Many jurisdictions around the world offer generous tax credits and other incentives to companies that invest in R&D and innovation activities.

Incentives are one of the key factors that management considers when deciding where a company should invest in innovation. Companies will also look into specific talent offerings, economic structure, education systems, and culture, amongst other factors, in order to determine where they will locate such activities.

The OECD recently published its 2021 study on such incentives offered by different countries (Measuring Tax Support for R&D and Innovation – OCDE (oecd.org). Canada continues to rank amongst the most favorable jurisdictions to favour such investments. Many companies see Canada as the gateway to North America. In addition to its competitive incentive regime, Canada is renowned for its global market access, skilled talent pool, low-cost environment, political stability, sound banking system, and quality of life.

In addition to Federal incentives, most of the Canadian provinces also offer various incentives.

R&D and innovation: the Quebec advantage

Combined with the Federal credit, Quebec’s R&D credit regime is probably one of the most advantageous globally. Canadian-owned private companies can obtain up to 71% of their investment in such activities, fully refundable. Non-resident corporations can obtain funding for up to a 45% of such investments.

Whether foreign or Canadian-owned, Quebec R&D and innovation incentives are fully refundable, whether an entity is subject to owing taxes or not.

In addition to R&D, the province also offers generous incentives to companies involved in specific sectors.

Such assistance is also available to companies that render services to non-resident-based organisations, as long as such activities are performed in Quebec / Canada.

Gaming sector

Quebec ranks amongst the top global jurisdictions for investing in the video gaming sector. More than 50% of Canada’s 32,000 people video game development talent pool is located in Quebec.

In this context, the Quebec government offers up to 37.5% of fully refundable credit to companies that operate through a permanent establishment in such province. This incentive is fully refundable and available to all companies, whether they are Canadian or non-resident owned: as long as a company operates through a Quebec fixed place of business, whether Federal / Quebec incorporated or operating as a branch of a foreign company. In contrast to the limits on the higher rates of R&D tax relief, no threshold applies to limit government credits for the video gaming sector.

Companies involved in the development of interactive video games, including related sectors, can access this incentive.

IT sector

Amongst numerous incentives offered to the IT sector, Quebec offers a C$25,000$ credit per eligible employee to companies involved in e-business related activities, where the activities performed by such entities transform the commercial processes of their clients. $20,000 of the maximum $25,000 credit is fully refundable, the $5,000 balance can be applied to reduce corporate taxes owing.

Deduction for innovation-related initiatives (Quebec)

Companies that develop patented technology can also access a deduction to reduce their provincial taxes owing to income related to the commercialisation of such innovations. All of such related income is exonerated from Quebec tax (only). This can be assimilated to what is known as a “patent box” incentive. As a result, qualifying corporations can be subject to no Quebec corporate tax owing on such income.

Other sectors

Quebec is also known for its strong credentials in the areas of cybersecurity, artificial intelligence, aerospace, cleantech, life science clusters/ecosystems, to name a few.

Authorities offer generous financial assistance to companies involved in such sectors for job creation projects, capital expenditure investments, and initiatives that contribute to accelerating the economic growth of the provincial economy.

Authorities are very proactive in discussions with such companies that have a business plan supporting innovative development. Government support increases in particular with projects that are beneficial to the environment.

Covid-19 related incentives

Both Canadian and provincial governments have been very proactive in assisting companies that face Covid-19 related economic challenges arising from falling annual income or increased operational expenses.

Incentives are offered as non-refundable government assistance on salaries to prevent job losses. There is also support for office rental expenses and forgivable loans for other costs, subject to meeting relevant criteria.

Global tax planning

In order to maximise the return on their global R&D and innovation investments, organisations should review their global corporate tax strategies to eliminate inefficiencies.

Most jurisdictions have transfer pricing legislation in place, with country-specific applicable methodologies and legislation. Organisations should review the remuneration levels for related party transactions, such as intra-group arrangements to ensure they can be supported both from a function and allocated margin standpoint. The overall guiding principle is that such agreements should reflect compensations as if corporations would be dealing at arms-length.

In the context of relocation of research and development activities, this could involve intellectual property transfer, licensing, and other intangible related transactions.

Conclusion

As each jurisdiction wishes to attract talent and structure innovation projects and investments, it is important to compare what is offered to support such initiatives and the related tax impacts.

With available budgets being limited both in terms of financial and human resources, it is important that efficient contemporaneous documentation is prepared to support the commercial and tax analysis of business decisions and investments. Global tax legislation is evolving rapidly and organisations will need to regularly review their operations to take advantage of the opportunities available.