The Canadian Chamber of Commerce (the Chamber) recently released its Roadmap to Recovery, laying out policy areas that it believes will assist in the effective recovery from the economic instability triggered by the COVID-19 pandemic. Under the heading of Technology and Innovation, the Chamber specifically recommends the adoption of an “innovation box”.
What is an innovation box?
An innovation box is an IP-focused policy that reduces the tax rate for corporate income generated from patented inventions or, in some cases, other intellectual property developed in Canada.
The term “innovation box” stems from the idea that a qualifying corporation can simply check off the box on its tax forms. The rate of tax reduction is country-dependent.
In theory, the innovation box is supposed to boost domestic innovation and encourage multinational organizations to spend research and development dollars in the country offering the innovation box. Ideally, it boosts capital investment within the country and creates employment opportunities.
International use of innovation boxes
20 countries have adopted their own versions of the innovation box, including Switzerland, Italy and Belgium, to name a few. This has allowed researchers to study just how effective this IP policy is.
A recent study published by Stanford found that in countries with an innovation box, two major policy objectives were achieved. First, there was reduced shifting of income outside the jurisdiction, since “an innovation box regime effectively reduces the applicable tax rate on a portion of reported income”. Therefore, income had to be generated and kept within the country for the tax reduction to be applied. Second, there was increased capital expenditure and employment within the country.
The study looked at values from the period before the Organization for Economic Cooperation and Development (OECD) announced new international guidelines regarding innovation boxes.
The OECD wanted the full benefits of this kind of tax incentive to materialize, as well as to protect against tax fraud. Given this, OECD published the Base Erosion and Profit Shifting framework (BEPS). Action 5 of the BEPS outlines certain requirements that corporations must meet to qualify.
Among others, Action 5 includes a requirement to show substantial economic presence in the country in which you are filing, as well as a requirement to show proof of IP ownership. These protective standards will only serve to solidify the benefits countries receive in return for implementing innovation box tax reductions.
Is a tax reduction too generous?
One might ask, however, why corporations should get a tax reduction when IP rights themselves are theoretically the incentive to innovate. An article published in The University of Chicago Law Review states, “Traditionally, the economic rationale for granting intellectual property rights in innovations has been that the rights provide an incentive or reward for the sizeable investments needed to create the intellectual property disclosed in the patent document”. So, is providing yet another benefit to potential innovators overly generous?
The fact is, IP protection and innovation boxes serve two distinct functions. While it may be that IP protection is sufficient to encourage innovation, the tax incentive would encourage innovation within Canada. With 20 other countries providing an innovation box, Canada risks losing innovative activities to those countries that do ease the tax burden. The tax reduction is not meant to be a fair return on the investment of labour, but a strategic economic play.
If Canada offers an innovation box, Canadian companies will be incentivized to invest domestically and multinational entities may be incentivized to prioritize innovation in Canada as well. In this way, Canada can boost the economy and generate employment opportunities, as we try to recover from the economic impacts of COVID-19.
Written by Rachel Marcus. Rachel is in her third year at Osgoode Hall Law School. She is a regular contributor to the IPilogue, and is currently enrolled in Professors D’Agostino and Vaver 2020/2021 IP & Technology Law Intensive Program at Osgoode Hall Law School.