OECD report urges caution using R&D tax credits and calls for more direct measures

An OECD report says indirect support to business such as R&D tax incentives can lead to unintended consequences for innovation and government revenues, as well as favouring large multi-national enterprises (MNEs) over domestic, stand-alone firms.

Entitled Maximizing the benefits of R&D tax incentives for innovation, the report — a synthesis of two upcoming OECD publications — warns that the increasing use of tax incentives throughout the world unintentionally penalizes smaller, knowledge-based intensive firms which account for the majority of job growth.

The issue is particularly relevant for Canada, which leads the world in the use of indirect support for R&D versus direct support, as noted in several recent report including the Jenkins Panel.

Within the OECD, the number of countries providing R&D tax incentives has more than doubled to 27 between 1995 and 2011, with several more considering their introduction.

"Intellectual assets generated by R&D, such as patents, may be developed in one country, held in another and used for production in a third … All of this has made it easier for MNEs to shift profits among tax jurisdictions and harder for tax authorities to establish where profits have been earned and to tax them accordingly," states the OECD report. "Fundamental changes to the international tax system are needed to address the gaps and loopholes that enable MNEs to achieve double non-taxation."

The report recommends:

• the use of cash refunds, carry forwards and payroll withholding tax credits to reduce the inherent bias against new firms;

• a well-designed and transparent system of direct support measures to complement R&D tax incentives, particularly those with high social returns. Contracts, grants and awards are more effective for mission-oriented R&D, particularly young firms ;

• a systematic evaluation of tax relief measures to assess the validity of their objectives and whether their targeting and design remain appropriate.

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