Saturday July 20, 2019
logo logo

How taxation can fuel Canada’s intangibles economy

Trevin Stratton PhD

Trevin Stratton is the Chief Economist for the Canadian Chamber of Commerce

A recent report by the Public Policy Forum finds that intangible assets like technology, intellectual property, branding, and design comprise 91% of the S&P 500’s total value.

Canadian businesses, from large tech firms to family farms, are adapting their business models to the drivers of long-term success in this increasingly intangible economy.

The parts of Canada’s economy that don’t fit our outdated policy models are growing by the day, with major implications as our economy struggles to keep up with more forward-thinking competitors. One area where Canada has a significant lag in policy evolution is taxation, where we continue to see other countries around the world adapt their tax policies to compete for investment, talent, and growth in the intangibles economy.

It might not be intuitive that many of the factors that drive growth and innovation – patents, copyrights, intellectual property, and research and development – continue to be closely tied to taxation. Let me explain.

There is ample research to confirm that taxation has a direct impact on innovation. According to the National Bureau of Economic Research, both corporate and personal income tax negatively affects the quantity, quality, and location of innovation. Tax rates impact the number of patents filed and patent citations. Tax policy influences where companies allocate R&D resources and how many researchers they employ. It also shapes where inventors decide to locate and what firms they work for.

Research from the Tax Policy Center shows that startups investing in new ideas tend to rely more on equity than firms that focus on tangible products. Not surprisingly, their financing costs and ability to raise capital is contingent upon providing an adequate return on investment. Tax policies have a significant impact on this return and can, therefore, determine which innovative ideas get financed and which investments are undertaken.

These findings consistently demonstrate that taxes have far-reaching consequences on technological progress and growth. If innovation is the result of intentional effort and investment, then a more competitive tax regime can be used to increase the expected return of these inputs. In other words, if designed properly, the tax system can be used to intentionally stimulate innovation.

The United States has already learned this lesson and taken action. Often lost amid the flurry of new tax rules contained in the 2017 Tax Cut and Jobs Act was a 13.125% U.S. federal tax rate on intangible income –  intellectual property, marketing, and services – that increases slightly in 2026. This provision creates an incentive to draw intangible activities to the United States.

A number of European governments have done something similar in the form of patent boxes. Countries such as the United Kingdom, France, and Ireland tax patent revenues at a preferential rate to incentivize R&D and encourage employment and commercialization within their jurisdictions. The Netherlands and Spain have gone even further by applying these preferential rates to all intellectual property.

Legislators around the world are concentrating on overall rate reductions and novel tax policy tools to spur innovative activity. Canada, in contrast, continues to use specialty credits that create distortions in the tax system.

The impact of the intangibles economy is also altering our international tax rules. The OECD recently put forward proposals to address the tax challenges of the digitalization of the economy. These include profit allocation rules for marketing intangibles, like trademarks, trade names, customer lists, and proprietary data that help with selling to customers.

These proposals are wrapped up in discussions about where value is created if it is decoupled from a physical bricks and mortar location. And this is why any successful approach to adapt tax policy to the intangibles economy must be a ground-up, comprehensive review. Our current approach uses partial measures that complicate the tax code with temporary provisions that favour one sector over another. The intangibles economy, in contrast, is ubiquitous and impacts all industries, from manufacturing to natural resources to the service sector.

A comprehensive review of Canadian taxation is mission critical if Canada wants to continue to be a nation of innovators. As it currently stands, we rank 18th in the world in patent applications, 23rd in R&D expenditures, and 39th in trademark applications according to the World Economic Forum.

We need to use all the tax policy levers at our disposal to adjust and promote these intangible growth drivers. This shift towards an intangibles economy is monumental. We need an equally colossal effort in the form of a comprehensive review to deliver new approaches to tax competitiveness that reflect the weight of this change.

This article originally appeared in The Hill Times.

Local

  • Politics

  • Sports

  • Business

  • How taxation can fuel Canada’s intangibles economy

    By Trevin Stratton PhD Time To Read: 3 min