Update: On January 31, 2024, the Government of Canada launched consultations on (i) the suitability of a federal patent box regime and (ii) cost-neutral ways to modernize and improve the SR&ED program. Submissions will be accepted until April 15, 2024.
Innovation from research & development (R&D) can be protected by intellectual property (IP) rights of various kinds, including patents, copyright and plant breeder’s rights. To encourage companies to invest locally in R&D that produces valuable innovations and economic growth, governments in jurisdictions around the world have implemented tax incentives, typically called a “patent box” or “IP box”, that tie a tax advantage to commercially relevant IP.
In Canada, the province of Quebec was the first jurisdiction to offer an IP box as a tax incentive to companies operating in that jurisdiction. This article will explore the key features of the Quebec IP Box for innovators and outline how companies can work with their tax accountants and IP advisors to realize these benefits and maximize the return on IP investments.
What is the "Quebec IP box"?
Originally introduced in 2016, the Quebec IP box was the first tax incentive of its kind to be implemented in Canada. The current iteration, known as the ‘Incentive Deduction for the Commercialization of Innovations’ (IDCI), applies to tax years beginning after December 31, 2020. The IDCI permits a qualified corporation to reduce its Quebec tax rate on eligible income attributable to a qualified intellectual property asset (QIPA) from 11.5% to as low as 2%.
A ‘qualified corporation’ has an establishment, and carries on a business, in Quebec, incurs R&D expenditures in Quebec and earns income from the commercialization of a QIPA in Quebec or elsewhere.
A QIPA is intangible property owned by the qualified corporation, which results from R&D activities carried on wholly or partly in Quebec and which is any of:
- an invention protected by a patent or certificate of supplementary protection (applied for after March 17, 2016);
- a computer program (created after March 10, 2020) protected by copyright; or
- a plant variety protected by a certificate of plant breeder’s rights (requested after March 10, 2020).
Income from the commercialization of a QIPA means the gross income that is reasonably attributable to the Quebec establishment of the corporation and that is any of:
- income from the sale, rental or lease of a property incorporating the QIPA;
- income from the provision of a service intrinsically linked to the QIPA;
- a payment for the use of or the right to use the QIPA; or
- an amount obtained as damages in litigation relating to the QIPA.
There is presently no requirement for a QIPA to be the result of Quebec-based R&D. However, for tax years beginning after December 31, 2023, there will be a need for a direct connection between Quebec R&D expenditures and the creation, development or improvement of a QIPA.
Benefits of the Quebec IP Box
The Quebec IP box has several notable benefits and advantages for companies operating in the province.
As mentioned above, the IDCI applies to a wide range of intellectual property assets, including patent assets, copyright protected software and plant varieties. This makes the IDCI advantageous and accessible to companies beyond the manufacturing sector (to which a previous iteration of the IDCI was limited). Notably, this means the IDCI can offer tax benefits to many software companies, including those in the gaming sector, cloud services, artificial intelligence and other areas. Additionally, companies in the life sciences and agricultural industries, including the fast-growing Canadian biotech and cannabis sectors, may also benefit from a tax deduction in the right circumstances.
The IDCI applies to innovations protected by issued patents (with a post-March 17, 2016 filing date and a maximum pendency before the patent office of 5 years) or patent applications (provided they issue to patent within 5 years after filing). Also, the underlying patent application can be filed in any jurisdiction, including but not limited to Canada. Additionally, the eligible income can come from sales in countries that differ from those where patent protection was sought.
Interestingly, and in contrast with the original tax measure of 2016, there is no longer a need to ascertain the relative importance of a QIPA to the income stream associated with a protected product or service. Conversely, the benefits from a QIPA can be applied to such income stream only once, and are not multiplied by having a greater number of eligible IP rights.
Some Caveats to the Quebec IP Box
Although at first glance the IDCI can appear very advantageous to a broad set of companies that pay tax in Quebec, there are limitations to be considered.
Specifically, the maximum advantage of the IDCI (i.e., a provincial tax rate of 2% on eligible income) is only attainable if, among other conditions, such eligible income comes from licensing activities or litigation damages. If the eligible income comes from the sale of goods or the provision of services, as is frequently the case, the tax benefits of the IDCI will be lower.
While many companies have a well-honed process for seeking other tax credits for scientific research and experimental development (SR&ED), and can easily provide supporting documentation to establish a link between R&D expenditures and the creation, development or improvement of a QIPA, some organizations do not. This may particularly be the case for certain companies in the software industry. As such, it may be challenging for such companies to support a claim that a piece of copyrighted software, though highly valuable and created within the right time frame, is a QIPA within the meaning of the IDCI.
Further, the master formula used by Quebec’s tax authority takes into account an implied “routine return” that is deemed not attributable to the QIPA. This has the net effect of making any tax benefit available only to companies that achieve certain minimum net earnings and net margin thresholds.
Additionally, a pending patent application used as the basis to claim the IDCI must issue to patent within 5 years to avoid a claw-back of the related tax deductions for previous years.
Finally, the additional costs associated with setting up and managing a program to apply for the IDCI, including working with certified tax and IP professionals, need to be taken into consideration.
How can companies take advantage of the Quebec IP box?
These are early days, but one can expect that combining a benefit as tangible as a tax deduction within a field as complex as IP will raise some high-stakes questions. To maximize the available benefits, companies should review and consider the IDCI together with the advice and counsel of qualified IP and tax professionals, and as part of an organization’s coordinated approach to IP management and tax optimization.
If you have any questions about the above, please do not hesitate to contact a member of our firm’s IP Strategic Advisory group.
The preceding is intended as a timely update on Canadian intellectual property and technology law. The content is informational only and does not constitute legal or professional advice. To obtain such advice, please communicate with our offices directly.
Smart & Biggar does not provide tax advice or services related to accounting; to obtain such advice please reach out to a qualified tax advisor or accountant.