Co-authored with DEEP Centre associate Warren Clarke
In a recent Globe and Mail editorial, Finn Poschmann, Vice President of Research at the C.D. Howe Institute, addressed our recent work on sovereign patent funds (SPFs), arguing that they are an ineffective and inefficient means of addressing Canada’s domestic innovation problem. In the November edition of Policy options, we argue that the potential sale of Blackberry’s patent cache presents an opportunity to consider whether Canada should match moves by Japan, South Korea and France to establish patent funds. These countries have established such organizations as a means of providing legal protection for innovative firms from lawsuits (notably from patent trolls) and transferring domestic IP from underperforming/bankrupt firms to other domestic ones. Part of the rationale for the creation of these entities is to prevent the ‘flight’ of domestic IP to other jurisdictions. As other countries are actively considering ways to protect their domestic intellectual property, we believe it is incumbent on the Canadian government to consider undertaking its own strategic initiatives to maintain and expand the country’s valuable intellectual property resources.
In response, Poschmann argues that:
Any restrictions on foreign bidding for the patents could only decrease the winning bid price for BlackBerry. That would punish current investors, who have taken the risk of hanging on to their shares, and leave less funding for the leaner company that might emerge. Implicitly, it would also shrink the rewards to creators of IP, exactly the opposite of what the patent system seeks to do. A Canadian government-controlled “patent fund” would turn taxpayers into high-tech venture capitalists, whose risks would be managed by a government whose risk-reward preferences are, by definition, different from theirs.
In reality, of course, Canadian taxpayers at both the Federal and Provincial levels are already playing the role of high-tech venture capitalists through programs such as the Federal government’s $400 million venture capital initiative. In addition, the creation of a SPF would not necessarily need to significantly depress returns to shareholders. While the Canadian government can use the Investment Canada Act (ICA) as a means of annulling proposed acquisitions, it can’t forcefully acquire private assets without significant legal costs. Is there a means for a public fund to provide market valuations for such assets? We believe this deserves further discussion given the efforts in other jurisdictions to retain domestically generated IP.
As an alternative to the SPF, Poschmann proposes the creation of a “patent box” that would provide preferential tax treatment to IP-related income. This proposal builds on an earlier report from C.D. Howe which argues that the patent box would make Canada a more “desirable host for business activity connected to R&D.” Given that established patent-box regimes in the UK and Holland use preferential tax rates of 10 and 5 percent respectively, how Canada will be tangibly advantaged without going to zero is questionable. This segues into what is the primary critique of such tax treatment, notably that it promotes a race to the bottom in corporate taxation. Indeed, the UK’s patent box regime was recently identified as harmful tax competition by the European Commission, and German finance minister Wolfgang Schaeuble has expressed similar concerns.
Perhaps more significantly, questions also remain as to whether this type of preferential tax treatment is an effective means of spurring domestic innovation. The UK Institute for Fiscal Studies finds that the preferential tax treatment through the patent box is an ineffective means of promoting domestic research. They argue that:
(The) Patent Box is poorly targeted at research as the policy targets the income which results from patented technology, not the research itself. Once a patent is in place, a firm has a monopoly on the use of those ideas, and so can capture all of the returns and therefore faces the correct incentives to maximise the related income stream. In addition, to the extent that a Patent Box reduces the tax rate for activity that would have occurred in the absence of government intervention, the policy includes a large deadweight cost.
Moreover, if the implicit goal of the patent box is to promote commercialization, it fails to address the most widely recognized barriers to commercialization in Canada. Preferential tax treatment itself will do little to ameliorate the funding environment for start-up companies and SMEs, nor will it help firms navigate the “valley of death” that fells a significant share of innovative firms. This is because small firms are often unprofitable, and thus pay no taxes, for several years. As a result, the patent box provides preferential treatment to large established firms while ignoring the needs of smaller innovators.
This disparity suggests that the patent box alone is not sufficient to bridge Canada’s innovation gap. None of this indicates, however, that the Canadian government should not consider a patent box approach. Indeed, the patent box does have the potential to attract large spenders on R&D. However, implementation in the Canadian context requires a greater focus on making the policy work not only for large firms, but also for small and medium size enterprises.
One way to improve the policy for the benefit of SMEs would be through the implementation of a tradable tax credit simultaneously with the introduction of a patent box regime. Tradable tax credits allow companies to sell their tax credits to others. Such a system could provide a means for unprofitable firms to secure the upfront cash needed to overcome the key hurdles noted above.
All options should be on the table when considering how Canada can improve its domestic IP regime. We believe that the patent box concept merits further study with respect to the experiences of existing patent box countries such as the UK, the Netherlands, Luxembourg, Belgium and Ireland. And, to be clear, while we promote the investigation of patent funds, we are not ready to promote the creation of them without further research. However if we’re serious about creating a policy environment to promote the development, use and production of IP assets in Canada, we can’t tackle one leg of this issue without the other. Here’s hoping this debate spurs an ongoing and intense examination of an issue that is central to Canada’s economic future.