The Canadian FDI Climate: Taxes and Incentives Advantages

Canada has a lot to offer as an investment location for foreign direct investors. Hundreds of foreign investors have chosen Canada for their plants and operations over the years because it is a place where businesses can compete on a global basis. As an investment location, Canada offers a world-class economy with one of the strongest banking industries in the world and a government fiscal policy that can compete with any G-7 country. Its unmatched investment climate also provides foreign direct investors with low corporate taxes and a progressive duty-free manufacturing tariff regime.

Another major attribute of Canada is its advanced research and development capabilities. With the lowest R&D structure in the G-7, and incentive programs and tax structures that compete on a global basis, Canada continues to be a chosen investment location. The following is an overview of Canada's tax competitiveness and incentive programs.

A Low Tax Regime
Canada is known as one of the most cost-effective places to do business. Its corporate income tax rate is more than 13 percent below comparable rates in the United States. In January of 2011, Canada reduced its federal corporate income tax rate from 18 percent to 16.5 percent and plans further cuts to 15 percent, bringing the combined provincial and federal corporate tax rate to about 26 percent in 2020. When comparing this to the 39.2 percent corporate tax rate in the United States, Canada offers a significant advantage to foreign investors. They will benefit from one of the overall lowest tax rates on new business investments among OECD countries¹.

According to the KPMG Competitive Alternatives 2010 Special Report: Focus on Tax, which compares total tax costs between countries and cities using a Total Tax Index (TTI), Canada ranks amongst the most competitive countries from a tax point of view. This report is a supplement to the 2010 edition of Competitive Alternatives, KPMG's guide to international business costs. It assesses the general tax competitiveness of 95 cities in 10 countries studied in the main research project, focusing on 41 major cities. TTI is a measure of total taxes paid by corporations in a particular location, expressed as a percentage of total taxes paid by corporations in the United States, which has a TTI of 100. Taxes include corporate income, capital, sales, property, and miscellaneous local business taxes. The calculation also includes statutory labor costs (i.e., statutory plan costs and other wage-based taxes).

According to the study, Canada ranks second to Mexico in terms of overall TTI. Table 1 (see slideshow) confirms that Canada is approximately 36.1 percent less costly in terms of TTI as compared to the United States.

When we compare overall TTI by city, Canada's three largest cities - Vancouver, British Columbia; Montreal, Quebec; and Toronto, Ontario - rank first, fourth, and fifth, respectively, amongst the 41 large international cities included in the study. When we look at TTI in the manufacturing sector, Canada again ranks second to Mexico with a score of 67.7, illustrating that it is some 32.3 percent more cost-effective than the United States from a tax point of view. Again, Vancouver ranks first, Montreal ranks fourth, and Toronto is fifth among the 41 large international cities examined.

When examining TTI in the corporate and IT services sector, Canada ranks second, scoring 64.5. However, in this case, Vancouver ranks first, Montreal ranks second, and Toronto ranks fifth. The results for the major international cities remain generally consistent with the national results and the overall city results, except for Montreal's strong ranking relative to other cities, which is s a result of incentives available in Montreal that specifically target firms in the IT sector.

One of Largest Free-Trade Zones
Canada is also becoming one of the largest free-trade zones in the world for firms importing manufacturing goods. It is the first country in the G-20 to offer a tariff-free zone for industrial manufacturers. Canada has implemented a major new incentive that will see tariffs on all manufacturing inputs reduced to zero by 2015. This will make Canada very competitive for firms importing manufacturing goods. Investors who choose Canada will have the advantage of importing advanced machinery and equipment into Canada from their parent companies free of import duties. The appreciating Canadian dollar, combined with these investment measures, helps reduce the import costs of advanced machinery and equipment. These very progressive measures make Canada an even more attractive investment location for foreign investors.

An Unmatched R&D Environment
Canada is known for being one of the lowest-cost countries in which to execute research and development. Canada promotes entrepreneurship and innovation with one of the most favorable tax treatments for scientific research and experimental development (SR&ED) in the world. According to the KPMG's Competitive Alternatives 2010, Special Report: Focus on Tax, Canada ranked second among 10 countries studied for R&D TTI, registering 29.3, some 70.7 percent less costly than the United States. (See Table 2 in slideshow)

When combining the federal SR&ED tax credits with provincial research and development tax incentives, this becomes especially evident. The average benefit on R&D investment is approximately 30 percent for an investor. The SR&ED incentive program, along with its provincial counterpart, offers stable tax credit design and productive administration, all providing the investor with diminished cost and risk. The process is simple, user-friendly, and profitable.

The Canadian SR&ED tax incentive program is aimed at the private sector. Companies based in Canada that invest in R&D can qualify regardless of their size, industry sector, or technology. In addition, the SR&ED incentives include research and development expenditures carried out of Canada, the eligibility of deducting the full cost of R&D machinery and equipment, unlimited sub-contracting of research and development, and part of R&D expenses occurred abroad on Canadian R&D projects. Large Canadian corporations and foreign-controlled corporations - both public and private - receive a tax credit of 20 percent of admissible R&D expenditures receiving a nonrefundable tax credit. This nonrefundable tax credit can be used to offset prior, current, or future federal corporate taxes over the next 20 years. There is no limit to the amount of tax credits made available to a corporation.

Numerous provinces have developed their own tax incentive programs for SR&ED activities executed in their respective jurisdictions. These provincial R&D tax credits must be deducted from the federal SR&ED admissible expenses. The net benefit is approximately one and a half times higher than the federal R&D tax credit alone. A particularly interesting advantage of many of the provincial R&D tax credit incentives is that they are refundable for foreign-owned corporations. What this means is that if a foreign entity is a cost center with no taxable income, the provincial tax credit is refunded directly to the corporation. Table 3 (slideshow) illustrates the effect of the federal SR&ED program on $5 million of qualified SR&ED expenditures. Table 4 (slideshow) illustrates the provincial SR&ED tax credit along with the federal credit, combining both credits for large and foreign-controlled corporations.

Innovation Model
Canada has a "Made in Canada" innovation model whereby basic research is integrated within business applications. This is a major driver of Canada's excellence in research and development. This university-industry cooperative model has resulted in lower research costs and accelerated get-to-market strategy for foreign investors. Canada has experienced significant increases in research and development spending both on the university side and in the private sector. Total expenditures in R&D amounted to $29.2 billion in 2010, which is a 42 percent increase over 2000².

Nine firms among the top 25 corporate R&D spenders in Canada in 2009 were foreign investors. Such global companies include IBM, Pratt and Whitney, Alcatel-Lucent, Ericsson, Sanofi-Adventis, GlaxoSmithKline, Novartis, Pfizer, and Merck. These nine companies alone invested over $2.1 billion in Canada in 2009. Despite the global financial crisis, these companies actually increased their investment in R&D expenditures by 6.5 percent from 2008³.

Other Incentives
Each of Canada's provinces and territories has its own distinct incentive programs promoting investment. These programs assist companies with reducing costs for all different types of investment projects ranging from capital expenditures in machinery, equipment, land, and buildings, to investments to increase productivity, to the building of research laboratories and centers of excellence. Programs cover many sectors and some specifically assist investment projects in specific sectors. Canada and its provinces are well known for supporting industries such as aerospace, biotechnology, information technology, and even the film industry, to name a few. Incentives are available through outright grants, interest-free loans, risk-sharing arrangements, and various investment tax credits. Each province has the jurisdictional responsibility for human resources development, and training subsidies are made available through the various provincial agencies. Too numerous to list, information about all these incentive programs and tax credits is available on the Internet.

1. Department of Finance Canada, April 2001
2. Statistics Canada, CANSIM, tables 358-001 and 380-0017 and catalogue numbers 88-001-XIE and 88B0006XIE
3. RESEARCH Info Source Inc., Canada's Top 100 Corporate R&D spenders