Income-Based R&D Tax Incentives Reduce Corporate Tax Liabilities by 35%, OECD Research Finds

New research from the Organisation for Economic Co-operation and Development (OECD) reveals that income-based tax incentives for R&D and innovation reduce firms' overall tax liabilities by an average of 35% across OECD countries. For jurisdictions that have implemented these policies, the reduction reaches 67%, highlighting a significant shift in how governments support business innovation. 

Two Distinct Approaches 

The research underscores an important distinction in R&D tax policy. While programs like Canada's Scientific Research and Experimental Development (SR&ED) and the US federal R&D tax credit provide expenditure-based incentives—offering relief on R&D spending as it occurs—a growing number of countries now offer income-based tax incentives (IBTIs) that reduce taxes on the income generated from successful R&D activities. 

Expenditure-based programs like SR&ED and the US R&D credit provide tax relief based on qualified R&D expenditures such as technical wages, materials, and contract research costs. These programs lower the cost of conducting R&D, making it more financially attractive for businesses to invest in innovation regardless of profitability. 

Income-based incentives—commonly known as patent boxes or innovation boxes—focus instead on outcomes, offering reduced tax rates on income derived from intellectual property and innovation activities. Rather than reducing R&D costs, they increase after-tax returns from successful projects. 

Dramatic Growth in Income-Based Programs 

The number of OECD countries offering IBTIs has increased fourfold from five in 2000 to 21 in 2024. Among EU countries, growth has been even more striking—expanding sixfold from three to 15 countries over the same period. 

As of 2024, IBTIs are available in 21 out of 38 OECD countries and 29 out of 51 countries covered in the analysis. Belgium, the Netherlands, the United Kingdom, Portugal, and Cyprus are among jurisdictions providing substantial income-based tax relief. 

Impact on Tax Burdens 

For countries with IBTIs in place, the average effective tax rate on R&D assets drops from 19.6% to just 6.5%—a 67% reduction. Across all OECD countries (including those without IBTIs), the average reduction is 35%, from 19.4% to 12.6%. 

However, significant variation exists across jurisdictions. In 2024, effective tax rates for R&D assets ranged from -9% to 25.78% in countries with income-based incentives, compared to 7.86% to 30.6% without such programs. 

The 2015 BEPS Action 5 minimum standard significantly influenced IBTI design through the "nexus approach," ensuring tax benefits are only granted to the extent that taxpayers contributed to creating the IP. This prevents companies from simply acquiring IP to benefit from reduced tax rates. 

Modest Government Costs 

While income-based incentives provide substantial benefits to qualifying firms, their overall cost to governments remains relatively modest. The OECD's 2023 estimates show Cyprus (0.26% of GDP), Israel (0.23%), and the Netherlands (0.21%) provided the highest levels of income-based tax relief, while the OECD area averaged just 0.05% of GDP in 2021. 

These figures stand in stark contrast to expenditure-based R&D tax support, which reached 0.13% of GDP across the OECD area in 2022—representing the dominant form of tax support for business R&D. 

Complementary Strategies 

Most countries offering income-based incentives also maintain expenditure-based programs, recognizing that the two approaches serve different purposes. Expenditure-based incentives reduce the upfront cost and risk of R&D investment, while income-based incentives provide additional rewards if R&D efforts generate valuable IP and commercial returns. 

Canada and the United States: Expenditure-Based Leaders 

Both Canada and the United States have focused their R&D tax support primarily on expenditure-based approaches. 

Canada's SR&ED program, administered by the Canada Revenue Agency, is one of the most established expenditure-based R&D tax incentive programs globally. SR&ED provides tax credits to businesses of all sizes conducting eligible R&D in Canada, encouraging companies to undertake research that leads to new, improved, or technologically advanced products or processes. Canadian-controlled private corporations can receive enhanced refundable tax credits on the first $3 million of qualified expenditures, while larger firms and foreign-controlled companies can claim non-refundable credits that reduce their federal tax liability. 

The US federal R&D tax credit, established in 1981 and made permanent in 2015, provides relief based on qualified research expenditures. The credit primarily offsets income tax liability, with rates varying by calculation method. Importantly, the program includes a provision allowing eligible small businesses to claim up to $500,000 of the R&D credit against payroll taxes instead of income taxes, meaning qualifying startups don't need to be profitable to benefit. 

Both programs exemplify the expenditure-based approach: they make R&D more affordable as companies conduct it, rather than waiting to provide tax relief based on income that R&D eventually generates. 

Key Implications 

The OECD research reveals several important considerations: 

Complementary tools: Expenditure-based programs lower barriers to R&D investment across all companies, while income-based incentives may be more effective at retaining valuable IP within a jurisdiction. 

SME accessibility: Expenditure-based incentives tend to be more accessible to small and medium-sized enterprises and loss-making firms. In 2024, profitable SMEs across the OECD received an average 19% tax subsidy on R&D expenditures (compared to 16% for large firms), while SMEs with no profits received 16% on average (compared to 13% for large loss-making firms). 

Growing reliance on tax incentives: Tax incentives now account for more than half of total government support for business R&D in the OECD area, surpassing direct funding mechanisms like grants. Thirty-four out of 38 OECD countries now provide expenditure-based R&D tax incentives. 

Looking Forward 

As countries compete to attract and retain R&D investment, understanding both types of incentives becomes increasingly important for financial planning and jurisdictional decision-making. For companies operating in Canada or the United States, the focus remains on maximizing returns from expenditure-based programs like SR&ED and the US R&D tax credit, which provide immediate financial benefits based on qualified research activities. 

The OECD's data shows that expenditure-based programs remain the foundation of most countries' R&D tax support systems. By reducing the cost of innovation at the point of investment, these programs help businesses of all sizes and profitability levels overcome the high costs and uncertainty inherent in research and development.