Chapter 5: Investment Environment

Fast Forward 5.0: Making Connectivity Work for Canada
Canadian e-Business Initiative (CeBI)
September 2004

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As firms operate in a fast-paced global market, governments are under increased pressure to develop tax and regulatory policies that build a flexible and competitive economy. In Canada, a major focus will continue to be making up the "productivity gap" with the United States. That is, increasing our productivity levels to build a more prosperous economy. One of the keys to improving productivity is investment in new technologies. In fact, ICT use by firms contributed significantly to productivity growth in Canada after 1995, primarily by promoting change and innovation in business processes.⁴¹

5.1 Tax and Regulatory Environment

A competitive tax and regulatory environment is crucial to attract new investment to Canada and to promote investment and innovation at the firm level, where tax and regulatory policies have a large impact on business decisions. In addition, Canadian tax and regulatory policies can have an impact on SMEs' ability to expand e-business capabilities to compete internationally.

International trade via e-business increases the need for international, and specifically Canada-U.S., cooperation on regulation that expedites border transactions. Canada-U.S. cross-border trade exceeds $1 billion per day. While border issues have figured prominently in recent Canada-U.S. relations, in the long run, clarity on these issues will mean more predictable and certain cross-border trade, which will encourage investment.

Currently, Canada has a very low-cost business environment. With a nine percent cost advantage in comparison to the U.S., a recent KPMG study named Canada as the lowest-cost jurisdiction in which to do business.⁴² Indeed, the high level of technology infrastructure, the low cost of telecommunications, and a highly educated population suggests Canada has the right mix of factors to become a destination for international investment and a technological leader. In terms of taxation policy, Canada has in recent years made good progress, with announcements in the last two federal budgets allowing for a phase out of the capital tax and decreasing significantly structural impediments to investment.

However, we neither do enough to communicate this advantage to our major trading partners nor do we seek out international partnerships and opportunities based on this advantage. In fact, international perceptions of Canada do not highlight our strengths but our weaknesses as a non-innovative, highly bureaucratic environment. International business executives perceive Canada as a jurisdiction with plenty of bureaucratic red tape and distorting regulations and subsidies.⁴³

Indeed, while business costs in Canada are low, more work needs to be done to improve the regulatory sides of the business environment. As the OECD, in its Economic Survey – Canada 2003, has stated: "The fundamental challenge is to make Canada an even more attractive place to live, work and invest. While past reforms have begun to pay off, there is still unfinished business." Canada needs a strategic plan for long-term economic growth—a plan that must include a competitive tax system that encourages effort, saving, investment and risk taking by firms and individuals. Such a tax system will work to enhance productivity and promote sustainable long-term economic growth. A smart fiscal policy must also focus on further reducing government debt, as savings realized from lower interest payments would make room for budget initiatives that can improve the standard of living and contribute to the quality of life of all Canadians. On the spending side, governments must prioritise and focus on those areas that can directly affect Canadian productivity and competitiveness, and enhance the economy's ability to grow.

Decisions undertaken in the 2004 Federal Budget were important steps to improve the Canadian business climate (see Box 5). Capital cost allowance (CCA) rates can have important impacts on business investment decisions. As such, they represent one of the most important ways in which the corporate tax system affects productivity growth. The 2004 Federal Budget increased the CCA rate for computer equipment from 30 percent to 45 percent and the rate for broadband, Internet and other data network infrastructure equipment from 20 percent to 30 percent, making ICT equipment more affordable.

To build an innovative economy, the federal government must also do more to facilitate commerce by removing regulatory impediments to using electronic commerce. Doing more means a commitment to regulatory review, as called for in the Innovation Strategy. The goal of such a review should be to look toward ensuring legislation is current, facilitates commerce throughout Canada, and builds a flexible economy. Some areas that could be included in a review are: a study of framework legislation; implementation of the Agreement on Internal Trade (AIT) to ensure a uniform commerce regime across Canada; setting sunset clauses or review periods in new legislation; and working with international trading partners on mutual-recognition agreements.

5.2 Venture Capital

To build a strong e-economy in Canada, firms engaged in research and development, and innovative uses of technology must have access to risk-capital financing. Venture capital plays an important role in the financing mix available to small firms by supporting firms engaged in risk, a key aspect of innovation.

In 2003, venture-capital activity in Canada fell to $238 million, continuing a declining trend over the past several years. For the first time this year, ICT was the top investment destination, ahead of life sciences.

It is also noteworthy that capital in 2003 went to fewer firms than previously, and that a relatively higher proportion represented follow-on financing for companies that had already received some venture-capital funding, indicating that diminished availability of sources of investment for new firms may continue.

Continued work on Canada's regulatory environment is needed to ensure large institutional and corporate investors are encouraged to invest. In particular, participation of the Canadian pension-fund sector in the private-equity and venture-capital asset class continues at a much lower level than peer funds in the U.S. Some of the reasons frequently cited for these lower investment levels include various structural impediments within the Canadian tax system that discourage large institutions, such as pension funds, from making investments in the venture-capital sector. Similar impediments affect the ability of non-Canadian investors, such as the vast pools of U.S.-based institutional capital, to invest directly in Canadian venture-capital funds.

After consultations with the Canadian venture-capital community, the Canadian eBusiness Opportunities Roundtable, and CEBI, the Government of Canada announced its intention to address many of these issues in the 2003 Federal Budget. Since then, it has released draft legislation. CeBI strongly supports these measures. Once these impediments are removed, the Canadian venture-capital community should have a greater ability to attract new capital from major institutional investors in Canada and the U.S.

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⁴¹ Wulong Gu and Weiman Tang, "Information Technology and Productivity Growth: Evidence from Canadian Industries" in Economic Growth in Canada and the United States in the Information Age, Jorgensen, ed., May 2004.

⁴² KPMG, Competitive Alternatives: KPMG Guide to International Business Costs, February 2004.

⁴³ World Economic Forum, Global Competitiveness Report 2003-2004, October 2003.