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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological Development
in Enterprises, European Commission DG XII European Technology Assessment Network. Version of 15 th August 1999
Version of 18-Aug-99
An International
Compendium of
INDIRECT SCHEMES &
MEASURES for
SUPPORTING RTD
in Enterprises
A supplementary report on the ETAN activity on the Promotion of
Employment in R&D in Enterprises
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological Development
in Enterprises, European Commission DG XII European Technology Assessment Network. Version of 15 th August 1999
This report is based on an annex to a report on the same subject by Segal Quince Wicksteed
Limited, economic and management consultants, November 1995 and then maintained by
DGXII of the European Commission throughout the ETAN action on Indirect Measures to
promote RTD employment in Enterprises, unless the sources of individual contributions are
specifically noted, up to 1.6.99.
This report is also available on the Internet, at URL http://www.cordis.lu/etan/src/topic-7.htm
under the section “Reports”, as of 1st October 1999.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological Development
in Enterprises, European Commission DG XII European Technology Assessment Network. Version of 15 th August 1999
DETAILS OF SCHEMES
This volume on indirect schemes and mechanisms for supporting RTD in companies presents
details of a number of indirect schemes and measures which have been implemented over the
last ten years, and came to be review in the context of the European Technology Assessment
Network exercise on this issue.
The case studies are presented in the same taxonomy as they appear in the main ETAN
report. The first section examines European Union Member States tax-based measures, the
second, financial support measures for personnel and equipment and in the third, some
“other” measures are detailed.
Within each section the more relevant schemes are presented first, followed by the summaries
of other schemes which were not researched in any detail. A further section then reviews
schemes outside of the structure of the European Union 15 member states.
Unless otherwise stated, all figures are in current terms, and have been converted to ECU or
EUROs (€) using the exchange rates current at that time.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
PART IV
INDIRECT SCHEMES AND MEASURES IN COUNTRIES
EXTERNAL TO THE EU
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
45. AUSTRALIA
50% Tax Concession (validated by A Gambardella, J Guinet and L Rubiello)
The 150% tax concession for R&D is the principal scheme, which has existed now for
nine years. There is a full review in a report (12/94) covering the whole Australian
R&D scene. In 92/93 BERD/GDP was up to 0.67% (from 0.25% in FY 81/82). Over
the last two years R&D investment has grown by double digit percentage points. Two
thousand seven hundred organisations perform R&D (up from 1300 in FY81/82.
Amongst G-24, Australia is 19th, and despite success of the scheme, is still 17th in
OECD terms - the same as in FY 81/82. Growth rate though is 2nd highest. Corporate
Tax rate is 33%. A 200% tax concession rate was seriously considered. Currently,
with concessions, A$1 of R&D costs 50.5 cents only. Tax concession has a floor of
20K A$. The rules are:
Objective of the R&D tax concession is to make Australian companies more
innovative and internationally competitive through:
A
B
C
D
increasing companies' investment in R&D;
encouraging better use of Australia's existing research infrastructure;
improving conditions for the commercialisation of new process and product
technologies developed by Australian companies; and
developing a greater capacity for the adoption of foreign technology.
The benefit is a tax concession that enables eligible companies to deduct 150 per cent
of eligible expenditure incurred on R&D activities against their taxable income. The
concession is for companies incorporated in Australia; public trading trusts; eligible
companies in partnership.
What expenditure is eligible? - expenditure on R&D projects that involve either
innovation or technical risk. Associated requirements are that the R&D must
(generally) be carried out in Australia; it must have adequate Australian content; and
the results must be exploited for the benefit of Australia.
Number of registrants - approximately 2500 per year, steady since 1990.
Tax revenue forgone - A$ 395 million (1992-93); A$415 million (1993-94 est).
Changes were announced in May 1994 in the Government White Paper:



expenditure threshold reduced from $50,000 to $20,000 to get more SMEs
involved;
specific R&D activities carried on outside Australia allowed as eligible on a
discretionary basis up to a limit of 10 per cent of total project cost;
syndicated R&D expenditure threshold reduced from $1 million to $500,000;
and a generic structure to be developed.
The definition of R&D is defined in:
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
Subsection 73B(1) of the Australian Income Tax Assessment Act defines R&D in two
parts:
"Research and development activities" means:
(a)
systematic, investigative or experimental activities (i.e. core activities)
that:
1)
2)
3)
are carried on in Australia or in an external Territory;
involve innovation or technical risk; and
are carried on for the purpose;
(i)
(ii)
(b)
of acquiring new knowledge (whether or not that knowledge
will have specific practical application)
creating new or improved materials, products, devices,
processes or services; or
other activities (i.e. supporting activities) that:
1)
2)
are carried on in Australia or in and external Territory; and
are carried on for a purpose directly related to the carrying on of
activities of the kind referred to in paragraph (a).
The syndicated approach works well - users tax credits that companies can "sell" and
share benefits. Social benefits are greater in this way. However the multiplier effect is
ca. 0.7 to 1.0; with social benefits though the multiplier is > 1.0.
Contracted R&D is permitted. But no major change in the scheme is foreseen as a
result. It has improved Australian competitively and innovation. Concessions will
remain in foreseeable future.
The scheme costs, annually, 455 MA$/Yr. (FY93). Proof of its success are not
empirically certain but R&D has improved. The administration aspects are
summarised thus:


The tax concession is jointly administered by the Industrial R&D Board and
the Australian Taxation Office.
The legal framework for the concession spans the Income Tax Assessment Act
and the Industry Research and Development Act.
The Commissioner for Taxation has responsibility for deciding the eligibility of the
amounts claimed.
The Board, through its Tax Concession Committee, is responsible for deciding the
eligibility of:



the activities claimed as R&D
the financial structures of R&D syndicates
R&D conducted overseas (from 1 July) within thresholds.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
The board is also responsible for:



registrations
monitoring
reviews and appeals.
The scale of support is still focused on small companies, but is the big companies who
really benefit from the scheme.
Table A1 shows that despite a doubling of BERD, the average scale of R&D in
enterprises remains small, in the 1 to 10 people FTEs.
Overall, small enterprises (<100 KA$/annum of R&D) are 40% of all applicants and
consume just 3.7% of the funding. Medium sized R&D undertakings also account for
42% of applicants but consume 16.7% of funding. Large enterprises in the sense of total
R&D spend (> 500 KA$/year R&D) are 18% of all applicants but they obtain 79.7% of
the funds available. The largest companies (13 applicants consume 27.7% of all funds).
Table A-2 shows the skewed distribution, and confirms that 63% of all R&D
expenditure is eligible for the scheme.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
Table A1: Australian BERD and Number of Organisations taking part in R&D
actions
Year
FY86
FY88
FY90
FY91
FY92
BERD
MillA$
1289
1798
2082
2320
2788
BERD as
% GDP
0,48
0,54
0,54
0,59
0,67
Org’s
R&D
FTEs
18479
20803
20907
21066
22811
3029
3048
2685
2398
2766
FTEs/
Org
6
7
8
9
8
Table A2: Scale of R&D in Australian Companies benefiting from Tax
Allowances
R&D Exp
KA$s per
annum
1-20
20-49
50-99
100-199
200-500
500-999
1000-1999
2000-4999
5000-9999
>10000
No. of
Companies
Registered
120
247
438
445
403
168
86
77
17
13
Total
2014
% of all
Registrants
5,96%
12,26%
21,75%
22,10%
20,01%
8,34%
4,27%
3,82%
0,84%
0,65%
BERD88/9
% Eligible
8
Cumulative
% of all
Registrants
5,96%
18,22%
39,97%
62,07%
82,08%
90,42%
94,69%
98,51%
99,35%
100,00%
% of R&D
costs
allowed
0,1
0,8
2,8
5,5
11,2
10,1
10,7
20,8
10,4
27,6
1137,3
MA$
1798
MA$
63%
Cumulative
% of all
costs
0,10
0,90
3,70
9,20
20,40
30,50
41,20
62,00
72,40
100,00
An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
The Australian Experience in Evaluating the R&D Tax Concession.
Introduction to the Australian 150% Tax Scheme
This paper presents the Bureau of Industry Economics' experience in evaluating the
Australian 150% R&D Tax Concession. The principal source is the Bureau's Research
Report 50, “R&D, Innovation and Competitiveness: An Evaluation of the
Research and Development Tax Concession”.
The introduction of the R&D Tax Concession scheme in 1985 coincided with a major
shift in Australian industrial policy away from protectionism and toward greater
openness and integration with the global economy. The Concession was seen as an
important instrument in reorienting Australian firms and in changing the attitudes and
priorities of management towards innovation.
The main goals of this policy have been to increase business expenditure on R&D, to
improve the effectiveness of the R&D undertaken by public research agencies such as
the CSIRO, and to improve the linkages between universities and industry. The
Concession, therefore, is only one of a suite of policies designed to achieve these
goals - albeit one of the most important in terms of the cost to Government.
The Changing Policy Environment
The late 1970s and early 1980s were the end of an era in Australian industry policy.
Industry was increasingly seen as overly protected from international pressures.
Foreign ownership was high, reflecting the trade barriers erected over the post-war
period. The BERD/GDP ratio was low by international standards and dropping.
Australia's fortunes were tied to natural resource industries - precisely those whose
terms of trade had displayed a worryingly persistent secular decline over the past 40
years. Manufacturing appeared in a state of irreversible decline.
Policy initiatives over the 1980s, following in part a world-wide trend for opening up
markets, saw the emasculation of traditional protectionist policies and a move towards
policies which addressed market failures, firm inefficiencies and impediments to
firms operating effectively. Science and technology (S&T) policies have figured
prominently ever since in industry policy agenda in Australia. There is a broad
acceptance of the view that a priority issue for Australia is to increase the
competitiveness of the economy in order to halt and reverse the fall in Australia's
world ranking in terms of per capita GDP.
From the mid 1980s onwards the basic goals of policy have been to increase
BERD/GDP through the 150% Tax Concession and assorted Grant programs;
increase effectiveness of public sector R&D by setting commercial objectives for
CSIRO and other public sector research agencies and improving the overall
functioning of the innovation system by encouraging the development of universityindustry links especially through the Cooperative Research Centres program.
Government policy statements have continually stressed the significance of science
and technology to Australia's economic development. R&D is seen as a central
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
element in the process of technological innovation through its role in developing new
and improved products and processes.
The impetus for innovation policy is now motivated by more than just a simple linear
view of the innovation process. There is a recognition of the importance of
networking linkages and feedback mechanisms. The motivations behind policy
initiatives and the initiatives themselves are therefore in a continual state of evolution.
Trends in total and business R&D
Over the period of the 1970s and early 1980s, Australian R&D performance differed
in two major respects from that of many other OECD countries: first, the ratio of
gross expenditure on R&D (GERD) to GDP was low, compared to both the OECD
average and other similar-sized R&D performing countries; and second, the ratio had
been declining during most of the 1970s, in stark contrast to the generally upward
trend in most other OECD countries.
Despite above-average growth in GERD during the 1980s (particularly since 1985-86)
Australia's international R&D ranking has not really changed from 1981 to 1992.
Australia's GERD/GDP ratio is 0.45 percentage points lower than the average for this
group of industrial economies.
A key feature of Australian R&D experience is the dominance of the Government
sector, at times accounting for as much as three-quarters of overall funding.
Internationally, Australia's performance on public R&D is good -- Australia ranks
eighth among a group of 28 OECD and other industrial economies in terms of
Government funded R&D to GDP. It is the low business R&D to GDP ratio which
makes Australia a relatively poor performer on overall R&D.
The dominance of publicly funded R&D has implications for the type of R&D
undertaken. The public sector (Government agencies and universities) perform
around 60% of Australia's R&D, and the bulk of this (around 85%) is concentrated in
the research rather than the development stage. By contrast, two-thirds of business
R&D expenditure is directed at product development, but this represents only onequarter of overall R&D expenditure. The major part of Australia's R&D effort
therefore tends to be concentrated in the early stages -- the research stage dominates
the development stage in the ratio of 2:1. Because of this feature Australia is
relatively strong in the research phase of the innovation process, it is relatively weak
in commercialising the results of that research1 .
The last two decades have been marked by several episodes of substantial swings in
business expenditure on R&D (BERD)2. Australian BERD to GDP grew at an
average annual rate of over 15% over the period 1981 to 1989 - the fastest growth
1
Pappas, Carter, Evans & Koop [PCEK] (1991), Block (1991), Australian Science and Technology
Council [ASTEC] (1991).
2
Real BERD slumped from 1973-74, reaching a low of 0.23% of GDP in 1978-79. In the period since
1981-82, BERD recovered, more than doubling in real terms, the BERD/GDP ratio reaching 0.48% in
1986-87. Since 1988-89, the BERD/GDP ratio has been relatively stable at around 0.55%, but
increased to 0.67% in 1992-93 - the highest figure since statistics have been collected and nearly three
times the low point of the mid-1970s.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
exhibited by any OECD country, but the current Australian BERD/GDP ratio is still
relatively low - about two thirds the median figure for other medium R&D performing
countries and about three quarters of the average for a group of G-28.
Relationship of the Tax Concession to Other Innovation Programs
When the BIE reviewed the general 150% tax concession program there was a
plethora of grant and other systems for assisting various stages of the innovation
process, though it represented ca. 65% of all support available. The grants system, for
example, included:

company based commercial R&D for enterprises unable to sufficiently access
benefits from the R&D Tax Concession (Discretionary Grants Scheme);

the development of new or emerging technologies of strategic importance for
industry competitiveness (Generic Technology Grants Program);

the research, development, trialing and demonstration of projects that have the
support of a government purchaser (National Procurement Development Program);

the development and diffusion of advanced manufacturing technologies in
Australia (Advanced Manufacturing Technology Development Program); and

company improvement projects through the use of highly qualified graduates
(National Teaching Company Scheme).
Other Support Schemes
A number of other programs stimulate R&D in particular sectors. The Factor f
program allows pharmaceutical companies higher prices for their products in
exchange for increased commitment to R&D and local production. Similarly, the
Partnerships for Development program provides incentives for large multinational
information technology firms who are major suppliers to government to undertake
R&D in Australia.
Developments
There has been some rationalisation and re-orientation. Following the May 1994
White Paper, the Government simplified the grants system - collapsing 5 distinct
programs3 into a single program of Competitive Grants for Research and
Development with a single set of eligibility and merit criteria. However, the grants
system and the 150% general tax concession still focus mainly on the R&D stage of
the innovation process. These elements are subject to the greatest technical risk. They
are widely perceived to be the points at which market failures are most extreme, due
to either capital market inadequacies or spillovers from new knowledge created by
research.
3
Discretionary Grants, the National Procurement Development Program, the Advanced Manufacturing
Technology Development Program, the Generic Technology Grants and the National Teaching
Company Scheme.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
Empirical results of the Tax Concession Scheme
Syndication. (by A Gambardella)
Related to the 150% tax concession scheme, Australia also developed a Syndicated
R&D programme. Syndication principally involves research companies with large tax
losses. The program allows these firms to trade their losses with financial partners for
R&D funds. The Bureau found that in contrast to most tax concessions, R&D
Syndication produces a big RoI. The essential difference between syndication and the
general 150% tax concession which explains the dramatic contrast in its impact is that
syndication generally works by facilitating finance for firms who otherwise face an
effectively infinite cost of finance: that is, capital is unavailable to them. In contrast,
the 150% tax concession reduces the cost of R&D for firms who can access finance.
Impact of the 150% Tax Concession on Companies' R&D Performance
Comparisons of R&D performance in the periods before and after the introduction of
the Concession.
The data did not allow a definitive conclusion to be drawn from comparisons of this
type. Real BERD and the BERD/GDP ratio rose more rapidly in the two years
following the introduction of the Concession than in any other years before or since.
However, BERD also rose strongly compared to past experience in the three years
prior to the introduction of the Concession. The introduction of the Concession also
coincided with a period of strong growth in the economy.
The Bureau, in an earlier interim evaluation of the Tax Concession[13], had asked
registrants to identify the factors that had contributed to the observed increase in their
R&D expenditure over the two-year period 1984-85 to 1986-87. This suggested that
around one third of the increase had been due to the introduction of the Concession,
and somewhat less to reclassification of expenditure following the introduction of the
Concession.
Evidence from the survey of registrants
In the survey conducted in 1992, 23% of the 839 respondents reported that the Tax
Concession had been critical to their proceeding with at least one R&D project in the
last three years:
The proportion of firms responding positively to this question differed little by size of
firm or taxable income status. However, of the 392 firms whose R&D performance
could be tracked continuously over the four year to 1990-91, those with fast growth of
R&D were twice as likely to have had a project critically influenced by the existence
of the Concession as those with no growth in R&D; projects critically influenced by
the Concession accounted for 10% of expenditure on eligible R&D (6 percent of
Incremental R&D; 12% of Strategic R&D; and around 20% of expenditure on pilot
plants). An implication of this question is that eligible R&D might have been around
10% lower in the absence of the Concession. Some 40 to 50% of respondents
indicated that the Concession had had a significant or very significant effect in
allowing projects to be continued; widened in scope; or improved in quality.
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
Firms were asked to indicate the level of R&D they would have undertaken if the
deduction rate had been 100% instead of 150%. The results suggested that
expenditure on eligible R&D would be 17% lower in the absence of concessionary
treatment of R&D. Around 50% of respondents reported that they would reduce their
expenditure on R&D if the 150% rate of deduction were reduced to 100%. Small and
medium firms; those with fast growth in R&D; and Australian-owned firms indicated
that they would make a relatively large proportionate reduction in their expenditure on
eligible R&D if the concession rate fell to 100%.
These responses, taken together, suggested that the amount of additional R&D
expenditure induced by the Tax Concession might lie in the range of 10 to 17% of
eligible R&D expenditure.
Impact of R&D on firms' innovativeness and competitiveness
Relation between R&D and Innovativeness
Internal R&D is a potential source of new products and processes. It may also give
firms the capacity to exploit new technology from other sources. Respondents to the
Survey indicated, however, that in-house R&D was by far the most important source
of their new technology. This would suggest a close link between R&D performance
and the extent of innovation by the firm.
The ability to exploit technology in the marketplace also depends on a broad range of
capabilities in addition to R&D. Hence the links between R&D and innovativeness
may be subject to considerable variability.
Recipients were asked what proportion of their sales in 1990-91 was accounted for by
totally new products and services introduced in the last three years; and by
significantly improved; incrementally improved; and unchanged products and
services. An average index of innovativeness was constructed, which show a clear
positive correlation between firms' R&D intensity and degree of innovativeness: the
proportion of firms' sales accounted by totally new products/ processes ranged from
11% for companies in the lowest R&D intensity category to around 43% amongst the
firms with the highest R&D intensity; and the innovation index also increases
systematically with R&D intensity.
Relationship between innovation and competitiveness
The performance of Tax Concession recipients was compared to that of all
manufacturing firms, and the performance of more and less innovative Concession
recipients was also compared. The principal findings were that Tax Concession
recipients had faster growth of sales/turnover than did all manufacturing firms over
the period 1988-89 to 1991-92. The less innovative firms had turnover growth of
about -2.5% per annum over this period, whereas moderately and highly innovative
firms had growth rates of around 3.5% per annum. They also had a higher ratio of
profit to turnover, but there was little difference in growth of profitability;
Recipients with moderate -to-high levels of innovativeness had faster growth of sales
over the same period than did those with low levels of innovativeness. However, there
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
was less relationship between profitability and innovativeness within this sample of
firms.
Recipients, especially those with moderate-to-high levels of innovativeness, reported
that technological innovation was important in achieving product quality and
performance, and customer satisfaction. Small firms (employment < 100) also
reported that innovation was important in broadening their product range, while larger
firms were also more likely to report that innovation was important in reducing costs
and increasing production flexibility.
Possible modifications of the Australian Tax Concession Scheme
Overview of recommendations
The full set of recommendations made by the Bureau are:
 The R&D tax concession is more likely to be welfare enhancing than not and
consequently recommends its retention.

Should compulsory tax consolidation be introduced in Australia, the R&D tax
concession be redesigned to reduce transfer payments.

Action should be taken to address the welfare loss arising from transfer payments
to foreign-owned companies.

Retrospective claims be allowed only when they are not more than one year old.

The IR&D Board investigate the reasons for the low proportion of tax loss
companies applying for the Discretionary Grants Scheme and, if necessary, more
actively market the Discretionary Grants Scheme to such companies.

The Discretionary Grants Scheme be broadened to include companies which are
unable to benefit fully from the R&D tax concession because of washout.

The Discretionary Grants Scheme be amended to make companies in the nontraded sector eligible for assistance.

Amending the minimum threshold to allow eligibility at the full concession rate
where a very small firm (with less than 20 employees) performs in-house R&D
every year and expenditure over a three year period exceeds $50,000.

As a general principle, the level of total support to business R&D should be
uniform across all sectors unless higher than average spillover benefits can be
demonstrated.

When the programs which give rise to higher than average levels of support for
R&D are next evaluated, the evaluations should address whether the benefits are
sufficiently high to justify the higher levels of assistance.

there be an assessment of roles and effectiveness of the many programs which
seek to enhance linkages between industry and the public research sector.

eligibility not be extended to the non-R&D costs of innovation until the R&D tax
concession is redesigned to reduce transfer payments.

the IR&D Board investigate the reasons why registrants do not continuously
perform R&D, and why a larger proportion of companies which have the potential
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
to benefit from R&D do not undertake it, in order to redesign R&D support
programs to have a greater impact on BERD.

information be sought on the effectiveness of alternative R&D support measures
which have lower transfer costs, with a view to piloting alternative schemes which
might have higher net social benefits than the current R&D tax concession.
The key issues include:


Possible ways to reduce the extent of transfer payments; and
The small proportion and lack of increase in the number of companies
registered for the Scheme.
Ways to reduce transfer payments
It was estimated that the Tax Concession had increased the eligible R&D of recipient
firms by between 10 and 20%. A corollary is that up to 90% of the R&D subsidised
by the Scheme would have occurred anyway.
This involves annual transfers of around $200 million annually. The economic cost of
financing this transfer by government was estimated to be of the order of $60 million
annually. Clearly the net benefit of the scheme would be increased, and its cost to
revenue substantially reduced, if transfer payments could be reduced.
The Bureau examined four types of scheme that offered the prospect of reducing
transfer payments. These were:
1. a general system of grants designed to provide support only to R&D projects that
would not have proceeded in the absence of the support; this might be possible, but
only at a substantial increase in the current very low administrative cost of the
program. It would nevertheless be hard in practice to assess whether the proposed
R&D was genuinely being induced by the grant.
2. a two-tier tax concession providing a higher rate of subsidy to projects likely to be
more responsive to the concession; however, the differences in responsiveness of
different categories of R&D did not appear to be large in practice. There would
also be the problem of R&D being redefined to fall into categories carrying a
higher rate of subsidy;
3. a tax concession scheme supporting incremental R&D only. Incremental schemes
subsidise the change between the present level of R&D and a calculated base which is ideally the level of R&D that would have been undertaken in the absence
of the concession. Schemes such as that applying in the USA offer a possible
model. However, until Australia requires companies to lodge consolidated tax
returns, the possibilities of abuse - by shifting R&D between companies in a group,
or to new subsidiaries - would be great.
4. schemes that attract applications only in respect of additional R&D
This approach involves designing R&D support measures that motivate firms not to
accept support for R&D, which they would have done anyway. Examples include
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
stock option grants and incentive compatible subsidies4. However, these schemes are
largely untried.
The Bureau therefore recommended that, should compulsory tax consolidation be
introduced in Australia, the R&D tax concession be redesigned to reduce transfer
payments, and that information be sought on the effectiveness of alternative R&D
support measures which have lower transfer costs, with a view to piloting alternative
schemes which might have higher net social benefits than the current R&D tax
concession.
The small number of companies registered for the Concession.
The effectiveness of the concession in increasing R&D can be judged not only in
terms of whether it encourages existing R&D performers to undertake more R&D but
also whether it has encouraged more companies to perform R&D. In respect of trends
in the number of registrants, around 200 new continuous R&D performers appear to
have emerged each year in the first three years of the scheme. Despite this entry of
new R&D performers, the overall number of registrants each year has averaged
around 2000 companies, and the number of consistent performers (undertaking R&D
in at least four of the first five years of the scheme) has been fairly stable at around
1000.
Viewed against the background of around 1000 consistent R&D performers and 2000
registrants overall each year, the 200 per annum new continuous registrants suggests
that the scheme has been modestly successful in encouraging new R&D performers.
It is not necessarily the case that a substantial increase in the number of registrants
should be expected. The analysis of factors influencing R&D expenditure confirmed
that R&D is mainly market and technology driven. Factors which influence the 'price'
of R&D, such as the tax concession, were viewed by survey respondents as playing a
secondary (though not unimportant) role. Further, it may well be that for many firms,
other forms of innovation are more critical to competitiveness than those associated
with R&D. Nonetheless, as consistent users of R&D on average have good records of
sales and profit growth, and as the social returns to R&D are often much higher than
the private returns, Australia would be likely to benefit if more firms regularly
undertook R&D. An investigation of the reasons why non-R&D performers choose
not to carry out R&D was beyond the scope of this evaluation.
Subsequent developments
Since the Bureau reported in the mid 90’s, the Government has brought down a major
policy statement, Working Nation: Policies and Programs, which included a number
of changes to innovation policies. These included:

increased access for small and medium firms to the 150% Tax Concession by
reducing from $50,000 to $20,000 the threshold for qualification for individual
companies;
4
See S.Folster, The Art of Encouraging Invention; A New Approach to Government Innovation Policy,
Almqvist and Wicksell International, Stockholm, 1991.
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
extending eligibility for the Tax Concession to expenditure by Australian
companies on some core research and development activities that cannot be
conducted in Australia;

merging the existing programs of Competitive Grants for Research and
Development into a single scheme;

introducing a new scheme to support early commercialisation by high technology
firms.
For its part the Bureau has undertaken two further studies relating to the Tax
Concession scheme, and has sponsored an Industry Economics Conference5.
Spillovers
The Bureau's study of the nature and extent of spillover benefits from Australian
industrial R&D examined 16 innovations undertaken by firms receiving the R&D Tax
Concession. This study focused on three major aspects of spillovers: the flow of
knowledge between firms, the benefits to consumers and intermediate firms from
improved final products, and benefits to the community more broadly. The BIE study
found that of the 16 innovations, three had high knowledge spillovers, seven had high
or very high benefits to consumers and two had moderate community spillovers.
The BIE study indicated that sufficient industry depth was necessary to capture
knowledge spillovers. In some product fields, where there were very few Australian
firms, knowledge spillovers may have largely benefited overseas firms. The report
noted that the critical issue, for assessing the net benefit from subsidising innovation
was the value of spillovers retained relative to the economic cost of the subsidy.
Incidental leakage of spillovers overseas was not a concern.
Overall, the study confirmed that firms were unable to benefit from all of the returns
from their innovative products. Hence, spillover benefits were pervasive. While the
value of spillover benefits varied considerably across innovations, it appeared
consistent with that assumed in the Evaluation of the 150% Tax Concession.
Syndication
Syndication principally involves research companies with large tax losses. The
program allows these firms to trade their losses with financial partners for R&D
funds. The Syndicated R&D program provides a revealing counterpoint to orthodox
tax concession measures. The Bureau found that in contrast to most tax concessions,
R&D Syndication produces a big RoI. The essential difference between syndication
and the general 150% tax concession which explains the dramatic contrast in its
impact is that syndication generally works by facilitating finance for firms who
otherwise face an effectively infinite cost of finance: that is, capital is unavailable to
them. In contrast, the 150% tax concession reduces the cost of R&D for firms who
can access finance.
5
Bureau of Industry Economics, "1994 Conference of Industry Economics; Papers and Proceedings",
Occasional Paper 23, Australian Government Publishing Service, Canberra, 1996
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Conclusions and lessons for policy
A fundamental concern of innovation policy around the world has been the design of
programs that induce substantial and worthwhile R&D with the maximum potential
for commercialisation. Against this lofty aspiration stands a disappointing record.
Reflecting design difficulties, tax concessions for innovation often extend the
concession to all R&D, rather than to incremental R&D. An endemic feature of tax
based innovation programs is a low inducement of new R&D and substantial
dissipation of concessions as transfer payments to firms - or to put it more
figuratively, a quiet `bang for a buck' (or a price elasticity approaching unity). Since
the revenues lost from such concessions must be financed through additional
distortionary taxation, there must be high social spillovers from the scant induced
R&D to generate net benefits. Symptomatic of this fundamental design problem, the
Australian 150% R&D tax concession generates only modest inducement of new
R&D. A relatively small number of companies undertake R&D with a relatively small
proportion of these critically influenced by the concession.
Given Australia's circumstances at the time the Concession was introduced, the
concession has probably had significant effects in increasing firms' innovativeness,
and contributed to their international competitiveness. More innovative firms had
better capacity to penetrate markets and achieve growth and higher profitability.
Although this paper has emphasised the quantifiable effects of the Tax Concession,
the full BIE evaluation indicates that the program had significant qualitative impacts
on firms' innovation. In particular, it raised the profile of R&D and broader innovation
as a key strategy for improving individual firm performance.
However a key policy challenge remains. Some economists have suggested
theoretically attractive ways in which R&D incentives could more effectively achieve
their goal of stimulating socially beneficial R&D. Incentive compatible programs
(such as the stock option grant) seem to have potential to reduce the transfer burden of
traditional concessions.
Ultimately of course, there is a need to recognise the limitations of any single
incentive. Increasing the proportion of companies undertaking R&D may well require
a longer broader process of cultural change than has been achieved to date, going well
beyond the partial impact of a single instrument such as the 150% tax concession.
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46. BRAZIL
(validated by J Monniot)
Brazil has a scheme whereby gross profits which are utilised for R&D are exempt
from profits (i.e. corporation) tax. In 1984 an additional law - the "Informatics Law"
approved certain fiscal incentives for nationally controlled industries, notably the
computer industry.
The treatment of R&D is based on the assumption that it is like an investment which
generates future income, and can be treated as a capital expenditure item therefore.
Rules therefore permit deferral and amortisation over a minimum of 5 years.
There are some exceptions :




R&D in informatics
production of computer and related equipment
software development
micro-electronic industries.
Granting of exemptions is vested in the CONIN committee (National Council of
Informatics and Automisation) and the Secretariat of Informatics.
Fixed assets may be depreciated by 1/3 annually, software cost amortised over three
years, and exemptions from import duties are frequently granted exemptions.
Royalties on technology transfer inflows are deductible operating expenses, and lump
sum payments can be amortised over the life of the contract.
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47. CANADA
(Validated by A Gambardella, J Guinet and L Rubiello)
Canada has a federal structure like that of the USA, and the states have similar
freedom to induce R&D into its territories as the US states, and exercises that right in
a number of ways. The review here includes the recent federal budget amendment of
February 1994 and changes in New Brunswick, Nova Scotia and Ontario throughout
the year.
CANADA Summary Overview ( by A Gambardella)
Canada offers the most attractive tax incentive package for manufacturing companies
engaged in R&D when compared to the tax systems of industrial countries such as the
United States, Japan and those in Western Europe.
One explanation of the Canadian “generosity” in R&D tax concessions is that Canada
has to attract R&D investments in competition with the US. It is estimated that with
the tax incentives schemes available in Canada (federal and provincial – see below)
companies can pay three engineers in Canada for the price of two in the US.
Moreover, it was estimated that the after-tax cost of $1million in R&D ranges
between $381K to $401K in Canada according to the province, compared to $590K in
the US. (See “A Comparison of Tax Incentives for Performing Research and
Development in Canada and The United States”, prepared for Industry Canada, by
Deloitte & Touche - March 1995.)
This is the result of a strong federal tax incentive package enhanced by the tax
treatment of R&D in several provinces that offer it. The federal corporate tax,
coupled with the varying provincial manufacturing and processing taxes (assuming
maximum use of available tax credits), offer combined tax rates generally in the range
of 18 to 23 per cent for small companies and 31 to 39 per cent for large companies
Federal corporation income tax allows for a 100% deduction for current R&D, capital
expenditure made on machinery and equipment used for R&D. Buildings and similar
large installations for carrying out R&D are allowed at the normal 4% depreciation
only. There is also an investment tax credit on R&D expenses of certain kinds - but
incurred in Canada itself. This is nationally 20% of R&D expenditures except for
Atlantic Canada where it was 30% until 31.12.94 when it was eliminated.
Small business R&D tax credits run at 35%, with current expenditures, machinery and
equipment qualifying; but they are taxable in that they are deducted from the base line
of current and capital expenses before the 100% deduction from business income is
implemented.
Individual provinces provide additional tax concessions for R&D. Particularly,
Manitoba, Ontario, Quebec, New Brunswick and Nova Scotia have schemes in
operation. The most articulated one is in Ontario which allows for a basic allowance
of 25% of expenditures plus an extra allowance of 37.5% on incremental R&D
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expenditures. These concessions rise to 35% and 52.5% in the case of small firms.
Quebec also allows for doubling the tax concession for smaller firms.
Detailed CANADIAN R&D FACTS
CD$10.9 billion (ca 6.2BECU at an exchange rate of 1.6CD$ = 1 ECU in 4/97) was
spent on R&D by private and public sectors in Canada during 1994, of which $6.1
billion was spent by the private sector (this includes foreign companies) on R&D in
1994. Canada's top 100 R&D performers collectively spent $5.1 billion on pre-tax
R&D activity in 1994. In 1994, the business sector performed 55 per cent of the R&D
activity in Canada, while higher education and the federal government performed 26
per cent and 15 per cent respectively. A total of 114 260 people were engaged in
R&D in Canada during 1991, of these 65210 were scientists and engineers (ie well
over 50%).
$1.02 billion was claimed as R&D investment tax credits by corporations conducting
R&D in Canada during 1991, representing ca 15% of all R&D costs at that time.
Canadian trade in research and development services has had surplus balances since
1990, while receipts have increased 23.5 per cent between 1988 and 1992. Canadian
advantages include:
- immediate write-off for current and capital R&D expenditures and federal
investment tax credits of 20 per cent;
- robust, nation-wide R&D infrastructure, including university, government and
company laboratories, linked by advanced telecommunications networks;
- steadfast government support for development of technology;
- expertise in speciality areas such as telecommunications products and services,
nuclear energy, pharmaceutical product development, biopharmaceutical technology
and computer software;
- highly trained professionals in several fields of knowledge at significantly lower
costs as compared to the United States;
- strong protection of intellectual property rights. To cite an example, in the
pharmaceutical industry, the duration for granting full-term patents has been extended
to 20 years.
In total, there are ca 25 multi-national companies whose total R&D expenditures in
Canada exceed 10 MECU annually.
“Basically, for every $1 you invest in R&D for eligible expenses, you get a 35-per
cent refund. So if you invest $2 million in R&D, you could get $700 000 back. In
addition to which, of course, your R&D expenses go under your expense line,
reducing your taxable earnings. I am not aware of anything comparable in the United
States or elsewhere.” Quote by Dr. R.D. Samuel Stevens, President Solarchem
Environmental Systems, 1997
Schemes
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Canada offers the most attractive tax incentive package for manufacturing companies
engaged in R&D when compared to the tax systems of industrial countries such as the
United States, Japan and those in Western Europe.
This is the result of a strong federal tax incentive package enhanced by the tax
treatment of R&D in several provinces that offer it. The federal corporate tax, coupled
with the varying provincial manufacturing and processing taxes (assuming maximum
use of available tax credits), offer combined tax rates generally in the range of 18 to
23 per cent for small
companies and 31 to 39 per cent for large companies
Federal corporation income tax allows for a 100% deduction for current R&D, capital
expenditure made on machinery and equipment used for R&D. Buildings and similar
large installations for carrying out R&D are allowed at the normal 4% depreciation
only.
There is also an investment tax credit on R&D expenses of certain kinds - but
incurred in Canada itself. This is nationally 20% of R&D expenditures except for
Atlantic Canada where it was 30% until 31.12.94 when it was eliminated.
Small business R&D tax credits run at 35%, with current expenditures, machinery and
equipment qualifying; but they are taxable in that they are deducted from the base line
of current and capital expenses before the 100% deduction from business income is
implemented.
Because the corporate tax system at the state and federal level are inter-twined, the
R&D system at the state level requires more detailed examination. Manitoba, Ontario,
Quebec, New Brunswick and Nova Scotia current have schemes in operation, that
differ markedly from the federal system as described above.
Manitoba
There is a non-refundable R&D tax credit of 15% since 1992. It is based on
expenditure definitions for the federal system, but is applied only to R&D physically
carried out in the state. It is deductible from the federal tax claims and from
provincial income tax claims.
Ontario
There is an incentive based on the amount of qualifying expenditure less the amount
of federal investment tax credit. It has two components, a basic allowance and an
incremental allowance. The basic allowance is 25% of expenditure for large
companies and 35% for small companies. For incremental R&D (current and capital
expenditure) over and above previous levels (defined as average spend over the past
three accounting periods), there is a 37.5% rate for large companies and a 52.5% rate
for small companies. The base rate scheme negates the impact of Ontario tax impact,
while the incremental scheme element rewards growth in R&D.
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As of 1.1.1995 there is also a 10% Ontario Innovation Tax Credit (OTIC), refundable,
to Ontario based small enterprises, which is deductible from both other state and
federal schemes.
Quebec
Quebec implemented one of the more radical tax relief scheme schemes in 1988,
which were then further developed in FY1989/90. There is a fully refundable credit of
20% of salaries and related costs of researchers, which is doubled for small
companies. It does not reduce the base of income tax assessment though, but reduces
the amounts that qualify for federal benefits and tax credits. It was notably successful
in attracting small high technology companies, some migrating from the US.
Nova Scotia
There is a refund tax credit scheme of 15% of R&D for Nova Scotia based
corporations, applied against state income tax. In other respects it is like the Manitoba
scheme.
New Brunswick
The smallest and most recent scheme - 10% tax credits for resident corporations, with
implementation features like that of Nova Scotia and Manitoba.
Overview
In overview, table C.1 shows the different schemes and rates.
A brief chronological review of Science and Research Incentives in Canada
One impact on the delivery of the SR&ED incentives is the frequency of legislative
change. The following is a summary of the changes to 1994. As the reader can see
there have been many changes to the program, especially in the recent years.
Pre-1961
 Current research and development (R&D) expenditures fully deductible in the
year incurred.
 Capital R&D expenditures deductible at the rate of 33% per annum.
1961
 Capital expenditures made fully deductible in the year incurred.
1962-66
 Additional tax deduction of 50% of the current and capital expenditures in excess
of the base levels prevailing in 1961 was put in place.
1966-75
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



The additional 50% deduction was replaced by grants under the Industrial
Research & Development Incentives Act (IRDIA) in the amounts of
25% of capital expenditures and 25% of current expenditures in excess of the
average level over the previous five years.
The 25% grant was non-taxable and provided the same incentive for firms paying
tax at the 50% rate as had the previous tax deduction.
Non-taxable firms now had access to the R&D incentives. The IRDIA program
was canceled in 1975 due to government spending restraint.
1977-78
 ITC of 5% to 10%, depending upon region, was introduced on both current and
capital expenditures. ITC deductible against taxes payable to a
 maximum of $15,000 plus one-half of tax otherwise payable in excess of that
amount.
1978
 Additional tax allowance of 50% of current and capital expenditures in excess of
the average level over the previous three years was introduced.

Minimum ITC was raised to 10% to 20% in Atlantic Canada and the Gaspe
region, and to 25% for small businesses.
1979
 IT-439, "The Meaning of Scientific Research, "released.
1980
 IT-151R2 released.
1983
 Partial refundability (20%-40%) of unused ITC's introduced for expenditures
made before May 1986.
 3-year carry-back of ITC's introduced; carry-forward extended to 7 years from 5.
 Limit on deductibility of ITC against taxes payable eliminated.
 Incremental 50% allowance eliminated.
 ITC rates increased by 10% to 20&, 30&, and 35% for general R&D expenditures,
Atlantic Canada R&D expenditures, and R&D expenditures made by small
businesses, respectively.
 Share Purchase Tax Credit (SPTC) flow-out mechanism introduced.
 Scientific Research Tax Credit (SRTC) flow-out mechanism introduced.
1984
 35% ITC limited to first $2 million of R&D expenditures per year.
 SRTC issues constrained to equity shares.
1985
 SRTC mechanism eliminated.
 100% refundability of 35% credit earned on current R&D expenditures
introduced.
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




"Wholly attributable to R&D" requirement relaxed to "all or substantially all
attributable".
R&D credit extended to expenditures of a current nature "directly attributable" to
R&D.
R&D recast as Scientific Research and Experimental Development (SR&ED).
Change of control rules introduced for ITC's and SR&ED deductions.
ITC base computed net of assistance.
1986
 SR&ED incentives extended to payments made to federal granting councils.
 20% and 40% refundability of unused ITC's extended to credits on expenditures
made before 1989.
 SPTC ended.
1987
 Buildings excluded from SR&ED incentives.
 Restriction introduced on amount of ITC's claimable in a year.
 Carry-forward period for ITC's extended from 7 years to 10 years
 Related to the business requirement strengthened; partnership rules introduced.
 20% refundability of unused ITC's eliminated for expenditures made before 1988.
 40% refundability of unused ITC's extended indefinitely.
 Information Circular (IC) 86-4R, "Scientific Research and Experimental
Development," released.
1988
 "Fast-track" introduced for partial SR&ED ITC refunds before notice of
assessment. IC 86-4R2 released
 IT-151R3 released
1993
 IT-151R4 released, applicable to SR&ED expenditures incurred after Dec 15,
1987.
1994
 For years ending after December 2, 1992, an alternative method (the "proxy"
method) is available for computing the amount of SR&ED overhead expenditures.
 Partial ITC's may be earned on shared-use equipment (equipment that is used
primarily for R&D) that was acquired after December 2, 1992.
 Removal of the annual ITC limit which limited the extent to which ITC's could
offset federal taxes payable.
 New capital cost allowance (CCA) class (Class 44) introduced for patents and
licenses acquired after April 26, 1993.
 Accelerated CCA rate for rapidly depreciating equipment.
 Increase in the annual taxable income limit with a corresponding decrease in the
$2M expenditure limit for corporations claiming 35% refundable credits for years
beginning after 1993.
 Definition of "SR&ED" clarified to include "experimental development"; i.e.,
shop-floor R&D.
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





Remuneration based on profits or bonuses paid to specified employees (related to
or own at least 10% of any class of shares of the corporation).
Definition of qualifying current SR&ED expenditures clarified to include a
portion of an expenditure where that portion is incremental to the prosecution of
SR&ED.
Definition of qualifying current SR&ED expenditures clarified to provide that
salary and wages can be accrued and need not be paid.
Sole-purpose SR&ED corporations no longer exempt from prescribed
expenditures for years beginning after February 22, 1994.
IC 86-4R3 released.
Department of Finance announces study of "contract payment" rules.
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Table C1:
Overview of Canadian State Scheme Tax Rates when compounded
with Federal Tax Concessions (Canadian Tax Treatment - An
International Comparison, J Warda, The Conference Board of
Canada, June 1994)
State
LARGECO
Inc Tax
R&D Incent
38.84%
20% + 15%
35.34%
20 + 25/37
30.74%
20% + 20%
wage
37.84%
20% + 10%
38.84%
20% + 10 %
Manitoba
Ontario
Quebec
N Scotia
N Brunsw
Inc Tax
22.84%
22.34%
18.59%
17.84%
21.84%
SMALLCO
R&D Incent
35% + 15%
5/10% & 37/52%
35% + 40% wages
35% + 15%
35% + 10%
The Canadian corporate tax system continues to offer a more attractive incentive for
manufacturing undertakings than many. The high ranking of Canada in R&D Tax
concessions is the result of a strong federal tax incentive package which is selectively
enhanced by further tax concessions in certain provinces. It certainly surpasses those
of the USA and Japan in its "generosity". Quebec, as a province, easily has the best
scheme of all the provinces, for both small and large undertakings.
Canada and the US in Comparison.
Canada has to compete for R&D with the US. Therefore its schemes are specifically
designed to compete with the schemes of the US.
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After-tax R&D Cost Comparison of a Large Canadian R&D Performer Eligible
for the 20% Tax Credit Rate and a Large U.S. R&D Performers
R&D Expenditure
Quebec R&D Tax
Credit
Other provinces
R&D Tax Credit
Federal R&D Tax
Credit
Ontario Quebec Other Incremental Non-incremental
province
$1000 $1000 $1000 $1000 6
$10007
($200)
(20% of $1000)
(15%8 of $1000)
($150)
($200)
(20%x$1000)
(20%x($1000-$200))
(20%x($1000-$150))
($160)
($170)
U.S. Federal R&D
Tax Credit
U.S. State R&D Tax
Credit
Tax Saving by
deduction
($200) (20%x$1000)
($60) (6%9x $1000)
($352)
(44%
of
(44% of ($1000-$320))
(299)10
Tax saving from deduction:
Quebec only
Federal
($186)
Quebec
($90)
Ontario only
($47)11
(29% of $1000 - $360)
(9% of $1000)
Tax saving from super-allowance
($303) (41%12 x ($1000-$260))
($410) (41% x $1000)
U.S. only
After-tax Cost
$401
Savings /1000$R&D $599
($1000-$200))
$364
$636
$381
$619
$437
$563
$590
$410
The source for the above table was “A Comparison of Tax Incentives for Performing
Research and Development in Canada and The United States”, which was prepared
for Industry Canada, by Deloitte & Touche - March 1995.
“Savings for Large Companies are especially significant. With the Canadian R&D
tax incentives, we estimate that we can get three engineers for the price of two in U.S.
high-tech areas”. Quote of Richard Peabody, President, Director General of Harris
Farinon Canada.
6
Assumes that a U.S R&D performer spent $6 million in direct salaries and wages related to qualified R&D in the current
taxation year compared to its $5 million qualified R&D base amount.
7
Assumes that R&D expenditure is not incremental or does not qualify for credit
8
New Brunswick offers a 10% non-refundable R&D tax credit. Nova Scotia offers a 15% refundable R&D tax credit, and
Manitoba has a 15% non-refundable R&D tax credit. For purposes of the example, 15% is used as an average rate
9
6% is an average investment tax credit rate. The following US states offer an investment tax credit for R&D expenditures:
Arizona, California, Colorado, Connecticut, Illinois, Indiana, Iowa, Massachusetts, Minnesota, North Dakota, Oregon, West
Virginia, Wisconsin
10
Effective provincial tax rates may vary. Nova Scotia, New Brunswick and Manitoba have special tax incentives that will
further reduce after-tax cost
11
Expenditures net of investment tax credits times the percentage for incremental costs for large performers times the provincial
tax rate [($1000 - $200) x .375 x .155]. For non-incremental R&D expenditures, the amount of tax saving from the Ontario Super
Allowance is $31 [($1000 - $200) x .25 x .155].
12
A 41% tax rate represents the top combined effective federal and state corporate tax rate for large U.S. corporations, assuming
a state tax rate of 9%.
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Significant cost savings are available to manufacturers who conduct R&D in Canada.
Based on the example above, the Canadian subsidiary of a foreign manufacturing
company would realize the following after-tax cost savings by conducting identical
non-incremental R&D in Canada rather than in the United States:
R&D performed in:
USA
After-tax cost of $1
million in R&D
Savings available if R&D
performed in Canada
Percentage savings
Ontario
Quebec
Other
$401 000
$364 000
$381 000
$189 000
32.0%
$226 000
38.3%
$209 000
35.4%
Can
$590 000
RTD Infrastructure in Canada
This has not been neglected at the expense of tax credits, and receives discrete but
consistent support from government. R&D consortia which have recievd indirect
support (in th esense that government does not pre-determine projects) have been a
part of the technology landscape in Canada for decades. As early as 1925, Paprican, a
consortia of Canadian pulp and paper companies, began conducting joint R&D. In the
late 1940s, Atomic Energy of Canada, Ontario Hydro and Canatom formed a large
consortium, which included several electrical equipment suppliers, to design and build
the CANDU reactor. Since 1980, the growth of technical alliances in general, and
technology consortia in particular, has been rapid.
Some of the major R&D consortia in Canada include:
PRECARN (PRECompetitive Applied Research Network). PRECARN was
established in 1987 as a non-profit organization whose mandate is to improve
Canadian industry's awareness of and competence in "intelligent systems" of all kinds.
Each of PRECARN's 39 members is afforded full briefings on research as it is
performed, and has access to all resulting technology. Some of the industrial members
of the consortium include: Asea-Brown Boveri Inc., Hewlett-Packard, Spar
Aerospace, Shell Canada and Xerox Research Centre of Canada.
SMC (Strategic Microelectronics Consortium), established in 1991 to develop new
products and processes that have immediate or mid-term revenue generation
capability. Some of the more prominent companies in this 21-member consortium are
ATI Technologies Inc., IBM Canada, LSI Logic Corp. of Canada Inc., Mitel
Semiconductor, Newbridge Micro Systems Inc. and Nortel.
SIMCON (Software for Integrated Manufacturing Consortium) established as a nonprofit organization to pool the resources of industry, the National Research Council
(NRC) and universities to develop prototypes of products that demonstrate integrated
solutions to manufacturing problems. Its three industrial partners — Electronic Data
Systems Canada Ltd. (EDS), Interfacing Technologies Corp. (ITC) and Phoenix
Systems Synectics Inc. — receive a royalty-free licence to exploit the technology
commercially.
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VISION 2000 is a partnership of industry, government and academia. It was
established as a non-profit corporation with the objective of accelerating the
implementation of advanced personal communications systems (PCS) and
technologies in Canada. The corporation is concerned with the stages of feasibility,
development, and trial and implementation of a product/project, but not
precompetitive research. Some of the members of this 43-member consortium are
IBM, Ernst and Young, Mitel, Motorola Canada, BCE Mobile Communications
Canada and Canadian Marconi Company.
SSOC (Solid State Optoelectronics Consortium) was incorporated in 1988 as a federal
non-profit research corporation to create a Canadian capability in integrated
optoelectronics research. The consortium has members (industrial) and research
affiliates (non-industrial). Its members include Bell Northern Research (BNR), Digital
Equipment of Canada Ltd., ITS Electronics Inc., Lockheed Canada Ltd., MPR
Teltech, and Spar Aerospace.
Industrial Research Assistance Program (IRAP)
Every year, IRAP helps thousands of Canadian firms improve their operations and
bring new products to market by putting them in touch with appropriate technologies
and expertise from Canada and around the world. IRAP is the program that helps
Canadian firms acquire, develop and exploit appropriate technology to meet the
challenges of a rapidly evolving global economy. It stimulates research and
development in small and medium-sized enterprises (SMEs), and build vital expertise
and knowledge within these firms. The science and technology infrastructure
provided by IRAP and its network members has accelerated technological innovation
in Canada. Situated in more than 90 communities across Canada, IRAP's Industrial
Technology Advisors (ITAs) have been strategically placed to provide communities
with easier access to sources of technology. About 70 per cent of ITAs work for some
100 public and private organizations other than the NRC. IRAP's network includes
provincial research organizations, research centres, universities and colleges, and
industrial and other professional groups. As well, international linkages, including
Canadian embassies abroad, allow IRAP's clients access to foreign sources of
technology unavailable in Canada.
IRAP is primarily focussed on providing high-quality and appropriate technical
advice and assistance to its industrial clientele, but it can also offer funding support,
where appropriate. In 1993-94, IRAP spent a total of $52 million.
Canadian Technology Network
The Canadian Technology Network has been established to improve the competitive
position and growth of Canadian SMEs. It will be aimed at optimizing the
effectiveness of technology and related business services. Administered by IRAP and
built on the same model, with its client-driven approach and focus on partnerships and
linkages, the Canadian Technology Network will not only help bring together the vast
array of services available to industry, but will also strategically add new services - be
they technology-focussed or business-related; where industry defines the need.
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INTELLECTUAL PROPERTY
Intellectual property in Canada is strongly protected by federal legislation, including
the following six Acts of Parliament:
* The Patent Act;
* The Trademarks Act;
* The Copyright Act;
* The Industrial Design Act;
* The Canadian Plant Breeders’ Rights Act; and
* The Integrated Circuit Topography Act.
With the exception of the Plant Breeders act which is administered by Agriculture and
Agri-Food Canada, these acts are administered by Industry Canada’s Canadian
Intellectual Property Office. This is again an indirect measure to support RTD
investment.
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48. INDIA
The R&D Tax Scheme
Govermnet policy belives that for any R&D effort to culminate into successful
commercial ventures, adequate term finance is essential. The government of India has
set up a number of financial institutions for industrial development. At the national level
are the Industrial Development Bank of India (IDBI), the Industrial Finance Corporation
of India (IFCI) and the Industrial Credit and Investment Corporation of India (ICIC). At
the state level are the Industrial Development Corporation (SIDC) and State Financial
Corporation (SFC)
Income Tax Act
The DSIR is associated with recognized in-house R&D units. A tax rebate is, however,
not restricted to in-house R&D units recognized by the DSIR. There is also a program of
investment allowances under the Income Tax Act. An enhanced rate of investment
allowance is available for plant and machinery installed after June 30, 1977 for the
manufacture of priority sector goods based on indigenous technology. The DSIR
implemented the investment allowance program although the program has now been
withdrawn.
Industries are encouraged to sponsor research projects that will utilize the infrastructure
and highly skilled manpower in the national laboratories and other such recognized
institutions. The expense of sponsoring such research projects qualifies for a weighted
tax deduction equal to 133%.
In addition to the weighted tax deduction for sponsored research, there is also a program
of weighted tax deduction for in-house research. According to provision 35(2B) of the
Income Tax Act (effective September 1, 1980), 125% of the amount spent to execute a
scientific research program in an in-house R&D unit can be deducted. This program for
was also withdrawn in 1984.
In view of the increasing investments made in education as well as scientific research in
academic, industrial and R&D institutions and laboratories, several promotional
measures were introduced to enhance the culture of R&D culture in India, such as:

Recognition of in-house R&D units, provision of tax incentives such as 125%
weighted deduction in income tax, as well as liberal imports of chemicals, etc.

Introduction of a technology absorption and adaptation scheme

Provision of National awards for excellence in R&D in industry

Availability of consulting services

Implementation of a pass-book program for liberal imports of equipment, spare
parts, chemicals, etc.
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Policies and incentives for foreign investment
The foreign investment and collaboration policy of the Government of India was
originally set forth in the Industrial Policy Resolution of 1948, but was clarified in a
1949 statement made by the then Prime Minister at the Indian Parliament. The main
features of the Statement were:
1. all undertakings, Indian or foreign, must conform to the general requirements of
government industrial policy;
2. foreign enterprises will have freedom to remit profits and repatriate capital subject to
foreign exchange considerations;
3. foreign enterprises will be treated on par with Indian enterprises;
4. if foreign enterprises are acquired on a compulsory basis, fair and equitable
compensation will be paid;
5. as a rule, major interests, working ownership, and effective control of an undertaking
will be in Indian hands.
No formal evaluation is available.
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49. China
13
Tax Treatment of R&D
The People’s Republic of China tax and accounting regulations applicable to foreign
entities operating in China were all promulgated as a result of the open door policy
adopted in 1979. Current tax laws and regulations do not address the topic of research
and development explicitly. Most foreign investments in China are relatively new,
accordingly there is no experience on the tax treatment in this area.
Current deductibility of expenses
Based on discussions between Cooper & Lybrand and the People’s Republic of
China’s Ministry of Finance, it appears research and development expenditure will
normally be treated as a deductible expense in the year incurred. However, after
reviewing on a case-by-case basis, the Chinese taxation authority may consent, if a
taxpayer wishes; to capitalise and amortise this expenditure. Again there are no set
rules on the period of amortisation.
Tax treatment of technology transfers
Foreign companies without establishments in China are taxable only on their China
source income, which includes fees for the use of proprietary rights, a concept
encompassing royalties or licence fees for the use in China of patented or other
proprietary technology, trade marks and copyrights. In the absence of a tax treaty the
withholding tax rate on payments of these fees to a foreign person is 20%. In order to
promote the importation of advanced technology, the Ministry of Finance adopted
regulations in January 1983, which provided that the withholding tax rate may be
halved or wholly exempt where the technology involved is advanced and the terms
offered are preferential. Under these regulations the tax reduction will be decided by
the local tax authority while tax exemption requires approval from the Ministry of
Finance. There is no concrete rule on the qualified technology for tax exemption or
reduction.
Current Policy
The Financial Times of 29.1.99 indicates that China is preparing actions to further
stimulate R&D and especially industrial innovation.
“Tax Treatment of R&D”, p. 57, Klynveld, Peat Marwick Goerdeler, Amsterdam, 1990, ISBN 1
85061 195 5
13
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50. Hong Kong14
Tax Treatment of R&D (pre unification with China, 1997)
The Hong Kong Inland Revenue Ordinance (IRO) contains general and specific
provisions on the treatment of research and development expenses and associated
income. Expenses are deductible to the extent that they are incurred in the production
of profits chargeable to profits tax and are of a revenue nature. Where expenses are
only partially incurred in the production of taxable profits, apportionment is permitted
to ascertain the deductible amount.
Definition of Research and Development Expenses
The IRO defines scientific research as “any activities in the fields of natural or applied
science for the extension of knowledge”. This definition is expanded to include all
expenditure incurred for scientific research facilities, but specifically excludes all
expenditure incurred to acquire scientific research rights.
Current Deductibility of Expenses
Scientific research expenditure, either of a revenue or capital nature, which is
appropriately related to the trade or business of a taxpayer is deductible in the year it
is incurred. In addition to the deductions which are generally available by virtue of
Section 16 of the IRO specifies certain types of expenditure to be classified as that
incurred on scientific research; viz:
– payments to an approved research institute for scientific research related to that
trade or business
– payments to an approved research institute, the object of which is the undertaking
of scientific research related to the class of trade or business to which that trade or
business belongs.
– expenditure on scientific research related to that trade or business, including capital
expenditure except to the extent that it is expenditure on land or buildings or on
alterations, additions or extensions to buildings.
14
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51. ISRAEL
Summary
( by A Gambardella)
One focus in Israel around the end of the 1980s was to provide tax shelters to R&D
investment companies acting as venture capitalists or more generally as promoters of
risky R&D activities by other enterprises. The programme however failed. Among
the various reasons, an important one was that without direct and systematic control
on the part of the administration these measures are more likely (than grants for
instance) to induce efforts to avoid taxation without really undertaking R&D costs.
The more general lesson provided by the Israeli case is that indirect schemes require
greater administration management and control, with implied administration costs.
More recently, Israel reformed the programme by introducing a tax credit rather than
a tax deduction. This simplified the procedures, as companies can obtain a check
limited to tax payments, instead of having to incorporate the deductions into their tax
reports, with implied complication of the calculations. Again, the more general lesson
to be drawn is that indirect measures can be procedurally complicated for the
companies. Simplifications of the rules and procedures can then have serious impacts
on the performance of the measures
Israeli Risk Capital Company Encouragement by Tax Shelters, encouraged with
Grants15, 9/88
To ensure the continued growth of R&D-intensive industry at a time when venture
capital has virtually disappeared from the Israeli economy, action must be taken to
promote the establishment of between five and seven R&D investment companies
(hereinafter: RDICs). The proposed method of promotion is that of the tax shelter.
In Israel previous efforts to promote R&D financing by means of tax shelters failed,
while grants achieved considerable success. This raises the question whether it would
not be preferable here, too, to encourage activity in this area by means of grants. After
study, grants were found feasible and, perhaps, even desirable for purpose of
marshalling venture capital from abroad, primarily from the US. Successful raising of
local investment capital in Israel, however, is not believed likely to result from the use
of grants, whose benefit is less tangible and much less attractive.
Analysis of past failures proves that they were due mainly to the absence of proper
quantitative control as to maintaining balance between volume of promotion and
volume of approved R&D activity. Insofar as scientific, financial and administrative
control of this type is lacking, any program of encouragement, even with grants, will
fail.
The Income Tax Commission is not and will not be able to provide such control.
Encouragement by tax shelter is therefore contingent on the consent of, and
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Risk Capital Company Encouragement by Tax Shelters and by Grants, Proposal and Methodology
for Implementation: B. Toren, The Jerusalem Institute for Israel Studies, September 1988
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organization by, the Chief Scientist of the Ministry of Industry and Trade (and in the
future, perhaps other government ministries), for whom the priorities and control
procedures for programs invoking different means of encouragement would be
identical in every respect.
It is proposed that a joint action team be appointed, which represents the Ministry of
Finance, including the Budget Department and the Income Tax Commission, and the
Ministry of Industry and Trade’s office of the Chief Scientist. Its purpose would be to
draw up a procedure for implementation and control.
Tax Shelter as Means of Encouragement: Why It Has Failed
Because capital in Israel has been avoiding risks in recent years, certain areas of R&D
financing have become problematic. Profitable enterprises with veteran R&D
operations have not met with this problem, because the existing grant, in addition to
the tax reduction brought about by treatment of the balance of the cost of the R&D as
tax-deductible expense, covers most financing needs (see Appendix A, line 2a). The
rest is financed from ordinary sources including the “main list” of Tel Aviv Stock
Exchange. In view of the recent capital market liberalisation, these financing
possibilities have expanded.
Venture capital is needed to finance R&D in enterprises which are not profiting,
which lack reputation, and/or which lack access to the capital market. In the main,
however, venture capital is needed for venture capital companies, which would use it
to finance new entrepreneurs’ R&D and the transition from R&D to production and
marketing. For the growth of R&D-intensive industry to continue, it is essential to
establish between five and seven RDICs. They may be of two types: venture capital
companies that invest in an enterprise, consolidate, and sell off their share with a
capital gain, or industrial holding companies that invest, consolidate, and retain
ownership for a longer period of time, for the purpose of earning a regular profit.
Venture capital companies will have to raise at least some of their capital on the
Exchange if they wish to be exempt from capital-gains tax.
RDICs depend on a larger government incentive than ordinary R&D promotion
because:
- they engage in high-risk activity
- they need to persuade entrepreneurs to enter into agreements with them to improve
commercialisation prospects;
It is theoretically possible to promote RDIC activity by means of either grants or tax
shelters. The use of grants to encourage R&D has proved itself over time. In stark
contrast, every attempt thus far to promote R&D by use of tax shelters has failed.
For control of R&D promotion to be effective, a certain quantitative ratio must be
maintained between the volumes of promotion and of agreed-upon R&D activity.
Without such control, there is almost no limit to the possibilities of fraud and
circumvention. When these take place, less R&D is done than agreed upon, and the
extent of effective support reaches or even exceeds 100 percent.
- In R&D promotion as governed by Paragraph 20a, Part 2 of the Income Tax Code
Ordinance, R&D activity is limited to the level of tax exemption by the use of
circular loans, which in effect cancel the investor’s net share in the financing of
R&D.
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- Under the “Elscint Law”, R&D activity was restrained by a buy-back arrangement
cancelling again part of the net share of the investors in the deal.
Tax-based promotion is not the only arena in which possibilities of fraud exist. If
quantitative control of the connection between promotion by grants and R&D
performed is lost, similar problems will surface here, too.
In this respect, there is no difference between direct R&D promotion via tax shelter
(between an investor and the enterprise undertaking the R&D) and intermediated
promotion through a financial broker. The “Gabbay Committee” correctly opposed an
R&D trust fund, which would have expanded the existing tax exemption
arrangements without proper control. Insofar as control is present, the financial
intermediator (the RDIC) may be of utility, and will do no harm.
The scheme is for the encouragement of R&D funding via RDICs by means of tax
shelters.
Procedure for Handling and Controlling Promotion of New Enterprises via
RDICs by Use of Tax Shelters
In RDIC’s wishing to benefit from a tax shelter will have to obtain the Chief
Scientist’s advance approval. Such approval will be given to an RDIC of two different
forms: a venture capital company that plans to sell its investments at a capital gain,
and an industrial holding company that invests in R&D-intensive firms and plans to
retain its investments for a protracted period.
The companies approved will be those based on
- extensive know-how and experience in Israel and abroad in managing venture
capital companies in the conventional American sense of the term
- a certain level of paid-up initial capital ($0.5 million, of which at least part should
preferably be American venture capital).
RDICs will invest in new R&D-intensive enterprises and in R&D of existing
industrial firms that lack access to the capital market. The RDICs will examine
requests for investment in R&D projects or for financing of transitional stages after
R&D.
- Financing of R&D for new entrepreneurs and ventures by means of mixed (grant
and tax exempt) assistance (see Appendix A, line 1a).
- Financing of new entrepreneurs’ and ventures’ transition from R&D to production
and marketing (see Appendix A; line 1c).
- Financing of R&D by existing firms (see Appendix A, line 2c).
The package of projects approved for financing by RDICs will be presented as a
framework program to the Chief Scientist’s Office for approval in principle (so it is
not quite “indirect” by our definition in the ETAN context).
- In cases of financing by private investors, the framework plan will include a
financing proposal with explanation of such rights – share of ownership in the RDIC,
royalties, etc. – as will accrue to the investors in return for their investments.
- In the event of a public issue, the framework plan will include a proposed prospectus
for dissemination and registration on the Security Exchange’s “parallel list”.
The Chief Scientist’s examination will include technological and scientific as well as
marketing and business aspects, all based on the business plan and complying with the
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provisions and regulations of the R&D Law. The Chief Scientist’s approval will also
be limited by the ambit of his obligational authority. The procedure for study of
proposals, deliberations in the Research Committee, defining of recognised R&D
expenses, approval and supervision will be identical for projects availing themselves
of different methods of encouragement.
Letters of approval in principle will be issued for projects approved by the Chief
Scientist on the basis of agreed-upon business plans; these letters will be based on a
tripartite agreement among the firm, the RDIC and the Chief Scientist.
All the projects together will constitute a “financing package”. The total sum of this
package will be confirmed by the Chief Scientist for the RDIC, as approval in
principle for a grant and tax shelter.
When the mixed (grant-loan) track is used, an advance of half the total of the grant
(12.5% of the total approved plan) will be paid to a new firm or entrepreneur engaged
in R&D via the RDIC.
The RDIC will provide interim and additional financing for the remaining finance
needs of the new venture or entrepreneur engaged in R&D. For existing companies
receiving marginal grants only, the RDIC will attend to almost all financing needs.
The Chief Scientist’s approval in principle, together with the Account General’s
receipt confirming the deposit, will be forwarded by the RDIC to the investors
(private investors or purchasers of shares at time of issue), and will entitle them to tax
exemption up to the sum of their investment. There is no intention to add this matter
to the annual personal tax returns of hundreds of thousands of citizens; it would
appear only under the item “Exempt Incomes/Royalties – From Other Sources”
(Section H, Question 49, Form 1301of the Israeli Tax Code). To be eligible for this
treatment, investors will fill out an appendix form provided by the RDIC, and attach it
to their annual tax returns.
The company carrying out the R&D will provide the Chief Scientist with a technical
and financial report on R&D performance within the framework of the approved plan,
of such departures from the plan as are approved by the RDIC and the Chief Scientist
under existing procedures. The financial statement will be examined in the
conventional way by the Chief Scientist’ accountants.
The Chief Scientist will confirm to the RDIC the fact that the R&D was performed in
the amounts specified in the approved framework plan and the financing package.
In keeping with the pace of expenditure, the Chief Scientist will pay via the RDIC the
second half of the grant due to the new venture/entrepreneur engaging in R&D
(12.5% of the plan) or, in the case of existing enterprises, the marginal grant of 5% of
the approved plan.
The RDIC must produce periodic reports on performance of R&D projects approved
under the financial package.
The Chief Scientist’s accountant will confirm to the RDIC that the total financing
package found eligible for a tax shelter – including approved amendments thereto –
with such R&D as was carried out and confirmed, less the amount of all projects
belonging to the financing package, is equal to the balance of the interim deposit with
the Accountant-General on account of this financing package.
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To implement this proposal, secondary legislation or amendment of existing
legislation will be necessary:
- Amendment of Paragraph 20a of the Income Tax Code to permit:
The granting of a tax exemption for investments earmarked for R&D and
executed by means of approved professional financial intermediaries – RDICs.
The granting of a tax exemption for up to 65% of investments meant to
finance the transitional stage from R&D to production and marketing.
Approval of tax shelter, on condition that the investment is part of an approved
financing package and that its proceeds are invested in R&D being performed
per approval of the Chief Scientist, or alternatively pending such an approval,
insofar as the proceeds of said investment are deposited with the AccountantGeneral. Accordingly, the provision which limits the approval of tax
deductions in a given year to investments made gradually over a full year
earlier is to be cancelled.
- Amendment of the appendix to Paragraph 18 of the R&D Law, so as to permit a
grant of 25% of an R&D project to a new entrepreneur or venture in its R&D stage, in
conjunction with an RDIC.
Comparison of the various methods
Promotion through tax deductions compared with grants:
- In view of the total failure of R&D promotion by means of tax shelters, a zealous
“rejection front” against further attempts has coalesced.
- The Income Tax Commission had not geared up to control the tax benefits, and the
Chief Scientist did not step into the breach. The Income Tax Commission’s
opposition has to be accepted at the very least in the sense that in the future, too, it
sees no possibility of effectively controlling this kind of program. The Minister of
Finance was quoted on this matter in the same vein.
Without such quantitative control of the connection between R&D activity and the
means used to promote it, the possibilities of conspiracy toward obtaining
encouragement (tax benefits); without full and agreed-upon performance of the R&D,
are unlimited and immeasurable.
R&D promotion is meant, of course, to encourage R&D activity. The goal can be met
by use of various grant or tax-benefit devices. The fact that the Israeli Chief Scientist
has succeeded for many years at preventing most misuse of grants indicates that his
scientific-financial-administrative control at least went very far toward establishing a
proper quantitative ratio between the volumes of R&D activity and the money spent
on its encouragement.
Thus the proposal calling for a renewed attempt to promote R&D by tax shelters rests
on the assumption that the Ministry of Industry and Trade’s Chief Scientist will
implement the same control arrangements for tax shelter purposes that govern the
award of grants. For this purpose, the Chief Scientist’s Office will broaden its activity,
instead of serving as a dispenser of grants, he will have to promote R&D activity by
various means, as warranted by the case at hand. The Chief Scientist will treat tax
shelters and grants equally in every respect, including priority and time spent on care,
attitude, level of care, etc.
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This is an essential prerequisite for the proposal’s existence. In absence of a
commitment in this vein, it would be best not to implement this proposal to promote
R&D by means of tax shelters. In such a case, too, there would be no prospect (nor
justification) of persuading the Treasury to agree to it.
Assuming that an identical attitude is adopted toward both promotion methods, the
proposal to encourage venture capital systems by means of tax shelters, cited in Part C
above, becomes applicable and feasible for implementation in terms of arrangements
and controls. The proposal does not impose a heavy burden on the tax officials, who,
as stated, cannot stand up to it under existing conditions.
Although it is feasible, the proposed procedure admittedly makes R&D promotion
policy more complicated. The question, then, is whether the same results might not be
attained by means of grants. If it can be shown that the same results can be achieved
with less complicated grants, the tax shelter device should not be used.
In terms of R&D investments from abroad, grants are preferable, because a tax
exemption provides no encouragement for investors who are not tax-liable in Israel.
Local financing companies, as stated, have abandoned the venture capital arena, and
the probability of their returning to it in the near future is very small. Perhaps
companies such as Israel Chemicals and Clal will provide exceptions to this assertion,
but they cannot be expected to solve the problem.
Black-market capital will not be invested in this sector. Under existing economic
conditions, bona-fide R&D cannot be carried out without government help, and this
proximity to the government deters black-market capital. This is so even in the case of
grants. They entail discussion of financing sources and audits by government
accountants, which deter black capital.
The remaining source comprises private savers who are tax-liable, and who are forced
to declare (or are interested in declaring) part or all of their incomes.
Thus the major remaining question is the attitude towards the tax-liable private savers.
Will they agree to consider a financial benefit on their investment in RDICs a
reasonable substitute for a comparable tax exemption? From the pure financial point
of view the private investor may be different. He exchanges a taxable income of, say,
US$100 (which leaves him with a net income of US$52 at the given highest tax
bracket) for a share of US$100 in the RDIC, irrespective of the method of promotion
– a grant, a tax deduction, or a tax credit.
The investor’s attitude, however, is not purely financial. In more general terms this
question has been answered thus far with a categorical “no”. Normal affluent citizens,
who have to declare their income, find tax exemptions alluring in the extreme. Insofar
as possible, they will prefer investments such as social benefit funds, which confer
exemption at lower risk. Once such investment has reached its admissible limit,
however, they may invest in R&D by means of tax-exempt investments in RDICs.
Substitution of tax exemption with an abstract financial benefit, such as improvement
of the ratio between value of investment and nominal value of the share issued them,
has no real prospect of attracting such investors.
There are several reasons for this. The tax exemption is financially immediate and has
highly positive psychological value for citizens who are not eager to funnel their
money to income tax. Incidentally, this psychology typifies investors in most Western
countries.
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The situation is different when the benefit is built on grants. A grant mainly affects
the investor’s chance of realising a gain at time of effectuation. Something of a
premium comes into play in other share issues, too. In the main, too, any share on the
Exchange whose asset value exceeds market value provides investors with the same
prospects for a gain, at a risk which usually seems lower to them.
Summing up, grant-based benefits are both less tangible and less appealing.
Promotion through tax credits vs. tax deductions in Israeli R&D
The final version of the Israeli tax shelter is to take the form of a credit rather than the
proposed deduction. The main change is to simplify personal taxation procedures. Tax
deductions must be incorporated into the annual personal tax returns and affect the
calculations. The proposed tax credit will take the form of a check, limited to tax
payments, so that tax liability calculations are not changed. Only the form of payment
is affected. The essential link between the investment and taxation is somewhat
weakened, but as long as actual tax payments are lowered, the psychological effect is
expected to remain strong.
Promotion through tax credits is easily adapted to foreign venture capital investments.
These will be offered the same benefits with ordinary checks free of the limitations to
tax payments. Tax credits will offer full benefits to local investors, even when their
marginal tax bracket is below the highest. Tax credits, like grants, will have to be
included in the budget, whereas exemptions from tax liabilities do not. This change,
however, is only a formal one, because even with tax deductions the proposed tax
shelter is not unlimited.
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of 15th August 1999
APPENDIX (A) to Israeli Schemes: Support Tracks and Financing for Industrial
R&D, for Ventures of Different Kinds.
(% of approved R&D budget)
Own resources16
Government assistance
Proven
paid-up
capital
RDIC
Grant
17
18
Tax
loss19
Total gov’t
aid20
a. R&D stage – mixed
assistance (20a)
39
25
36
61
b. R&D stage – RDIC and grant
37.5
62.5
c. Transitional stage – tax
shelter (20a)
7121
Funding type
Type of venture and track
1. New entrepreneur or venture
62.5
2922
29
50
22.523
72.5
5
42.7
47.7
5
42.7
47.7
2. Medium/ large ventures
a. Profitable firm
27.5
b. Losing firm – outside investor 52.3
(20a)
c. Losing firm – RDIC (20a)
52.3
16
Own financial resources plus total government aid come to 100%.
R&D investment companies – these, too, may marshall at least part of their resources on the Stock
Exchange.
18
Grant rates are as prescribed by the R&D Law. The computation disregarded a 1% deduction from
the sum of the grant for a Fund for Technological Advancement.
19
Loss from tax exemption to investors (lines 1a, 1b, 2b and 2c), and tax loss of company carrying out
the R&D as a result of recognition of R&D expenses as current expenses for the purpose of setting
corporate tax (line 2a).
20
Computed as amount of grant plus tax loss.
21
36% = 48% tax on total RDIC investments of 75%. It is clear that the company invests 75% in the
venture, not only 39%.
22
The tax shelter will be awarded for 65% of total investment, on condition that the RDIC invests
another 35% from its own resources (e.g., funds provided by foreign investors). The tax loss is 31%
(65% of 48%). The remaining 34% (65% of 52%) and the RDIC’s 35% investment of its own
resources total 69%.
23
Approved Enterprises pay a corporation tax rate at 25% instead of 45%. Because the reduction of tax
liability is only 12.5%, total government aid comes to 62.5%.
17
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An International Compendium of Indirect Schemes and Measures for Supporting Research and Technological
Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
52. JAPAN
Non defence expenditure in R&D in Japan is 81% in the private sector. Researchers in
Japan (541.000) are up 4.3% in 1993. Absolute expenditure though is reducing (from
9.7T¥ (1991) to 9.16T¥ (1993)). But Japan has lowest level of Basic R&D for all
OECD (13%) Tax credits are supplemented by low interest credit loans (to 100B¥).
Grant system for international joint research (materials energy or environment) imp.
to total 1B ¥.
Overview
(by A Gambardella)
The Japanese scheme is based on 5 points:
1.
Tax credit for increasing R&D expenses.
Tax credit for R&D by small-medium enterprises (allowed on increased limit to 15%
of corporate taxation for companies under 1000 employees)
Tax credit for special R&D expenses (e.g. with universities, foreign labs, or for
special purposes like energy saving or environment)
Tax credits for R&D facilities for fundamental technologies/basic research.
5.
Tax incentives for Technological Research Associations:
Special depreciation of charges imposed on members by Associations for the
acquisition of fixed sssets.
Advanced depreciation of fixed assets acquired by Associations.
The first three categories above can be (and are frequently) applied on a selective
basis. In practice, a mixture of accelerated depreciation, increased initial depreciation
and standard appreciation applies. These mixes make it very difficult to isolate
“typical” situations and typical “rates”.
Although the Japanese scheme has been operational for 20 years, it is still not easy to
evaluate if it has been totally successful or not. It is clear that it is a significant
instrument, as Japan collects more corporation tax as a proportion of its tax base than
other countries, and that in Japan the ratio of private to total R&D (about 80%) is
higher than in other advanced industrial countries (e.g. compared to 74% in the US
and about 65% in Germany and France).
Detail of schemes
In Japan, Corporation Tax payers 37.5%, and is 24.4% of all Government Tax
Revenue - 21/2 times UK, 5 times the pay level of Germany systems.
Current expenditure for R&D into developing and manufacturing of new products are
fully deductable in the year in which they are incurred, or amortised over a maximum
of the subsequent 5 years. Capital items must be depreciated, but the rates at which
this is allowed is a major policy instrument for the promotion of certain industries
over others, or for the attainment of specific sectorial and or national policy goals.
The outline of the Japanese scheme is based on 5 points:
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1.
2.
Tax Credit for increasing R&D Expenses.
Tax Credit for R&D by Small and Medium Sized Enterprises (allowed on
increased limit to 15% of Corporation tax for companies of under 1000
people)
3.
Tax Credit for Special R&D Expenses .
A. R&D with National Research Laboratories (and Universities) (Cost 100M¥
per year)
B. R&D with Foreign Research Laboratories (new in 1994)
C. R&D for Special Purpose Research such as efficient use of Energy,
Utilisation of Recycled Resources, Orphan Drugs and Medical Appliances.
Politically an important area. This part is relatively new, starting in 1993.
Overall very small though.
4.
Tax Credits for R&D Facilities for Fundamental Technologies/Basic
Research.
200 listed facilities benefits cost 4 B¥ / year. Preferential rate will be
reduced
for 7% to 5% though soon.
5.
Tax Incentives for Technological Research Associations:
 Special Depreciation of Charges Imposed on Members by Associations for
the Acquisition of Fixed Assets.
 Advanced Depreciation of Fixed Assets Acquired by Associations.
The first three categories above can be (and are frequently) applied on a selective
basis.
In practice, a mixture of accelerated depreciation, increased initial depreciation and
standard appreciation applies. These mixes make it very difficult to isolate "typical"
situations and typical "rates".
Machinery and equipment is usually depreciated on a 10% straight line basis. This
standard. Larger high technology companies situated within designated technopole
areas and small businesses with R&D are also allowed for the first year to write an
increased initial depreciation allowance of up to 30% of acquisition costs. In these
cases it is only the balance remaining (ie just 60%) that is written off over 9 years.
This has a significant effect on the actual costs of the asset over its useful life.
Buildings, usually depreciated at 4% on a straight line basis, are, when R&D for small
companies is performed in them, are allowed to be depreciated at double that rate - ie
8% for the first year.
Tax credits are also available in Japan, at a basic rate of 20%. Dating from 1966, the
basis for incremental calculation is the highest year of R&D expenditure between now
and then, and the current years expenditure. Eligible expenditure is widely defined,
and includes all salaries, costs of employment and cost of materials, and depreciation
of plant and equipment. Furthermore, the R&D tax credit is not taxable and thus
maintains the level of the deductible base. The limit is up to 10% of Corporation Tax
total, and the total cost is 75 B¥ (750MUS $), so quite small overall. The system is
stable now for 20 years well known and widely used.
There are two targeted tax credit systems also operational in Japan, both rather more
recent than the main system described above.
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of 15th August 1999
Basic Technology Tax Credits is an additional 7% tax credit on top of the 20% basic
tax credit described above. It applies to assets which are depreciated, i.e. machinery
and equipment, used in R&D for advanced technologies, currently defined as





advanced robotics and process machinery
artificial intelligence and environments
advanced electronics
new materials technology
biotechnology.
Small and Medium Enterprises may claim a general 6% tax credit on all R&D
expenditures in place of the incremental scheme mentioned above.
SMEs with stable R&D are allowed to deduct just 6% of all tax against it. Total cost
10B¥/year (100M$). Research Associations can write down 100% of costs or values
of fixed assets.
There are ca. 80 special measures for corporation tax reduction (432B¥ cost 93) of
which 90B¥ are R&D related.
Neither of the special schemes of tax credits are taxable. Both can be claimed
cumulatively.
The effect of these are rather difficult to assess, not only because of their structure and
targeted nature, but also because of the nature of the Japanese company tax system.
The average company pays three taxes - to the state (typically 37.5% although there is
a current surcharge of 2.5% also in operation), the prefectures (an enterprise tax,
which is typically 8-9% but can be as high as 12.6%) and the municipality (the
inhabitants tax, of between 17.3 and 20.7 % typically). They are not cumulative
though, and the overall effect is a tax rate, typically, of


38% for a small company
50% for a big company.
with an associated tax credit system of :


6% general and 7% basic technology for small companies
20% incremental and 7% basic technology for large companies.
These figures suggest that large companies are preferentially assessed for R&D, and
indeed this is where most of the R&D is performed. It has been estimated that these
can amount to 44% of all costs.
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Assessment & Evaluation
Although the Japanese scheme has been operational for 20 years, it is still not easy to
evaluate if it has been totally successful (Prof Yamamoto, OECD WG on Science
System, Intervention, April 28th 1995, Paris) or not.
It is clear that it is a significant instrument, as Japan collects more corporation tax as a
proportion of its tax base than other countries, and that its private sector R&D element
of total R&D is that much greater compared to its main industrial rivals (Table J.1) twice that of Germany and France.
Table J1: Ratio of Corporation Tax to Total Government Revenue, and Private
Sector R&D Government Sector R&D
County
Ratios
Corp Tax
24.4%
15.4%
9.7%
9.5%
4.9%
Japan
USA
UK
France
Germany
Private Sector
R&D/Gov. R&D
81.4/19.6% = 4.15
74.3/25.7% = 2.9
N/A
63.8/36.2% = 1.76
66.2/33.8% = 1.96
When one considers the long term data on Japanese R&D resources of the past 10 years,
there has been a smoothing of the trends on a year to year basis, suggesting an element
of stability and sustained growth in the sector. Table J.2 suggests a strong recovery in
R&D personnel in the last 2 years despite a relative weak economic performance, and a
weakening of absolute expenditure on R&D from a peak of 9.7 TYen (FY 1991) to 9.2
TY (FY 1993).
Table J2: Japanese R&D Personnel data in Universities, Research Institutes and
Industry, with relative proportions, FY 1982 through to FY 1993
Tax
Year
University
YoY
%
Inc
R&D
Inst.
YoY%
Inc
Totals
FTEs
% Univ
%Res
Int
329,728
31,58
9,91
%
Industry
58,52
1982
104,112
1983
109,930
5,59
31,170
-4,60
201,137
4,25
342,237
32,12
9,1
58,77
1984
114,183
3,87
31,980
2,60
223,882
11,31
370,045
30,86
8,64
60,50
1985
118,018
3,36
32,167
0,58
231,097
3,22
381,282
30,95
8,44
60,61
1986
121,324
2,80
32,459
0,91
251,771
8,95
405,554
29,92
8,00
62,08
1987
124,234
2,40
33,257
2,46
260,846
3,60
418,337
29,70
7,95
62,35
1988
128,109
3,12
34,469
3,64
297,298
13,97
459,876
27,86
7,50
64,65
1989
131,722
2,82
35,710
3,60
294,202
-1,04
461,634
28,53
7,74
63,73
1990
134,133
1,83
36,265
1,55
313,948
6,71
484,346
27,69
7,49
64,82
1991
136,886
2,05
37,084
2,26
330,996
5,43
504,966
27,11
7,34
65,55
1992
139,917
2,21
38,143
2,86
340,809
2,96
518,869
26,97
7,35
65,68
1993
145,891
4,27
38,842
1,83
356,406
4,58
541,139
26,96
7,18
65,86
32,674
Industry
YoY%
Inc
192,942
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of 15th August 1999
The tax advantages accruing are also notably focused on the development and applied
research element of the spectrum. Table J.3 shows that Japan undertakes less basic
research than its competitors but more applied research and more development.
Table J3:
Country
Japan
USA
Germany
France
UK
Breakdown of R&D by Categories, and Ratio of Applied R&D and
Development to Basic Research
Basic R&D
13,35
15,65
19,55
20,2
16,1
App R&D
24,55
23,25
30 (Est)
31,4
25,4
Develop.
62,25
61,2
50,7
48,55
58,5
App & Dev
86,8
84,45
80,7
79,95
83,9
A&D/BR
6,50
5,40
4,13
3,96
5,21
(This data is averaged for two fiscal years, FY1991& 92).
It shows that for every unit of basic R&D the Japanese carry out 6.5 units of more
market oriented R&D, compared to typically 3-5 times more. Therefore any support at
this level will inevitably feed through into price advantages in the market.
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of 15th August 1999
53. KOREA
Current expenditure for R&D into developing and manufacturing of new products are
fully deductable in the year in which they are incurred, or amortised over a maximum
of the subsequent 5 years.
Capital expenditure is treated differently though. There are complex rules that relate
to essentially a series of regulations for the depreciation of such costs. Residual costs
methods give typical rates of 20-25% for machinery and equipment, and typically 5%
for buildings and manufacturing plant. There are certain rules and exemptions for
"key” industries that permit far higher rates, with a cap that overall the reductions on
taxable income must not exceed 50%
Additionally, domestic enterprises are eligible for a tax credit for the development of
technology and manpower; at a rate of 5% of current and capital R&D expenditures
for large; and 10% for smaller enterprises.
Incremental tax benefits are available, at a rate of 25%, for companies whose current
R&D outgoings exceed those of the past two years averaged; whereas neither of the
previous two credits reduce the deductible base for R&D expenditure - ie schemes are
cumulative! Special rules apply to newly founded companies, and again for those
oriented towards technological domains.
Korea has various specific tax support systems for R&D:
- a reserve fund R&D system
- tax exemptions for technology and human development expenses, and local tax
exemptions for private research facilities
- reduction of tariff rates for R&D equipment
- favorable action regarding industrial property rights
Reserve fund R&D system
Under the current Technology Development Promotion Law, expenses for developing
technology, such as R&D spending for the development of new products and processes,
research spending for the assimilation and improvement of imported technology,
technical information acquisition costs, technical expenses, research equipment
acquisition costs, sponsored research costs, expenses for commercializing industrial
property rights, are recognized as non-taxable losses for income accounting purposes.
As a result, industries can reserve funds for investment in R&D and, under the system of
technology development reserve funds, industries need not pay taxes on funds reserved
for the development of new products and processes. The ceiling on reserve funds is 20%
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of total income before tax (or 1% of total sales) for the period in which the income (or
profit) is made for the taxation period of such income
Exemption from certain taxes
When industries establish their own laboratories, 8% of the facilities acquisition cost
(10% if the facilities are procured in the country) is exempted from corporate taxes and
income taxes. In addition, non-taxable special depreciation reserves have a one-time
exemption for up to 90% of the acquisition costs of testing and analysis facilities for use
in technology development. Industries that are building research facilities and acquiring
test equipment can obtain long-term, low-interest loans for such construction and
acquisition.
Reduction of tariff rates for R&D equipment
Expenses for the application or commercialization of research results are also untaxable.
For instance, up to 6% of the acquisition costs of facilities directly used for
commercialization of new ideas (10% if the facilities is procured within the country) is
exempted from corporate taxes and income taxes. Such non-taxable status is applicable
when patented new ideas of research results coming from the national research institutes
are commercialized for the first time, provided such commercialization is recognized by
the Minister of Science and Technology in consultation with the Minister of Finance.
Favorable action regarding industrial property rights
Favors are also given for the commercial application of government-sponsored research
results. Some government-sponsored research projects have resulted in industrial
property rights, and among such rights are those which can be applicable on a
commercial basis. For such rights, the license is granted free of charge wholly or
partially to the institute which developed the research or to those who jointly invested
with the government in the research. Such favors are designed to encourage industries to
promote R&D activities through increased investment in the development of new
products and processes.
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of 15th August 1999
54. MALAYSIA
Malaysia has a very similar system to that of Singapore, which may be expected in
order to reduce regional disparities (S Lhuillery, CREI, Univ Paris Nord, National
Systems of R&D Tax Credits, Draft OECD Unpublished Paper, 19 Jan 1995). Apart
from a single 200% volume based tax credit rate for R&D, there are no accelerated
depreciation rates but a 10 year tax exemption of all R&D in a medium to low
corporate tax rate of just 35%.
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55. MEXICO
Current R&D costs are 100% deductible in the year in which they are incurred.
Capital equipment can be amortised at up to 35% per year, and buildings at 5% (much
higher than elsewhere). Both are straight line depreciations. Certain subsidies are also
available.
The corporate tax rate at 35% is medium to low. Outside the metropolitan areas, an
optional method may be selected that is equivalent to the depreciation of capital assets
above in present value terms. The option is to select an investment allowance of
91% of cost of acquisition and
51% of cost of fixed equipment/industrial buildings.
The purpose of this is to impact early phases of R&D in the regions of Mexico. The
recent devaluation of the local currency versus the US$ particularly is expected to
attract foreign based R&D into Mexico.
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56. The Philippines
The Philippines wanted to promote the teaching of science at schools and higher
education institutes. In the 1960’s-70’s they instigated an issue of Science Tax
stamps. Not much information is known about them but they were used to raise indirectly - revenue from documents requiring fiscal probity.
Some of the stamps so issued form the cover of the main ETAN report, and are
reproduced with the kind permission of the Philippine Government.
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Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
A novel indirect Measure to raise
money for science
in the Philippines: Science Stamps
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Development in Enterprises, European Commission DG XII European Technology Assessment Network. Version
of 15th August 1999
57. SINGAPORE
Singapore has a scheme which has been very successful, whereby a great proportion
of R&D expenses are allowed at a rate of 20% deduction from profits tax.
In 1994, Singapore was the worlds 2nd most competitive nation (1994 - The World
Competitiveness Report), but is largely driven - and the factor is that most of industry
in the hand of foreign multinationals.
This can explain why Singapore is only 27th ranked in R&D spending, and the
government knows it must develop indigenous innovation rapidly. The tax incentives
developed in the 70's were focused on foreign multinationals (Technology, Strategy
and Dynamics in National Economic Development - The Case of Singapore, KT Yeo,
RESTPOR'95 Regional Management of Science and Technology 13-16-02-95).
The strategy now is to encourage these to set up regional HQ and R&D Centres by
means of extended tax credits. Government directly contribute just 11% of all R&D
resources (61% for private sector).
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58. South Africa24
Tax Treatment of R&D
Definition of Research and Development Expenses
The South African Income Tax Act (the Act) contains no explicit definition of
“research and development”. However, the legislation does recognise scientific
activities relating to: - scientific research
- devising and developing technological (intellectual) property
It is considered that scientific activities can be divided into three main categories,
namely:
- research and development
- research-related scientific activities
- non-research related scientific activities
Research and Development - Definitions
“The principle objective of research and development is to gain scientific knowledge
or to devise new applications”. Research and development would include:
- basic research
- applied research
- development
The aim of basic research is the extension of the boundaries of knowledge; that of
applied research is the solution of problems peculiar to science and technology; while
development is the activity which seeks to utilise the knowledge gained from basic
and applied research in developing new products and ideas. Thus research relates to
the increase of scientific and technological knowledge, whereas development is
directed at devising new applications for that knowledge.
Research-related Scientific Activities
Activities belonging to this category include:
- dissemination of scientific and technological information
- training and education of scientific and technological personnel
- collecting data for use in scientific research
- museums and zoological and botanical gardens
“Tax Treatment of R&D”, p. 147-155, Klynveld, Peat Marwick Goerdeler, , 1990, ISBN 1 85061
195 5
24
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Non-research Related Scientific Activities
Some of the more important activities in this category which do not qualify as
research are:
- testing and quality control
- patenting and licensing
- specialised medical care and clinical activities
- technical and scientific advisory services
- policy-related activities
Scientific Research
The Act defines scientific research as “any activity in the field of natural or applied
science for the extension of knowledge”. The definition thus restricts scientific
research in two ways:
- the activities must relate to the fields of natural or applied science; in other words
activities relating to the human sciences are excluded
- the objective must be for the extension of knowledge
Devising and Developing Technological Property
The expression “devising and developing technological property” is not defined in the
Act. However, it refers specifically to intellectual property in the form of a
- patent as defined in the Patents Act
- design as defined in the Designs Act
- trade mark as defined in the Trade Mark Act
- copyright as defined in the Copyright Act
- model, pattern, plan, formula, process or other property or right of a similar nature
The terms “technology” and “technological property” as used in this chapter should
be understood to refer collectively to patents, designs, trade marks and copyrights, as
well as to any of the other forms of intellectual property specified in the Act.
Current Deductibility of Expenses
Where scientific research is concerned, the costs of erecting a laboratory and of
manufacturing special plant and equipment for use in the research are all items
regarded as of a capital nature. On the other hand, the costs of materials used in the
research, the remuneration payable to scientists and laboratory personnel and the hire
costs of laboratory and other equipment (none of which may produce any obvious or
enduring benefit) are all regarded as items of a revenue nature.
However, all expenditure incurred in devising or developing technological property is
considered to be of capital nature.
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While revenue expenditure on scientific research is fully deductible in the year of
assessment during which the amount is expended, any capital expenditure, whether on
scientific research or on developing technological property, is only deductible over a
period, as described below.
Patent extensions
A deduction is also permitted of any expenditure actually incurred during the year of
assessment in obtaining extensions of the term of a patent under the Patents Act, the
registration period of a design under the Designs Act or the renewal of the registration
of a trade mark under the Trade Marks Act, provided the patent, design or trade mark
is used by the taxpayer in the production of his income or income is derived by him
from it. Again the deduction specifically excludes expenditure deductible under any
other provision.
Expenditure by exporters
A further deduction is permitted to a taxpayer who is an exporter as defined in the
Act, in respect of expenditure (including search and application fees) in obtaining the
registration or restoration of any patent or the registration of a design or trade mark or
the extension of the term or registration period of or the renewal of the registration of
a patent, design or trade mark in any export country. This expenditure will also
qualify as marketing expenditure for the enhanced marketing allowance available to
exporters.
Exchange control
Exchange control approval is required to remit funds abroad for the acquisition of any
technological property. The application must be submitted by the taxpayer’s bankers
direct to the South African Reserve Bank, together with a copy of the agreement of
sale. Where the Reserve Bank views the transaction as the acquisition of an asset of
an enduring nature, it will require the proceeds to be remitted as Financial Rand.
Lump sum payments (lease premiums)
An allowance is granted in respect of any premium or like consideration paid by a
taxpayer for the right of use of technological property or for the imparting of
information connected with that property. A “premium or like consideration” passing
from the lessee to the lessor is a sum having an ascertainable money value which is
distinct from and in addition to or in lieu of the rent or royalty.
The allowance for any one year for the right to use the technological property is
calculated by dividing the total premium by the number of years for which the
taxpayer is entitled to the use of the technology. When this exceeds twenty-five years,
the allowance must be calculated over a period of twenty-five years. The
Commissioner may determine the probable duration of use by reference to the period
of the lease, including all possible renewal periods.
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59. Switzerland25
Tax Treatment of R&D
Definition of Research and Development Expenses
The Swiss tax law makes no special provision for taxpayers engaged in research and
experimental activities. There is therefore no legal definition for these terms.
However, the federal tax authorities have published a memorandum on the tax
treatment of costs incurred in connection with industrial research. According to this
memorandum, current expenses such as materials and wages can be deducted.
In the case of Swiss resident companies which provide research services to related
corporations outside Switzerland, the Swiss tax authorities require a share of the
group profit to be assessed at the level of the Swiss corporation. The profit assessed in
Switzerland is generally a minimum of one-tenth of the total expenses or one-sixth of
the total local payroll cost (cost-plus method).
Current Deductibility of Expenses
Expenses in connection with basic research cannot be capitalised and amortised. They
must be currently deducted.
Expenses incurred for specific production units may be capitalised and amortised over
a period of up to five years.
Tax Treatment of Qualified Expenses
The tax treatment is generally based on the accounting treatment. If the amortisation
method has been chosen, the capital expenses can be amortised over five years
beginning from the first income producing year. The tax authorities in various cantons
would, however, not insist on this treatment. All research and development
expenditure could be deducted in the current period.
Some cantonal tax laws allow, under certain conditions, accelerated depreciation or
immediate deduction of equipment purchased for use in research and development
and in other fields. It is recommended to get an advance ruling on these specific
items.
Computer Software Development Costs
No specific provisions exist for the tax treatment of computer software. Software
development is viewed as a form of research and development activity, and hence
accounting as well as tax treatment is similar to ordinary research and development
expenses. General development costs are fully tax deductible when incurred, whereas
“Tax Treatment of R&D”, pp. 171-175, Klynveld, Peat Marwick
Goerdeler, Amsterdam, 1990, ISBN 1 85061 195 5
25
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development costs of specific projects may be capitalised provided technological
feasibility can be established and marketability is secured.
Purchased software must be capitalised and amortised normally over a five year
period as is applicable for a company’s own specific development costs for which the
amortisation method has been chosen. Tax authorities in certain cantons allow an
immediate full tax deduction or the application of a shorter or extended amortisation
period if the actual useful life can be established accordingly.
Tax Credits
Tax credits are not available in a “basic” form as such..
Tax Treatment of Technology Transfers
Inward Transfer of Technology
Royalty payments are basically deductible. Where royalties exceed arm’s length
amounts, the excess is treated as a profit distribution and therefore is subject to
withholding tax at 35%, reduced under various tax treaties.
Switzerland adheres to the principle that royalties should be exclusively taxed in the
recipient’s country. For appropriate licence fees, Switzerland does therefore not levy
any withholding tax.
Royalties should not be determined as a percentage of net profits but rather of gross
sales figures.
There are no exchange control restrictions on payments of royalties to foreign
licensors.
Licensing of Outbound Technology
Royalty payments received from related entities must meet the arm’s length test. The
Swiss tax authorities require royalty fees to be dependent on gross sales figures and
not on profit.
Treaty favoured royalty income is subject to the restrictions imposed by the 1962
Abuse Decree. Treaty benefits are thus available only provided the following
conditions are met:
- debts may not exceed six times the amount of equity
- not more than 50% of royalty income derived from treaty countries may be passed
on to non-resident recipients
- at least 25% of treaty income must be distributed as a dividend
According to the arm’s length principle, insufficient royalty fees received from a
related company would give rise to deemed profit distributions and the amount of the
undercharge would be added to taxable income. In addition, the deemed profit
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distributions would be subject to withholding tax at a rate of 35%, reduced under the
various tax treaties.
Cost-sharing agreements are likely to remove the need for actual royalty charges.
However, the terms of the agreement must be in line with the arm’s length principle.
Transfers of Developed Technology
There are no specific rules with regard to transfers of developed technology.
Basically, transfers to related entities are not treated differently from transfers to
unrelated third parties. However, the arm’s length test has to be met, ie: the terms of
transfers to related companies need to be similar to the terms of transfers to unrelated
companies.
Capital gains achieved in selling technology are taxed at ordinary rates.
Tax Treatment of Cost-Sharing Arrangements
Expenditure
The recouping of research and development cost through cost-sharing agreements is
permitted under the Swiss tax regime, although no specific tax law exists. The arm’s
length principle must prevail and participants must bear risk in relation with the
projected reward. Therefore, arrangements should not represent a disguised profit
transfer. Participants must be able to demonstrate definite legal rights to the
technology resulting from the research, which should be relevant to their business.
Single project costs or costs on all projects within a product sector may be divided in
relation to each partner’s expected profit – an allocation based on turnover will not
meet the arm’s length test in every situation. An advance ruling from the respective
tax authorities is recommended on this matter. In order to obtain a tax deduction on
project contributions which include a profit mark up, it is necessary to have a
recognised cost accounting system together with supporting documents.
Cost-sharing payments are neither subject to Swiss withholding tax, nor to turnover
tax or any other indirect tax.
Receipts
A research centre for specific product and technology development organised as a
legal entity under the Swiss jurisdiction with research costs being financed by two or
more parties represents a taxable entity. Whether the will fall under the tax regime
applicable for service companies ie: cost-plus taxation or be assessed for a reasonable
profit element will depend on the contract terms, the relationship and jurisdiction of
the contributing partners etc. Attractive tax rulings can be obtained at federal and
cantonal level if the project has economic significance for the local area.
A unincorporated research centre may or may not qualify as a permanent
establishment. A permanent establishment is defined under national (federal) law as a
fixed place of business in which from both a quality and quantity viewpoint a
substantial part of the activities of the enterprise are performed. It includes, but is not
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limited to, a registered branch, a place of management, a plant, or a workshop.
Notwithstanding treaty provisions to the contrary, research and development
activities, if of preparatory or auxiliary nature only, will not qualify as a permanent
establishment. Assuming such status is given in cases with significant assets or
importance to the group as a whole, taxation should be discussed with the respective
authorities in advance. In any event, no Swiss withholding tax will be levied on profit
transfers.
Tax Incentives, Grants, Tax Holidays etc
Swiss legislation basically does not provide any special incentives for research and
development generally nor for the computer software industry in particular. However,
newly set-up and existing companies are, under certain conditions, granted privileged
tax treatment. Specific provisions for such activities are tax allowable as well as
newly introduced general recession reserves. Tax holidays up to ten years may be
granted by various Swiss cantons to newly set-up companies. When meeting certain
requirements laid down in tax laws of several cantons, base or mixed company tax
status benefiting from no or low cantonal tax may apply.
In addition to fiscal relief, enterprises meeting applicable laws for promotion of trade
and industry can obtain further support, eg:
- financing facilities at reduced interest rates
- non-repayable investment contributions
- financial relief for purchases and exploitation of plots of land
However, specific matters have to be discussed beforehand with the respective tax
authorities and other government bodies.
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60. TAIWAN
Taiwan has had a tax statute dealing with four categories of provisions since 1990 for
a trial period of 10 years (KPMG Tax Treatment of R&D Expenses, 1990,
International Tax Centre, Amsterdam, ISBN 1 85061 195 5):




deductibility of R&D expenditure for profit making industries (MoF - Ministry of
Finance Scheme, 1990)
tax credit allowances for R&D in production enterprises (SEI - Statute for the
Encouragement of Investment, 1990))
a minimum level of R&D costs that are to encourage investment in R&D by
enterprises (SEI)
taxation schemes dealing with preferential treatment for technology transfer
income (MoF)
The MoF has wide ranging guidelines on what are allowed expenses, which include :





payroll and training expenses for full and part time workers
costs of improving management skills for operations
supplies and all current expenditure.
all costs for patents, copyrighting and know how acquisition and protection
contracted services of a relevant nature (though allowed only retrospectively, not
in current period).
A 20% tax credit is awarded for the incremental R&D over the highest amount over
the previous 5 years, or, if the undertaking is less than 5 years old, 0.5% of the current
years revenue. There is a ceiling of 50% of all tax, and unused credits can be carried
forward into future tax years.
There is a specific SEI scheme for the encouragement of young companies that
exceed 300M NT$ (ca 10M ECU at a rate of 30-33 NT$ = 1 ECU, 1992-1995)
turnover, with flat rate allowances between 05.% and 1.5% of turnover, reducing as
revenue build sup through 1B (33MECU) and 10B NT$ (330MECU).
Unusually, any amount unspent below 1% of turnover is pooled back into the
Governments R&D Foundation, and excluded from future tax credits. This
encourages optimal rates of R&D to be undertaken in all accounting periods.
In order to encourage technological development, all costs associated with the use of
imported technology is deductible, either directly or over the maximum of 15 years
normal IPR protection. This only applies to transactions in Taiwan, so any such
agreements concluded outside the island are exempt from this scheme.
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61. THE UNITED STATES
Rather like in Japan, the overall picture is blurred by a blending of state and federal
taxes. There are a plethora of specific schemes for specific states, though they are
required overall to conform with federal taxation laws, which has been established
since 1954.
Overview (by A Gambardella)
The R&D credit does not work as intended. Recent econometric studies generally
indicate that, at the very least, the R&D credit produces a dollar of increase for every
dollar spent. (See Hall, 1995, for a review.) Moreover, these studies indicate that the
effect is likely to be larger in the long term than in the short term. It is logical to
expect that the private sector response would be improved if the credit were made
permanent, and would have been greater if the credit had not suffered a one year lapse
from July 1, 1995 to June 30, 1996. Prior to the lapse, firms could count on the credit
being extended retroactively. Many companies kept the R&D credit in their research
plans after the expiration date on advice from tax advisors that an extension would be
retroactive, thereby preserving corporate funding for high risk projects. The lapse
caused all taxpayers to remove the credit from their corporate research plans after the
credit expired on May 31, 1997, and resulted in less research overall.
The R&D credit costs too much. The most recent data available show that in 1992
US companies received around $1.5 B in R&D credits. This is equal to only 1% of the
total income taxes paid by corporations in that year. Given the high multiplier effect
of R&D expenditures on the economy and the resultant increase in economic growth
and job creation, the expenditures for the R&D credit are a good investment, and one
that pays long term solid dividends.
Only a few very large companies benefit from the R&D credit and it is not used by
smaller businesses. In fact, over 94% of the 10,928 firms earning the R&D credit in
1991 had assets of less than $100 million, with over 74% having assets of less than
$10 million (KPGM study). Moreover, as noted earlier, even if many small start-up
firms are in a tax loss position, an unused R&D tax credit can be a valuable asset, and
one that is recognized by investors, banks and venture capitalists, if they can carry the
credit back and forward. The trend toward greater utilization of the R&D credit by
smaller companies is then likely to continue and accelerate as new companies emerge
in key growth markets such as biopharmaceutical research, Internet, communications,
and other high technology endeavors.
Federal Incentives
The earliest forms of national R&D Tax Credits were granted under the 1954 Internal
Revenue code section 174, where a taxpayer may elect to deduct or amortise R&D
expenses over 60 months or more. This gives a faster write down of the capital
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created than economic depreciation. The USA has now ca. 15 years of significant tax
credit policies that are relevant to this study, based on the Economic Recovery Act of
1981.
Most firms do not garner all the returns from a subsidy individually, as other
companies learn from the work undertaken and are therefore more innovative.
Government argues that this is a benefit for the industry as a whole and therefore a
stimulant in its own right.
Sometimes the consumer benefits (i.e. a return to society), where it is more difficult to
assess the cost/benefit issues. The PC industry is a classical case. R&D in the PC
industry has benefited consumers through lower prices and advanced technology,
which are not generally a benefit for the producer, but overall the industry in the USA
now is the world leader in soft and hardware.
Policy alternatives for correcting under-investment in R&D (or Research &
"Experimentation" which is the US legal terminology) included
1.
2.
3.
Allowing firms to capture returns by joint R&D venture.
Create a property right.
Subsidise activity via:
 direct subsidy
 tax credits.
The USA spends huge amounts in defence, space and health. These expenditures give
very large and strategic spillovers to the private sectors ("Dual use technology"
policy), even after the reduction in military based expenditures of recent budgets.
Incremental R&D tax credits across all areas plus accelerated deprecation (100% in
fact) which is in effect a tax subsidy, are available.
Capital equipment credits is important in capital intensive areas.
Current expenditure is fully deductible in the current period. Corporations may
amortise this over 5 years by election. capital items are treated as extraordinary items
for depreciation, with a 5 year double declining balance category. Building and fixed
assets are depreciated over 40 years.
The federal government offers an investment tax credit of 20% on the excess of
currently qualified R&D expenditure over a based amount calculated over a specific
base period (the base amount may not be less than 50% of the qualified research
expenses for the year in which credit is sought - ie the "new" R&D is capped at
double the base amount this is called the "base constraint"). The tax credit is taxable
though, thus reducing the deductible base for expenditures.
About 65% of all R&D reported is eligible for tax credits in USA. The remaining 35%
is final product development. So some development is included in credits.
Incremental tax credits only incur incremental costs to government. Government
should seek areas where total social return is important.
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US Tax Exempt Bonds for RTD facilities26.
This is a major source of funding for US institutions, with both public and private
being eligible. In FY1994-5, 3.8B$ were raised by this method, which are considered
to stabilise employment (as opposed to explicit effects in increasing RTD
employment). This is probably because 1B$ (ca 800MECU27) were spend on
renovation and repair of exisiting installations; equally split between the privatre and
public sector. As a result ¼ of all US physical academic facilities are at a standard to
be used in the “most sophisticated” research28 in its field.
However, there is also enough expansion planning for double this rate of investment;
and as US long-term interest rates decline these bonds offer increasingly attractive
“costless” subsidies even though there is evidence of diminishing returns as volumes
increase29. New and unmet needs construction planned accounts for an extra 8%
relative to existing space and imply a direct need/demand for a commensurate
increase in RTD employment to undertake the higher volume of RTD (another 10%
of all space is planned to be renovated and updated as well30); though these rises will
be implemented over 2-3 years often.
A seeming contradiction in the data is that Computer Science requires much less of
this type of funding than the Biological and Life Sciences although the employment
expansion expectation is heavily weighted in the former area.
As a preparatory measure, there is legislation coming to the US Congress31 this
Autumn to about double the visa quota for foreign workers with high-tech skills to
115,000 per year (up from the current 65,000 per year) by 2001.
26
These are often called "Industrial Development Bonds". They typically work like this: A corporation
approaches a state, county or municipality to do something in the given region i.e. build a facility. The
state or county that is interested in the facility locating there agrees to issue Industrial Development
Bonds that are of course guaranteed by the State i.e. low risk and are exempt or partially exempt from
income taxes for the bond buyer. The state turns around and lends the money to the company typically
with some conditions like a certain number of jobs must be created, or a specific activity carrried out.
This mechanism funds just about anything that is of interest to the State or its County’s; i.e. a football
stadium, a university expansion or industrial promotion.
27
Average Xchange rate 1995-6 US$-ECU
28
S&E 98 5-17, Text Table 5-2
29
M.R. Marlin: “The Hidden Costs of Private Activity Tax-Exempt Bonds”, in The Review of
Regional Studies, Fall 91, 21(3), p.277
30
S&E 98 Table 5-12, p. A-214
31
USIS Washington File 31 July 1998
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R&D Incentives within individual states
(validated by L Rubiello, A Gambardella and J Guinet)
A recent study has compared the systems in three typical states - California (very
large economic base, high technology sector), Michigan (services, mixed economy,
manufacturing based technology), and Illinois (advanced manufacturing systems).
Typical has to be taken very loosely here - states are rarely typical although the top 10
states for R&D performed have not changed in the last 20 years. However, there are
"hotspots". California hosts 37% of all aircraft and missile R&D, 20% of all
machinery, electrical engineering and vehicle R&D. Michigan, for example, hosts
over 60% of all motor vehicle R&D.
US States R&D Tax Incentives32
Conclusion
Although most states offer some type of R&D tax incentive, the relative impact of
these incentives is uncertain – possibly less clear than national schemes. The total
amount of about 250-350M$ is negligible compared to total US industrial R&D
spend, and ½ of this is spend in one state – California.
The limited amount of data available on the number of companies that use the
incentive and the subsequent tax expenditure prevents any assessment of the specific
effectiveness of the R&D tax incentives in encouraging R&D activity. Therefore it is
likely to be more relevant to stabilisation of R&D than in additionality.
Schemes relevant to employment subsidies are novel in places (Mississippi) and
generous (Florida) but there is no evidence to suggest strategic impact. Other
employment schemes are marginal at best.
Detail by State
The State Science and Technology Institute surveyed the individual US states in 1996
to determine the type and extent of state R&D tax incentive offerings, which
complement the national scheme for tax, credits for industrial R&D. The results are
reported by state33, type of tax incentive and description in Table USS1.
In 1996, 35 states out of 50 offered some type of incentive for research and
development activity. Many states offered an income tax credit modeled after the
federal research and experimentation guidelines. There were 15 states that applied the
federal research tax credit concepts of qualified expenditures or base years to their
own incentive programs.
States that used this approach frequently specified the credit could only be applied to
qualifying expenditures that could be attributed to activities taking place within the
state.
32
This was undertaken as part of the background work for the ETAN group on Indirect Measures for
RTD employment.
33
With states offering no additional incentives included for completeness.
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States offer other types of R&D incentives as well as income tax credits. Several
states exempt R&D activity from sales taxes or property taxes. Other states offer
programs that are distinctive. For example,
-
Hawaii exempts contracts with the federal government for scientific work from
usage taxes. Gross proceeds from technical services for the production and sale of
computer software are exempt from the general excise tax for services to a
customer at a point outside the state.
-
R&D firms organised to engage in business in Montana for the first time are
exempt from the whole state corporate income tax for the first five years of
taxable activity in the state.
-
Louisiana offers credits and exemptions to R&D firms that locate in the
university research park.
-
The amount of the job tax credit in Mississippi is based on the county in which
the business is located. This is a unique feature, but probably sub-critical.
- South Carolina: a ceiling of $300 on the sales and use tax applied to R&D
machinery.
In addition to confirming the availability of specific tax incentives, states were asked
in the survey to approximate how many companies use the incentives annually and
the approximate annual costs of the tax expenditure. Many states do not keep the
level of detail that would provide an indicator of the relative usage of specific R&D
tax treatments.
Table USS1. State Research and Development Tax Incentives34, 1996
Type of
State
Incentive
Description of Scheme at time of survey (or last scheme)
Alabama
None
Alaska
None
Arizona
Income
Businesses engaged in qualified R&D performed within the
state are eligible for an income tax credit. For the first
taxable year in which the taxpayer claims the credit, the
maximum allowable credit is one hundred thousand dollars.
For the second taxable year, the maximum allowable credit
is two hundred fifty thousand dollars. For the third taxable
year, the maximum allowable credit is four hundred
thousand dollars. For each taxable year after the third
taxable year, the maximum allowable credit is five hundred
thousand dollars. Qualified research expenses that exceed
the maximum allowable credit in a taxable year may be
carried forward for not more than fifteen taxable years.
34
Source: State Science and Technology Institute Survey, 1997
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Arkansas
Income
California
Income /
Personal
Property
Colorado
Income
Connecticut
Delaware
None Offered
Income/Gross Companies in targeted industries including R&D that invest
Receipts
at least $200,000 in new or expanded facilities and hire at
least 5 new employees can qualify for corporate income tax
credits: $250 for each new qualified employee and $250 for
each $100,000 investment. During the 10-year life of
credits, credits may not exceed 50% of the company's precredit tax liability in any one year. Unused credits may be
carried forward. In addition, firms are eligible for gross
receipts tax reductions on a 10-year declining scale, which
begins with a 90% reduction one year from start-up.
Sales and Use Research and development labour is not subject to tax.
None
Excise and Use Contracts with the federal government for scientific work
are exempt from use taxes. Gross proceeds from technical
services for the production and sale of computer software
are exempt from the general excise tax for services to a
customer at a point outside the state.
None
Income
Corporations are eligible for a 6.5% credit for qualifying
R&D expenditures above the average R&D expenditure by
the taxpayer in the previous 3 years.
Income
Corporations are eligible for a 5% corporate income tax
credit on the portion of qualifying research expenditures
that can be attributed to activities in Indiana. The definition
of qualifying research expenditures is tied to the federal
credit allowed for increasing research activities. There is a
carryover provision.
Income
A 6.5% credit may be taken for research expenditures.
Florida
Georgia
Hawaii
Idaho
Illinois
Indiana
Iowa
Businesses engaged in qualified R&D performed within the
state are eligible for an income tax credit equal to 33% of
qualified research expenditures. The credit is limited to
50% of the total net tax due. The carry forward limit is
three years.
Corporations are eligible for an 8% corporate income tax
credit on the portion of qualifying research expenditures
that can be attributed to activities in California. The
definition of qualifying research expenditures is tied to the
federal credit allowed for increasing research activities.
There is also a credit for 6% of the qualified cost of tangible
personal property used for R&D.
Companies conducting R&D activities in an enterprise zone
are eligible for a 3% credit for R&D expenditures above the
average R&D expenditure by the taxpayer in the previous 3
years. Eligible expenses that exceed the allowable credit
may be carried forward until the total amount of the credit is
used. The definition of qualifying research expenditures is
tied to the federal credit allowed for increasing research
activities.
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Kansas
Income
Kentucky
Income
Louisiana
Various
Maine
Income
Maryland
Personal
Property
Massachusetts Income
Michigan
Minnesota
Credits are available equal to 6.5% of the amount that R&D
expenditures exceed such the average of expenditure by the
taxpayer in the previous 3-year period. Only 25% of the
allowable annual credit may be claimed in any one year.
Any remaining credit may be carried forward in 25%
increments until exhausted. The definition of qualifying
research expenditures is tied to the federal credit allowed
for increasing research activities.
State income tax credits of up to 50% of start-up costs and
up to 50% of annual rentals for 10 years for new or
expanding service or technology business that employ 25 or
more Kentuckians and provide more than 75% of their
services to out-of-state customers.
Any manufacturing, R&D, support or service business
which is located in a university research and development
park and whose primary activity is related to R&D may be
granted certain exemptions from state corporation, income
and franchise taxes and may be eligible for rebate of state
sales and use taxes.
Corporations are eligible for a 5% credit for R&D
expenditures above the average R&D expenditure by the
taxpayer in the previous 3 years, plus 7.5% of the basic
research payments. Federal taxable income for corporations
must be increased by any research expenses used in
determining the research expense credit. The credit is
limited to the tax liability of the taxpayer and, in the case of
corporations, the credit is limited to the first $25,000 of tax
liability before credits plus 75% of the liability that exceeds
$25,000. Carryover provisions apply.
Machinery, equipment, materials and supplies that are
consumed in or used primarily in research and development
are eligible for an exemption equal to the assessment on the
R&D property which is in excess of 50% of the original
cost.
An income tax credit is available equal to 10% of the
increase in qualified research expenses over the base
amount and 15% of incremental increases in basic research
over the base amount. Taxpayers may elect to use either
Massachusetts or federal gross receipts for base amount
calculation purposes.
None Offered
Income
A corporation may take a credit against income tax liability
for 5% of the first $2 million of the excess of qualified
research expenses for the taxable year over the base period
research expenses and 2.5% of the excess expenses over $2
million. A Minnesota deduction may be allowed for
expenses not allowed to be taken on federal taxes.
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Mississippi
Income
The amount of the job tax credit is determined by the
county in which the business is located. Counties are
ranked according to unemployment and per capita income
figures for the most recent 3-year period with credits
ranging from $2,000 annually for each full time employee
for 5 years if employment is increased by 10 or more to
$500 per employee with the requirement of 20 new jobs
added. Any job requiring R&D skills qualifies for an
additional 5 year, $500 tax credit for each net new
employee.
Missouri
Income
Businesses having qualified research expenses in Missouri
may receive a state income tax credit of 6.5% of the excess
of qualified research expenses during the tax year over the
average qualified research expenses of the preceding 3 tax
years. The Department of Economic Development must
certify the credit amount. The credit may be carried
forward for up to 5 additional years.
Montana
Income
R&D firms organised to engage in business in Montana for
the first time are exempt from the corporate income tax for
the first five years of taxable activity in the state. In
addition, R&D assets have a lower property tax assessment.
Nebraska
Sales and Use / Tax credits are available to companies that conduct
Income /
research, development, or testing for scientific, agricultural,
Property
animal husbandry, food product, or industrial purposes.
Credits may be used to reduce a portion of the income tax
liability or obtain a refund of sales and uses taxes paid.
Credits are: $1,500 per net new employee or $1,000 per
$75,000 new new investment.
Nevada
None Offered
New
None Offered New Hampshire's R&D tax credit was repealed effective
Hampshire
June 30, 1995.
New Jersey Corporation
R&D tax credits up to 10% (but not exceeding 50% of the
Business
tax liability before they apply the credits) are available for
increased research expenditures in the state. The base
period amounts and qualified expenditures are determined
by the guidelines for the federal research credit.
New Mexico Gross Receipts The receipts from selling certain research and development
services sold to prime contractors operating federal
labouratories in New Mexico are exempt from taxation.
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New York
Corporate
Franchise /
Personal
Income / Sales
and Use
New York offers companies a choice regarding R&D tax
credit incentives. First, a general investment tax credit is
available at a rate of 5% of the first $350 million of
qualified expenditures and 4% of qualified expenditures in
excess of $350 million. Companies electing this option may
also claim an employment incentive credit between 1.5%
and 2.5% in the following two years if their employment
increases. Alternatively, companies may use a credit for
R&D property only at a rate of 9% of the cost or other basis
for federal tax purposes of qualified property.
Taxpayers may claim a 7% personal income credit for their
qualified R&D property.
Sales of energy used or consumed directly and exclusively
in R&D are exempt from sales and use tax. Sales of
tangible personal property purchased for, used or consumed
directly and predominately in R&D are exempt from sales
and use tax.
North
None Offered
Carolina
North Dakota Income
Corporations are eligible for a credit equal to 8% of the first
$1.5 million of qualified research expenses for the taxable
year in excess of the base period. The credit is equal to 4%
on expenses that exceed $1.5 million. The definition of
qualifying research expenditures is tied to the federal credit
allowed for increasing research activities.
Ohio
Sales and Use Qualified R&D equipment is exempt from state and county
sales tax. R&D equipment is defined as capitalised personal
property, and leased personal property that would be
capitalised if purchased, used to perform research and
development. Tangible personal property used in testing is
not qualified research and development equipment unless
such property is primarily used by the consumer in testing
the product, equipment, or manufacturing process being
created, designed or formulated by the consumer in the
research and development activity or in recording or storing
such test results.
Oklahoma
None Offered
Oregon
Income
A research tax credit is available for increased R&D in the
fields of advanced computing, advanced materials,
biotechnology, electronic device technology, environmental
technology, or straw utilization. The credit is equal to 5%
of the increase in qualified research expenditures over the
average of the preceding 3 tax years.
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Pennsylvania Sales and Use / Property used in research activities having as its objective
Franchise
the production of a new or improved product or utility
service or method of producing a product or utility service
is exempt from sales and use tax. Assets used in
manufacturing, processing and R&D are exempt for the
purposes of computing corporate capital stock/franchise tax
liabilities.
Rhode Island Income /
An income tax credit is available equal to 5% of the
Property
increase in qualified research expenditures over a base
period as defined in the application of federal R&D.
There is a 10% credit for R&D property acquired,
constructed, reconstructed or erected after July 1, 1994.
South
Sales and Use The maximum tax levied on the sales and use of machinery
Carolina
for R&D is $300.
South Dakota None Offered
Tennessee
None Offered
Texas
None Offered
Utah
None Offered
Vermont
Income / Sales An income tax credit of $1,500 per job is available for new
jobs in R&D created between 1/1/92 and 7/1/96.
Virginia
Washington
Tangible property consumed or used in industrial,
commercial or agricultural R&D is exempt from sales
taxation. The property cannot be used for normal testing,
quality control inspection, or studies or surveys.
Sales and Use R&D companies are exempt from the sales and use tax on
tangible personal property purchased for use or
consumption directly and exclusively in basic R&D in the
experimental or labouratory sense.
Business and High Technology Credits and Deferrals/Exemptions are
Occupations / available to eligible research and pilot manufacturing
Sales and Use businesses for biotechnology, advanced computing
technology, electronic device technology, advanced
material technology and environmental technology. To be
eligible for the tax credit, firms must invest at least .92% of
their gross income in R&D. Non-profit firms engaging in
R&D are eligible for a credit equal to .515 of 1% of
compensation received. Others are eligible for 2.5%.
Equipment and structural spending is exempt from sales tax
if approval occurs before spending. Effective June 6, 1996
any manufacturer involved in qualified R&D is eligible for
sales tax exemption.
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West Virginia Corporate
Franchise /
Income
Wisconsin
Income
Wyoming
None Offered
A Credit for Research and Development Projects may be
applied against the business franchise tax, business and
occupation tax and severance tax, and may used to offset up
to 50% of the taxpayer's adjusted liability. A company
electing to apply credit against its income tax liability must
first add back 10% of any eligible investment taxed as a
federal deduction to its federal taxable income.
An income tax credit is available equal to 5% of increased
research expenditures over the base amount plus 5% of the
costs incurred for depreciable R&D property.
However, sixteen states were able to address, to some degree, questions regarding the
impact of the tax incentive in terms of number of companies that receive the incentive
and the resulting tax expenditure. These impacts are shown in Table USS2. Because
of variations in the way in which states reported their data, direct comparisons
between states are not possible.
Table USS2. Tax Incentive Impact35
Approximate Annual
Number of Companies
State
using Tax Incentive
36
1.5
Arkansas
California
3,500
Illinois
Not Available
Iowa
100
Louisiana
0
Minnesota
300
38
18
Missouri
Montana
10
New Hampshire
Not Available
New Jersey
100
Ohio
Not Available
Oregon
45
Vermont
0
Virginia
Not Available
Washington
140
35
Approximate Annual
Tax Expenditure in Million US$
0.0165
120
16.537
2
0
11
1.24
N/A
0.96839
3.140
19.2
1.3
0
11.841
30.6 made up by 11.1 M Credits
& 19.5 M Exemptions.
Note the differences in methodology mean that these figures are not directly comparable.
Annualised total based on data for 1987-1995.
37
Based on a sample of income tax returns for the 1993 tax year
38
Annualised total based on data reported for 1994 and 1995
39
Annualised total based on data for the first half of 1995, the year in which the incentive was repealed
40
Partial year total for the initial year of the scheme: 1994
41
Estimate for FY 1997 as calculated by the Virginia Department of Revenue, derived by multiplying
the total annual industrial expenditures on tangible personal property used directly in research and
development, estimated from federal and state data sources, by the effective Virginia sales and use tax
rate
36
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Wisconsin
400
$20,000,000
Schemes with a major EMPLOYMENT Aspects
Only a few schemes had employment creation as a stated objective. These included
Delaware, Florida, Mississippi, Nebraska and Vermont. The Delaware scheme seems
trivial (0.25% effective subsidiy rate). Florida has an attractive scheme of zero
(company) taxes for R&D personnel. However, Table 2 shows that the reported zero
cost of the scheme in Vermont suggest it is sub-critical. Mississippi has an interesting
“regional league table” approach to balancing job creation, but again the total offered
is 10,000$ over 5 years (ie something like 1.5-2% of medial salary for an R&D post).
Nebraska and New York schemes are also employment creation oriented but represent
no more than 1.5-2.5% of a gross salary (so even less of total employment costs) for
1-2 years.
The fact that the list of states offering job-based subsidies are not in the primary
league of US R&D states suggests they are not of major relevance.
Some US States Indirect Tax Incentives & Employment Incentives Policy
Environment
This section describes some specific US State R&D Tax incentives with a direct
employment element, and its detailed policy context within that state:
ARKANSAS
Overview of Arkansas: Arkansas has an effective corporate income tax rate of 5.4%
and a personal income tax rate of 7%. The state promotes small business capital
formation by offering a capital gain tax cut of 50% for qualified stock held 5 years
and increasing tax reductions so that the proceeds from stock sold after being held for
10 years is not taxable. Arkansas offers a 15 year Net Operating Loss (NOL) tax loss
carry forward provision for biomedical companies. Arkansas exempts most
biotechnology purchases of machinery and equipment from the states sales and use
tax. Arkansas’ investment tax credit offers biotechnology companies a 5% income tax
credit on the costs of construction, expansion, renovation or purchase, of
biotechnology facilities and equipment, exclusive of undeveloped land. The
Biotechnology Development and Training Act of 1997, provides the following
incentives for companies engaged in the biotechnology business in Arkansas:
20% tax credit on qualified R&D expenses; 30% tax credit on the cost of cooperative
research with state universities; 30% tax credit on the cost of training necessary to
prepare employees to work in biotech (in facility or at an accredited Arkansas higher
education institution); tax credits to offset first $50,000 of tax liability, and no more
than 50% of the remaining tax liability. Any unused credit may be carry forward 9
years.
State Programs:
Arkansas Research Alliance: This organization is an alliance of research scientists to
enhance opportunities for collaborative research. The alliance publishes a directory
and maintains a database which serves as a technical information center on
biotechnology development in the state.
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Technology Development: The Arkansas Science and Technology Authority is a state
agency with a variety of funded programs to support technology development,
including a competitive basic research grant program and applied research grant
program which provides matching funds for industry-sponsored projects, an R&D tax
credit, technology transfer assistance grants, and a seed capital investment program to
assist in initial capitalization of Arkansas-based companies.
Biotechnology Center: The University of Arkansas (UA) for Medical Sciences
Biomedical Biotechnology Center develops an infrastructure and support for
biotechnology and affiliated institutions in the fields of agriculture and medicine. The
Center also provides staff support for the Arkansas Biotechnology Association.
Incubators/Shared Research Manufacturing Facilities: Genesis, the business incubator
at the University of Arkansas, Fayetteville, was named Incubator of the Year in 1993
by the National Incubation Association. Located in the UA engineering experiment
station, Genesis is constructing an addition to its facility to meet demand. Additional
incubator space is available on the medical sciences campus in Little Rock. Two
research parks and a technology incubator are under development.
Capital Access Funds: There are a number of state-supported financing and economic
development tools offered through the Arkansas Development Finance Authority, the
Arkansas Capital Corporation, and the Arkansas Industrial Development Commission
that can be utilized by biotechnology companies for R&D and manufacturing
facilities and operations. The Arkansas Science & Technology Authority has funds to
leverage private sector investment in early-stage companies.
IOWA
Overview of Iowa: Iowa’s corporate tax is based only on the percentage of total sales
income generated from within the state. Iowa corporate income tax may be reduced or
eliminated by the New Jobs Tax Credit, and by fifty percent deductibility of federal
taxes. Iowa has no sales tax on manufacturing/production machinery & equipment
and computers (used in processing) purchases. The state has no personal property tax
and the lowest unemployment insurance rate in the nation.
State Programs:
R&D and Investment Tax Credits: Iowa offers a 6.5% tax credit for increasing R&D
expenditures; however, because Iowa has created a special incentive program for
capital intensive “targeted industries,” such as biotechnology, under this program, the
New Jobs & Income Program (NJIP), Iowa offers biotechnology companies a 13%
refundable R&D tax credit. The state tax credit follows federal guidelines and
definitions. Iowa offers an investment tax credit of up to 10% of the total project cost.
Employment Training: Iowa is known to have a highly educated workforce. Iowa is
home to numerous excellent education institutions and offers various technical
training incentives. Iowa has a New Jobs Tax Credit for new jobs created. Iowa’s job
training program combines state and federal training programs provides for screening,
skills assessment and testing. Travel for new employees to train anywhere in the
world, on-the-job training reimbursement, customized training programs to meet
specific needs, at no additional cost to the company. Biotechnology firms qualify for
double the job training funds.
Technology Transfer: Iowa assists biotechnology firms with technology transfer
through the Wallace Technology Transfer Council.
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Product Development: Iowa Products Development Corp. assist biotechnology and
seven other targeted industries for economic development.
MAINE
Maine Science and Technology Foundation: MSTF works to increase industry access
to science and technology resources, expand research and development funds
(matching grants), and provide technical assistance and help with technology transfer.
MSTF funds Centers for Innovation in Biomedical Technology (CIBT), Aquaculture
and Technology Transfer.
Investment Tax Incentive: Maine offers a partial reimbursement for personal property
taxes paid for business machinery and equipment.
R&D Tax Credit: Maine offers a research and development tax credit for the 100% of
the first $25,000 of tax due, and follows federal guidelines and definitions.
Task Force: The State has established a Task Force on Economic Development Tax
incentives. The task force is charged with making recommendations to change laws,
rules, regulations or ordinances necessary to ensure that the state's economic
development tax incentive policies and programs maximize creation and retention of
quality jobs and compliment the State's long-term economic development plan.
Venture Capital Funding: Maine has several venture funds which make money
available to local biotechnology firms. The Maine Economic Development Venture
Capital Revolving Investment Fund, is a venture capital tax credit program that
provides increases in available tax credits and makes equity investments available to
small and start-up businesses (gross sales of $2 million or less). The Maine
Technology Investment Fund within Maine’s Science and Technology Foundation has
an $800,000 fund used to provide matching funds for federal grants and to encourage
direct investment in science and technology for targeted industries. The foundation
directs funds to commercial activities with high growth potential including
biotechnology, environmental technology, and biomedicine & biomaterial. A new
$6.5 million small business fund was established by to help biotechnology and other
high technology firms.
Employee Training: Maine promotes modernization and job training for small and
medium-sized businesses by offering a tax credit for taxpayers with fewer than 150
employees that upgrade equipment and conduct employee training.
NORTH CAROLINA
Overview of North Carolina: North Carolina has a 4% state and 2% local sales tax
rate. The state's sales tax is reduced to 1% or less for R&D uses and exempted for
manufacturing equipment purchases. North Carolina's personal income tax rate is
7.75%. The state offers a 25% investment tax credit (maximum of $75,000) for
investments in North Carolina. North Carolina has an R&D tax and a five year NOL
carry forward period.
State Programs:
Biotechnology Center: The North Carolina Biotechnology Center, created in 1981,
receives an annual appropriation from the NC General Assembly. A technology
development center, rather than a scientific center, it has awarded more than $40
million in grants and financial assistance to start-up companies and research
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institutions since 1984. The center helps arrange collaborations with local universities,
provides access to venture capitalists and government officials, and provides training
for biotechnology employees. The Center also has committed resources to
biotechnology education. Specific programs include:
- University-Company Collaborative Research Funding Assistance
- Economic Development Finance Program for companies
- SBIR Matching Fund Program
- Commercial Biotechnology Events Grants
- Patent Funding Assistance Program
Incubator: The North Carolina Technological Development Authority is developing a
6,000 sq.m. laboratory complex as an incubator for growing biotechnology
companies. Another incubator is being planned for development in Greenville, NC
close to the East Carolina University School of Medicine, and in Winston-Salem near
Wake Forest University/Bowman Gray School of Medicine.
Financial Incentives: North Carolina offers low cost financing for renovation and
facility upgrade projects.
Tax Incentives: North Carolina offers an Investment Tax Credit of 7% for qualified
purchases of machinery and equipment and a 5% credit for R&D expenditures made
in North Carolina. In addition, North Carolina has a Business Property Tax Credit of
4.5% for purchases of up to $100,000 in business property per year.
Job Creation & Training: North Carolina offers a worker training tax credit.
Available annually, companies receive a $500 to $1,000 credit for each employee
trained. For each new job created, North Carolina gives a tax credit ranging from
$500 to $12,500.
OHIO
Overview of Ohio: Ohio has a 8.9% corporate and 7.5% individual tax rate. The
maximum state and local sales tax rate is 7% but Ohio has a sales tax credit for R&D
manufacturing expenditures. The state allows a 15 year carry forward for losses.
Tax credits: The Ohio Job Creation Tax Credit benefits businesses that are expanding
and/or locating in Ohio. A portion of the company’s corporate franchise’s tax, which
is paid for new full-time employees, is returned to the business (up to 60-70% for up
to ten years) based on their capital investment and the quality and number of jobs
created.
Ohio’s 166 Direct Loan Program: The program offers 4 - 5% loans for the purchase of
fixed assets such as land, buildings, machinery, and equipment. 166 Direct Loan
Program can finance up to 30% of a project’s fixed asset investment.
Enterprise Bond: The Ohio Enterprise Bond Fund provides long term, fixed rate
financing for the acquisition, renovation, or construction of depreciable assets. These
funds are offered at rates usually below the prime lending rate. Recently, one
biotechnology firm was offered low cost state and local financing to cover 90% of the
cost of a $30 million facility, plus additional incentives, including tax breaks.
Technical Assistance: Ohio has a technical assistance coordinator available to assist
companies access funding through the federal SBIR program.
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Job Training/Recruitment: Ohio Industrial Training Program (OITP) provides
assistance through competitive grant awards for up to one-half of all eligible training
costs. The Ohio Bureau of Employment Services (OBES) provides labor market data,
and work force recruitment and screening of potential employees. An experienced
labor specialist is assigned to a company to assist in work force recruitment.
Technology Investment Tax Credit: Ohio’s Technology Investment Tax Credit
program offers a variety of benefits to Ohio taxpayers who invest in small, research
and development and technology-oriented firms. Through this innovative program,
Ohio investors may reduce their state taxes by up to 25% of the amount they invest in
qualified, technology-based Ohio companies. The program’s maximum credit is
$37,500 per investment.
Centers of Excellence: Ohio has three Centers with some biotechnology industry
focus, with a collective budget of $9 million. Center activities include basic research,
training, technology transfer, economic development, seed funding and education.
The Edison BioTechnology Center offers unsecured funding of up to $100,000 per
investment.
Incubators: There are three incubator facilities in Ohio that provide capabilities to the
start-up companies in the biotech field: Cleveland, BioEnterprise; Columbus,
Business Technology Center; and Cincinnati, BioStart.
Summary on US State Schemes
US Corporation tax is 35%, but state rates vary considerably from zero to 12%. State
income taxes are fully deductible from taxed income for federal tax assessment.
Broadly, one is looking at a federal 20% tax credit against a taxable level of 35% 42% overall, with additional state credits of zero % to at most 10% depending on
location.
Evolution of the R&D Credits Scheme
It does seem that recently (since 1980's) the overall effect of these schemes has not
been as positive as initially imagined, because of the "base constraint" mainly. The
current R&D Tax Credit Act expired in June 1995, was renewed for two years and
because of political problems was allowed to lapse recently (May 98); and the
possible long term replacement has not yet been agreed, but target a possible
permanent statute that enshrines the R&D Tax Credit.
The "foreign tax excess credits" further complicate the picture - US Corporations are
assessed on world wide income but after deduction of locally paid taxes only. The law
encourages companies to seek efficient cost allocation formulas for R&D in their
international sphere of activity. Local R&D may be best billed to foreign subsidiaries
and then used to minimise US taxes. This interaction is a little more difficult to
evaluate but it is finite (Hines "On the sensitivity of R&D to delicate tax changes :
The case of US Multinationals, 1992, International taxation, Chicago University
Press).
Due to frequent "tinkering" with the allowances, a historic table of rates and
allowances can be drawn up which enable economic conclusions to be drawn. Table
U.1 shows the history of the US Tax Credit system from 1981 to 1991, and the
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conclusions following have been partially validated against this net price data and the
changes in the system.
Table U1: Tax Treatment Changes for R&D Expenditure in the USA over time
From
To
Credit
Rate
Corp
Tax %
Base
Def
Qualified
Expenditure
Art
174
Foreign
Allocat.
07/81
12/85
25%
46%
A
C
0
100/0
01/86
12/86
20%
34%
A
D
0
100/0
01/87
12/87
20%
34%
A
D
0
50/50
01/88
04/88
20%
34%
A
D
0
64/36
05/88
12/88
20%
34%
A
D
0
30/70
01/89
12/89
20%
34%
A
D
subtr. 50%
64/36
01/90
12/91
20%
34%
B
D
subtr. 100%
64/36
Note E
Notes
A. Maximum of Previous three years average or 50% of the current fiscal year
B. The 1984-88 ratio of R&D to sales multiplied by the current sales (max ratio 0.16
or 0.03 for startups)
C. Excludes R&D outside the US, humanities, social sciences and third party R&D
contract research
D. Narrowed definition to technological research and also excluded leasing costs.
E. First figure - the amount that can be deducted against domestic income, second
figure - the amount that can be allocated normally.
R&D by US Multinationals
Recent evidence confirms that the levels of R&D spend in companies is sensitive to
its after tax cost. The changes in the Tax Act of 1986 suggested that US
multinationals may increase the amount of R&D they undertake outside the USA
where fiscal incentives were greater. In fact it stayed almost constant at 10% (No
Place like Home : Tax Incentives and the Location of R&D by Multinational,
J R Hines, JFK School of Government, Harvard, NBER WP 4574, December 1993).
This is because of a counterbalance tax incentive which is geared towards R&D
performed in the USA and then used outside it, by firms with surplus foreign tax
credits. Therefore overall the 1986 Act increased the cost of R&D for indigenous US
firms while decreasing it for US based multi-nationals with excess foreign tax credits.
Overall these virtually balanced out and made that element neutral in terms of total
R&D undertaken overseas. This has had one long term effect so far - the revenue
impact of foreign sourced royalty payments (which receives generous tax treatment
when repatriated) is 5 times greater than that of the R&E Tax Credit, due to the
amount of R&D undertaken in the US and exploited overseas.
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How The US Research and Development Tax Credit REALLY Works
In 1981, Congress created the research and experimentation tax credit (better known
as the Research and Development Credit or "R&D Credit") to encourage business to
increase research and development, as opposed to rewarding firms for doing research
they would have performed absent the tax incentive.
To accomplish this goal, Congress determined that the research and development
credit should be an incremental as opposed to flat tax credit. A flat credit is calculated
by multiplying the rate times every dollar expended in the current year. Using this
approach, every research dollar the taxpayer incurs in the current year would be
eligible for the credit. In contrast, an incremental credit is designed to capture
increases above a base period, thereby rewarding firms that increase their research
year after year.
Firms with flat or declining R&D expenditures may not be eligible to receive an
incremental R&D credit, but would benefit under a flat credit.
The Basic Computation
The incremental R&D tax credit, authorized in section 41 of the Internal Revenue
Code, allows businesses conducting R&D to claim a credit against federal income tax.
The amount of the credit is determined as follows:
Credit Amount = 20% x (Qualified Research Expenses in the current year - a Base
Amount).
The Base Amount is a term of art and is designed to approximate the amount of
research a firm would have conducted without the credit on the theory that the
incremental credit induces and rewards R&D on the margin.
The Base Amount is computed as follows: Base Amount = Fixed Base Percentage x
average gross sales revenues in the last 4 years.
The Fixed Base Percentage is a snapshot of all qualified research expenses over the
1984 to 1988 period expressed as a percentage of all of the aggregate gross receipts
over the same period.
The Fixed Base Percentage is multiplied by the average gross receipts over the last
four years before it is taken.
In constructing the base amount in this way in 1989, Congress sought to achieve
several objectives. Congress found that businesses often determine their research
budgets as a fixed percentage of gross sales. Tying the base amount to gross receipts
was a change from the prior base amount rule enacted in 1981 which keyed off the
prior three years R&D expenses only. In this way Congress reassured that taxpayers
are rewarded for research and development expenses in excess of amounts they would
have spent in any event. By using gross receipts, firms in fast growing sectors of the
economy are not unduly rewarded if their percentage of R&D expenses to gross
revenues does not increase. Likewise, firms in slow growth sectors would qualify for
the credit as long as R&D expenditures are commensurate with growth in gross
revenues.
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Limitations on Credit
The Fixed Base Percentage is "capped" at 16% for revenue purposes even if the
percentage of R&D spending to sales was higher during this period. The base years
selected were arbitrary and random, and became part of the law only because they
preceded 1989, the year the credit calculation was revised.
The 50% rule limits the Base Amount by stating that the Base Amount can never be
less than 50% of the current year’s qualified expenses. Congress adopted this rule to
reduce the overall revenue loss to the government. The 50% rule can cause great
disparities between the firms subject to the 50% rule and those that are not.
Start Up Firms
Until the R&D Credit was revised in 1993, companies without at least three tax years
with both qualified R&D outlays and sales revenues during the 1984 - 1988 base
period could not claim credits. In recognition of this problem and the importance of
small firms to the innovation process, Congress changed the rules for start up
companies.
Under the 1993 and 1996 amendments, "start- up" firms are assigned a fixed base
percentage of 3% for the first five taxable years beginning after 1993: base
percentages derived from their individual experiences were to be phased in over the
subsequent five years.
Limitations on Qualified Research Expenses
The definition of qualified expenses in Section 41 encompasses only wages and
salaries of researchers, their direct supervisors and support staff, directly related
supplies and computer time-sharing. Outlays such as those for utilities, rents, leasing
fees, travel, insurance, taxes and administrative overhead, not to mention durable
equipment and structures, are excluded. Even employee compensation other than
wages (for instance, non-wage fringe benefits) is excluded.
Paralleling these limitations on qualified expenses for in-house R&D only 65% of
amounts paid to others for eligible research could be counted toward the credit; 75%
in the case of qualified collaborative research. These limitations, intended to reduce
revenue loss, facilitate compliance and monitoring and reduce revenue loss, as well as
reduce the significance of the credit further and cause large disparities among credits
for different types of projects.
R&D Credit Carry Forwards and Carry Backs - Hidden Assets For Young
Firms
New start- up firms may not currently be able to enjoy the benefits of the R&D credit
but an unused R&D credit is a valuable asset nonetheless. If a firm cannot use the
R&D credit because they have no taxable income in the current year, they can carry
back the credit three years and carry forward the credit up to 15 years. In essence, the
credit is a hidden asset that can be unlocked in the future when the company becomes
profitable or is sold. Venture capitalists and lenders understand the importance of
these hidden assets and may grant more favorable terms if they know a credit exists
and can be deployed in the near future.
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When A 20% R&D Credit Is Really Much Less
Beginning in 1990, any credit taken must be subtracted from the amount of R&D
outlays that can be "expensed", that is taken as a deduction in the first year. This in
effect adds the amount of the credit "taken" to taxable income as it could not offset
income. Tax credits always offset taxes paid. Since most corporations pay at a 35%
income tax rate, the effective rate of the R&D credit is reduced from the statutory rate
of 20% to a maximum of only 13%. This is calculated by multiplying 35% times 20%
to yield 7% - the portion of the credit lost by this change (See, at page 3, CRS Report
to Congress, "Research and Experimentation Tax Credit: Who Got How Much?
Evaluating Possible Changes", William Cox, June 4, 1996).
The 50% Rule further reduces the effective rate of the credit. Under the 50% Rule,
when qualified research expenses reach double the base amount, any further increase
raises the Base Amount by one half of the increase generated by tax credits. As a
result, the 50% Rule can cut the effective rate of the credit for additional R&D
expenses from 13% to 6.5% for two categories of firms.
The first are those whose ratio of R&D expenses to sales has more than doubled since
the base period, 1984 to 1988.
The second are firms with a Fixed Base Percentage of more than twice the 16%
maximum; that is, during the 1984 to 1988 base period their ratio of R&D expenses to
sales was 32% or more.
The primary motivation for Congress instituting both the 50% Rule and the 16% cap
on the Fixed Base Percentage was to reduce the revenue loss. In the process they
created serious disparities between fast growing firms and those that spend a high
percentage of gross sales on R&D, and firms with slower rates of growth in R&D.
Why the R&D Credit Helps Small Start-Up Businesses
Small start-up businesses may not be profitable for many years. If they conduct
qualified research, they may not be able to use all or part of the R&D credit due to tax
liability limitations.¹ As such, any of the unused R&D credit can be carried back to
the three preceding tax years, beginning with the earliest year.
Should there still be any unused R&D credit, the entity may carry it forward to each
of the fifteen years after the year of credit. In this way, companies can "bank unused"
credits for use in future years where they may recognize a profit.
Should an entity be unable to utilize the three year carry back or fifteen year carry
forward due to death, cessation of business or expiration of the fifteen years, the entity
may take the unused business credits as a deduction in the first year following any of
these events.
Financial Statements
Reporting of the unused credit by the entity at its year end is accomplished by a
footnote to the financial statements. The anticipated credit in the succeeding tax years
should the entity have sufficient income to utilize the credit would be incorporated in
the "Deferred Tax Footnote".
There is no entry to be made to either the balance sheet or income statement to reflect
the unused credit, footnote disclosure is adequate.
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The credit may be referred to as an "asset" to the entity due to it being a direct offset
to future tax liabilities and when the usage of the credit occurs, the entity need not
outlay cash to pay the liability.
An "Unused" R&D Credit Has Value
Banks and venture capital firms take the amount of unused R&D credit into
consideration when a small company applies for a loan, equity financing, or if it goes
public. In many cases, the R&D credit can be used by an acquiror corporation in the
event that a small company is sold or merges with another company.
US R&D Credit - Criticism and Rebuttal
There has been much debate about the scheme every time it is renewed. The
following are stock answers to the major criticisms of the R&D credit:
1) The R&D credit does not work as intended.
The R&D credit was enacted to encourage firms to conduct additional research and
development. While it may be difficult to estimate the return to society in general,
recent econometric studies generally indicate that, at the very least, the R&D credit
produces a dollar of increase for every dollar spent (OTA Study). Other studies, such
as the KPMG study, show that a dollar expended stimulates two dollars of additional
R&D in the long term. It is logical to expect that the private sector response would be
improved if the credit were made permanent, and would be greater if the credit had
not suffered a one year lapse from July 1, 1995 to June 30, 1996. Prior to the lapse,
firms could count on the credit being extended retroactively. Many companies kept
the R&D credit in their research plans after the expiration date on advice from tax
advisors that an extension would be retroactive, thereby preserving corporate funding
for high risk projects. The lapse will cause all taxpayers to remove the credit from
their corporate research plans after the credit expires on May 31, 1997, and result in
less research overall.
2) The R& D credit costs too much.
The most recent data available shows that total U.S. private sector R&D spending was
over $78 billion in 1991, which was about a 3% increase and consistent with GDP
growth. In 1992 by contrast, U.S. companies received around $1.5 B in R&D credits.
This is equal to only 1% of the total income taxes paid by corporations in that year.
Given the high multiplier effect of R&D expenditures on the economy and the
resultant increase in economic growth and job creation, the expenditures for the R&D
credit are a good investment- one that pays long term solid dividends.
3) Only a few very large companies benefit from the R&D credit and it is not used by
smaller businesses.
While it is true that the bulk of R&D spending is performed by large firms, smaller
companies are growing at a faster rate. The fraction of total U.S. R&D performed by
companies with less than 1000 employees more than doubled over the 1980 to 1991
period (KPMG Study). However, over 94% of the 10,928 firms earning the R&D
credit in 1991 had assets of less than $100 million, with over 74% having assets of
less than $10 million. Many small start- up firms are in a tax loss position.
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Nonetheless an earned but unused R&D tax credit is an asset that has value that can
be recognized by investors, banks and venture capitalists. The trend toward greater
utilization of the R&D credit by smaller companies should continue and accelerate as
new companies emerge in key growth markets such as biopharmaceutical research,
Internet, communications, and other high technology endeavors.
4) Current law is ineffective because its application can be arbitrary and hard to
predict.
While one may argue that many features of the current law inhibit the full utilization
of the credit, much of the arbitrariness is related to an individual firm’s prospects in
the marketplace, in particular their profitability in any given year. The base year
calculation, the 50% limit rule and 16% cap on the fixed base percentage were all
enacted by Congress as part of an integrated political compromise driven in part by
revenue loss considerations. As such they can be changed by Congress if there is a
need to correct a patently arbitrary and capricious result. The "on again, off again"
status of the credit over the last 16 years and the one year lapse of the credit in 19951996 are the most damaging factors as they inhibit the taxpayers ability to plan long
term, high risk research projects which may yield the next major technology
breakthrough or medical discovery.
5) The R&D credit rewards profitable companies for doing what they would be doing
anyway. It amounts to corporate welfare.
Since its inception, the R&D credit has been designed to encourage and reward
incremental research expenditures. In other words, in order for a company to be in a
position to benefit from the credit, it must be engaged in qualified research activities
that exceed its historical base of research. In contrast, a flat credit, which some have
proposed in recent years, would apply the rate across each dollar of qualified research
in a given year. The current incremental nature of the credit is critical to maintaining
the incentive for U.S. companies to build each year on their previous research
expenditures.
6) Base Period Issues
The Ways and Means Oversight Subcommittee held hearings on the effectiveness of
the R&D credit on May 10, 1995. One of the issues discussed during the hearing was
the base period. As a result of the Subcommittee hearings, Ways & Means marked up
an extension of the R&D credit which included an alternative modified flat credit.
Under the alternative credit regime, a credit rate of 1.65 percent applies to the extent
that a taxpayer’s current-year research expenses exceed a base amount (computed by
using a fixed-base percentage of 1 percent) but do not exceed an alternative base
amount (computed by using a fixed-base percentage of 1.5 percent). The base amount
equals 1 percent of the taxpayer’s average gross receipts for the four preceding years.
A credit rate of 2.2 percent applies to the extent that a taxpayer’s current-year
research expenses exceed a base amount computed by using a fixed-base percentage
of 1.5 percent but do not exceed a base amount computed by using a fixed-base
percentage of 2 percent. A credit rate of 2.75 percent applies to the extent that a
taxpayer’s current-year research expenses exceed a base amount computed by using a
fixed-base percentage of 2 percent.
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A Brief Legislative History of the US R&D Tax Credit
The R&D tax credit was first enacted as a temporary provision in the Economic
Recovery Tax Act of 1981. It was intended to give U.S.-based firms a robust
incentive to increase their spending on R&D, a critical element in long-term
productivity growth. Initially, the credit was equal to 25% of the excess of qualified
research expenditures in a given tax year over average qualified research expenses in
the three previous tax years. This base amount had to equal 50% or more of a
taxpayer’s qualified research expenditures. Shortly after the credit took effect it
became clear to many analysts that its design contained a serious flaw: over time, the
credit’s efficacy would wane because the more a firm spends on R&D in a given year,
the harder it will be for the firm to receive the credit in future years.
Congress made the first significant changes in the credit when it passed the Tax
Reform Act of 1986. The Act extended the credit through December 31, 1988. In
addition, it modified the credit in three ways. First, the credit rate was lowered to
20%. Second, the definition of qualified research expenses was narrowed so that it
only covered activities directed at generating new technical information that could be
useful in developing new commercial products or processes. And third, a separate
credit was established for basic research conducted by universities under contract with
taxpayers. These changes by and large reflected the general thrust of the Act, which
was to curtail or eliminate existing tax benefits and lower statutory income tax rates.
The credit was further altered by the Technical and Miscellaneous Revenue Act of
1988 (TAMRA). More specifically, the Act extended the credit through December 31,
1989. It also reduced the tax savings a taxpayer can obtain from the R&E credit by
decreasing the deduction allowed under Section 174 for qualified research expenses
by 50% of the R&D tax credit claimed in the same year. Section 174 permits
taxpayers to expense (or deduct) the full cost of these expenses in the year in which
they are incurred. Before TAMRA, a firm could simultaneously reap the full tax
benefits of expensing and the R&D credit.
The Omnibus Budget Reconciliation Act of 1989 (OBRA 89) made additional
modifications in the credit. The most consequential involved altering the method for
calculating a taxpayer’s base amount. Under previous law, the credit applied only to
increases in a firm’s R&D spending over average R&D spending during the previous
three years; this average was the base amount. OBRA 89 substituted a "fixed-base
percentage" for this moving average. This percentage was the ratio of a firm’s
research expenses to its gross income in three of the years from 1984 to 1988. The
base amount, then, was determined by multiplying a firm’s average gross income in
the previous four years by its fixed-based percentage. Start-up firms, or firms that had
no income or qualified R&E expenses in that period, were assigned a fixed-base
percentage of 0.03. These changes in the base amount were intended to enhance the
effectiveness of the credit by severing the link between current R&D spending and
future credits. OBRA 89 also effectively extended the credit for 9 months by prorating
qualified research expenses incurred before January 1, 1991. It also made research
related to a firm’s prospective lines of business eligible for the credit; before the
enactment of OBRA 89, the credit applied only to research related to a firm’s current
lines of business. Lastly, the Act increased the reduction in the amount of qualified
research expenses that could be expensed from 50% of the R&D credit claimed to
100%.
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The Omnibus Budget Reconciliation Act of 1990 extended the R&D credit through
December 31, 1991, and repealed the special rule enacted in OBRA 89 to prorate
qualified research expenditures made before January 1, 1991.
The credit was further extended by the Tax Extension Act of 1991, this time through
June 30, 1992. While the Congress passed two major tax bills in 1992 that would have
further extended the credit, President Bush vetoed both for reasons not directly related
to the R&D credit. As a result, the credit lay dormant from July 1, 1992 until the
Omnibus Budget Reconciliation Act of 1993 (OBRA 93) went into effect. OBRA 93
retroactively extended the R&E credit for 3 years: from July 1, 1992 through June 30,
1995. It also revised the method for calculating the base amount of the credit for startup firms. The credit expired on June 30, 1995.
In late 1996, the Small Business Protection Act of 1996, contained a provision that
extended the R&D tax credit for the period July 1996, through June 1997. For the first
time in its history, the credit was not extended retroactively - there was a gap in the
law between July 1, 1995 through July 1,1996. Part of the reason for the gap was that
the Administration did not pay for the R&D credit in its budget in 1996 and 1997.
The Act also expanded the definition of "start-up firms" to include any firm if the first
taxable year in which such firm had both gross receipts and qualified research
expenses began after 1983. The Act also allows taxpayers to elect an alternative
incremental research credit regime.
Summary
Some conclusions for the USA:

There is a definite Tax Price Elasticity > 1. (this is across 1,000 largest US
manufacturing companies)

Revenue cost ca. 1 B$/year.

Revenue impact only 20% of foreign based royalty payments from R&D exploited
outside of USA

Incremental R&D comes to ca. 2 B$/year.

Long term response more stable than short term as credits appear to stabilise.

Relabelling of development or non-eligible work as R&D; it does occur but it is
small.

Every firm is different, a global system is difficult. For a "normal" firm with
incremental design, the long term effect is nearer 5% than the 25% subsidy rates
(same experience as reported for analysis of the Japanese system).

Subsidy via incremental tax credits encourage creative baseline accounting.

credit interacted with other taxes, usually beneficially.

the schemes proposed are frequently tinkered with and produce a climate of
instability which is not ideal

the administrations of the late 80's and 90's do not agree on a preferred method for
a stable long term R&D Tax Incentive scheme
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
Social cost/benefit factors are very difficult to define, but across a 1000
companies in ca. 10 years is of the order of a 2 fold multiplier.
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