Making the most of R&D tax incentives

Making the most of R&D tax incentives

Our latest edition of frontiers in tax examines the new trends and developments that are transforming the financial services sector. In this issue, we take a closer look at the developments around R&D tax incentives.

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Many governments in the ASPAC region are keen to promote research and development as a route to innovation and competitiveness, and are willing to offer tangible tax benefits to support this in the right circumstances. Many multinational corporations are at least generally aware of the possibilities. But taking full advantage of the opportunity requires a full understanding of the structure of the various incentives; it also requires thorough attention to definition, demonstration and audit.

Innovation and technology are crucial to enhancing corporate competiveness; and boosting a country’s technology and innovation capability through R&D is a key policy contributor to economic growth. Many countries in the Asia Pacific region offer tax incentives for R&D as a method to encourage local and foreign direct investment in technology.1 But the details vary from one jurisdiction to another; and it can be difficult to assess the potential tax savings in each. Some key examples include:

• China offers significant tax incentives  for R&D. It provides a 150 percent R&D Super Deduction which equates to a net saving of 12.5 percent for eligible expenses. It also offers High and Advanced Technology ‘Status’ to specific companies that meet a strict set of criteria, and if eligible, the corporate tax rate is reduced from 25 percent down to 15 percent for eligible companies. Given the size and rate of growth of the Chinese economy, this is a major factor in the regional picture (see panel).

• Australia offers an R&D tax incentive or credit of 45 percent for small companies and 40 percent for large companies. In after tax terms, this translates to net tax savings of 15 percent and 10 percent respectively. In addition, if a small company has tax losses, it can ‘cash out’ the tax deduction and receive a 45 percent cash refund.

• Malaysia offers a double deduction of 200 percent for eligible R&D expenditure, which translates to a net saving of 25 percent. This is one of the highest R&D benefits in the region, although it is important to note that companies must pre-register their intention to claim the R&D benefit and they will be thoroughly audited before receiving any potential benefit. Malaysia also offers tax exemption tax status to approved operational headquarters.

• Singapore has managed to attract significant foreign direct investment over the past decade and has transformed itself into a financial and regional services hub. It offers a 400 percent R&D incentive on the first SGD$400,000 ($308,000) and a 150 percent benefit thereafter. It also offers enhanced benefits to small and medium sized enterprises.

Tax is not the only decisive issue in a company’s decision on the structure and location of its R&D activities. Other factors such as access to skilled staff, the level of wages and salaries and the broad context of industrial development incentives are at least as important. However, tax considerations are significant determinants of cost and hence return on investment, and deserve greater attention than they may receive. In addition, the tax treatment of technology transfers, transfer pricing and other related local tax issues, is a vital consideration. It is important that a company evaluate all the R&D incentives available, and the impact of all R&D costs on other tax benefits in countries around the ASPAC region, before coming to a decision on where to locate R&D programs.

In this context, a number of key issues should be considered:

• The net cost of R&D: The relative costs of performing R&D in one country versus another, net of respective available R&D incentives, are important in evaluating where and under what circumstances R&D activities should take place.

• Intellectual Property (IP): In planning how IP will be created, it is important to consider the tax consequences, the arrangements under which it is created, where it will be used, how it will be paid for and where it will be owned. Entities undertaking R&D in the region should be aware that tax authorities in ASPAC countries are focusing on the transfer pricing issues arising from the development, ownership and compensation for use of IP.

• Transfer pricing: Transfer pricing provisions in ASPAC countries are complex. They apply to the economic, legal and tax aspects of transfers of technology, and products or services based on technology, to related entities. These provisions may encourage companies to locate some of their R&D activities in one country rather than another. India, Australia, China, and Japan have all recently seen an increase in transfer pricing audits, and China and Singapore’s tax authorities have recently signalled that they intend to step up their transferpricing compliance and field audit work.

• Short-term economic stimulus measures: Short term measures implemented by governments as economic stimulus packages in response to the global financial issues, such as accelerated deduction programs for investment in tangible depreciable assets, are worth taking into account, as these may top up existing benefits delivered through R&D incentive schemes.

• Navigating through these issues, and successfully utilizing the opportunities on offer, is not primarily – or even mainly – a task solely for tax specialists. A company’s engineers and scientists are critical to successfully determining whether activities should qualify for relief, and demonstrating that effectively to fiscal authorities. This requires a detailed understanding of the innovative and technically challenging aspects of a company’s projects, combined with detailed awareness of R&D programs in question, their intellectual novelty and their potential contribution to innovation and growth. Among the principal issues to consider are:

• Which activities are eligible R&D?

• How do you calculate eligible R&D expenditure?

• What is the claim process and how long does it take?

• What will happen if your claim is audited and how can the audit be defended to enhance outcomes?

• What records are needed to substantiate a claim?

Engineers, scientists, technologists and software specialists should be part of this process. Sustaining eligibility over a period requires a convincing audit program to demonstrate technical progress. Tax specialists are of course needed to understand the precise operation of schemes and to interact with the relevant authorities. But they need to operate as part of an integrated team.

The opportunities exist. Many companies could be doing more to take advantage of them.

R&D incentives in China

China’s R&D spending has grown rapidly from RMB461.6 billion ($US75 billion) in 2008 to RMB1.19 trillion ($US192 billion) in 2013. In 2011, China surpassed Japan as the world’s second highest R&D spender in the world. This growth has been facilitated in part by government support for innovation in eight high-technology areas:

• electronic information technology

• bioengineering and new medical technology

• aeronautical and space technology

• new material technology

• high-tech service

• new energy and energy saving technology

• resource and environment technology; and

• high technology to transform traditional industries.

The Chinese government offers two broad tax incentive frameworks to underpin this support: the R&D Super Deduction and the High or New Technology Enterprise (HNTE) program.

R&D Super Deduction

The R&D Super Deduction program has been in place for over 10 years. It is available in all industry sectors, and offers:

• 150 percent tax deduction on qualifying R&D expenses incurred during the year. This generates a net saving of 12.5 percent.

The definition of eligible R&D expenses is very broad and can include improvements to products and technologies in many industry sectors such as financial services (usually software development), IT, logistics, retail, food/beverage, agribusiness, manufacturing, engineering and mining – as well as more typical R&D industries such as pharmaceuticals and automotive. However, many companies with operations in China are unaware of the scheme and fail to take advantage of it.

HNTE

Companies working in any of the eight supported high-tech industries are potentially eligible for HNTE status. Qualifying companies are allowed a reduced rate of corporation tax (15 percent as opposed to 25 percent) for a period of three consecutive years. However, the six eligibility criteria are difficult to meet, especially if the company is increasing sales.

Among the principal criteria are:

• the company must own the intellectual property for at least one core technology under development

• its R&D expenditure must be at least 3 percent of total turnover for large companies

• revenue from relevant technological products and services should exceed 60 percent of the total

• it must exceed minimum standards for the proportion of technologists, R&D specialists and graduates on the payroll.

Eligibility for HNTE status is determined by a weighted points system used to score the various criteria. A score higher than 70/100 is required: since the IP component itself scores 30/100, it is a key determinant.

Other schemes

The Chinese government also offers Advanced Technology Service Enterprise (ATSE) status to companies in specific service industries, again with reduced corporation tax benefits, and advantageous tax provisions for purchase of R&D equipment by qualified R&D companies.

Footnotes

For a detailed survey, see R&D Incentives: adding value across ASPAC, KPMG, 2015 edition

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