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Growing economies and businesses are fuelled by R&D spending. Making the most of various government R&D incentives, both locally and internationally, could help your business invest for its future.
Evidence shows that investment in research and development is a critical factor driving innovation and growth. This is true both on a macro level for governments and for individual businesses. In an era when the world is becoming more research-intensive, Grant Thornton’s latest International Business Report (IBR) shows that global net R&D investment expectations rose to 36% in the first half of 2019. This was up from 31% in the second half of 2018 and is the highest level on record.
This is part of a longer-term trend. For example, EU member states collectively spent €320 billion on R&D in 2017, which represents 2.07% of GDP. In 2007, that R&D intensity was just 1.77%[i]. Even these impressive numbers are dwarfed by other regions and countries; R&D intensity in South Korea was 4.22% in 2015 and in Japan 3.28% in the same year. The EU, through its Horizon 2020 programme, aims to increase its R&D intensity to 3% in 2020.
Innovative interventions driving R&D
Governments worldwide use a variety of tools to stimulate R&D in order to make their homegrown businesses more successful, as well as to attract foreign direct investment and international talent where specialist skills are scarce. Between 2000-13, government incentives accounted for nearly 70% of all R&D undertaken in OECD countries[1].
In recent years there has been an increase in government activity in several regions, with benefits often being seen rapidly. According to IBR data, in Singapore net R&D investment expectations jumped to 17%, the highest since Q2 2017, following the introduction of a new R&D incentive regime in which every dollar of qualifying expenditure on R&D received enhanced tax deductions of 250%. In Poland, which increased its tax deduction on R&D in 2018, net investment expectations were 44% in the first half of 2019, the highest on record. Italy and Greece also saw changes to patent box and innovation incentives and witnessed robust hikes in net R&D investment expectations. In Italy it rose to 44%, up from 30% in the second half of 2018, while in Greece it leapt to 48% from 16%.
Applying for grants takes time
Some jurisdictions don’t offer tax incentives for R&D - for example, Germany, Finland and Mexico only offer direct government funding through grants. However, the recent trend has been a shift away from direct funding towards use of tax relief. Indeed, even the German government is proposing a new R&D tax credit to come into force in 2020 that would allow businesses to claim a tax credit worth 25% of the wages and salaries paid to research staff[2].
Katy Rabindran, innovation tax director at Grant Thornton UK, says: “In the UK, grants are often sector focussed and used by the government to encourage further investment aligning with policy. However, while grants definitely have their place, for those in the right field, they’re often very competitive and the process of applying can be burdensome which puts many businesses off.”
It’s natural that countries differ in the way they approach grants, but some businesses find there isn’t always consistency within one country as to the availability of funds. What is available one year may not be offered the following year and it can be a challenge for businesses to find the right grants that apply to them.
Martha Oner, partner and national leader of the R&D and government incentives practice at Grant Thornton Canada, says businesses need to beware: “The challenge is that grants take time to apply; sometimes, the programme is overrun with applications and the money is no longer there. The grants are very diverse, and some are a bit obscure. It can be challenging for the average business to find the programmes and apply for them in time.”
Using the correct language to define projects can be very important for success in South Africa, explains Khanyisa Cingo-Ngandu, tax director at SNG Grant Thornton, since authorities rely heavily on the applications submitted. Her advice is to seek assistance from experienced advisors who have assisted clients with similar applications in the past.
R&D Tax relief is increasingly popular, but businesses crave certainty
For the most part, R&D tax relief programmes point investment where the market needs, rather than policymakers wish. Every country has its own definition of qualifying R&D and its own approach to policing tax relief, but, generally, they are less prescriptive than grants.
The UK increased its support for R&D relief significantly in 2013, when the government introduced a repayable tax credit scheme for larger companies, where one had previously only existed for smaller enterprises. Rabindran explains: “The 2013 increase in R&D support for large businesses was welcomed and saw an 36% increase in claims made by these companies over two years. This had a big impact for loss making large businesses.”
But certainty in the system can be as valuable as the benefit itself. At one extreme, the R&D tax credit in the US was only made permanent in 2015, a full 35 years after its creation. Businesses could not be sure it would be there from one year to the next. Now, at last, they are free to take the R&D tax credit into account when forecasting for the future.
Meanwhile, in Australia, there is a debate about tightening up the regime by capping the amount of R&D tax credits businesses can get. Sukvinder Heyer, R&D tax partner at Grant Thornton Australia, says: “Over the past six years, since Australia’s main flagship R&D incentive programme has been around, there has been talk about changes. Companies with multi-year R&D programmes (e.g. life sciences and fintech) want a bit of certainty around the programme. They want to know if the rate is going to be 43.5% or will drop to 41%, or whether the mechanism for the calculation will change.”
Then there is that category of business less familiar with R&D and less certain of the regulators’ interpretation of what qualifies. “Those same companies will read in the press about companies going to court about fraud in the system and shy away from the programme because they don’t want that hassle.”
Peter Vale, tax partner at Grant Thornton Ireland, says Ireland’s R&D tax relief programme is a valuable credit, but also an expensive one for the country to pay out. “A key consideration is whether companies would carry out the R&D in Ireland regardless of the availability of a tax credit. This point was examined in some detail with the results showing a positive correlation between the tax credit and enhanced R&D activity; in short, the tax credit was more than paying for itself.
In our experience, the R&D tax credit can be the biggest attraction for companies establishing in Ireland initially. The Irish operations may not be profitable early on so that our low corporate tax rate is of less interest than the ability to reduce your R&D salary costs by 25% through the tax credit. For multinational businesses, there is an increasing trend of IP moving to Ireland while the tax credit is also a valuable source of financing for Irish indigenous businesses.
In South Africa, the government introduced an R&D tax incentive which according to the Department of Science and Technology has supported about R49 billion in R&D expenditure since 2006, a modest amount compared to the country’s GDP over the same period[iii].
Do income-based tax programmes incentivise R&D expenditure?
Often referred to as ‘patent box’ or ‘innovation box’, income-based tax incentives provide relief on the income generated from the R&D, such as income from licensing or asset disposal attributable to R&D and patents. Patent box regimes are relatively widespread, with most implemented in the last two decades. However, OECD countries have agreed on the Modified Nexus Approach for IP regimes as part of the organisation’s Base Erosion and Profit Shifting (BEPS) Action Plan. The agreement requires regimes to have a clear link between R&D expenditures, IP assets and IP income in that jurisdiction. As a result, previously non-compliant countries have either closed or amended their patent box regimes in the past few years.
Switzerland is among the latest jurisdictions to introduce a new patent box, which comes into effect in 2020, providing a maximum tax base reduction of 90% on income from patents and similar rights developed in Switzerland[iv].
Some businesses are not always aware of what they are entitled to in this area. The Netherlands, for example, has a broad innovation box regime with qualifying assets including patents, software and less novel or obvious assets applied to smaller businesses.
But as Monique Pisters, International Business Centre director and partner for international tax at Grant Thornton the Netherlands, says: “Often our clients come to me and say ‘I don’t have such R&D.’ When I ask them if they are working on making their processes more efficient, they say ‘yes’. In which case they’re doing R&D. Many people often think new products have to be designed. But innovation is much broader than that. It’s also obtaining new knowledge which can be used to make your production process or systems faster or more efficient – that is already R&D.”
According to the OECD, there is less evidence around how effective patent boxes are in stimulating further R&D activity. Rabindran says: “That makes sense because patent applications are often the result of successful R&D activities. UK patent box, and similar reliefs internationally, incentivise the exploitation of IP developed. Although many companies will re-invest these savings in additional R&D work, some may be at a later stage where more commercial activities are prioritised.”
These income-based incentives provide ‘follow on’ savings from R&D tax reliefs and grants, encouraging businesses to hold and exploit the IP developed in the jurisdiction which invested in the R&D activities. However, whether and to what extent these incentives directly stimulate further R&D is unclear.
[ii] Tax Foundation, April 2019
[iii] https://www.dst.gov.za/rdtax/index.php/reports/annual-reports/27-2017-18-r-d-tax-incentive-programme-annual-report/file