FISCAL INCENTIVES FOR R&D – INTERNATIONAL EXPERIENCES

In an effort to increase their level of innovation many countries have turned to fiscal incentives for R&D. A plethora of mechanisms are employed around the world, to support business R&D. They range from indirect measures such as subsidies on inputs to direct measures like grants and tax measures. Tax incentives for business R&D are widely regarded as an important policy tool to stimulate private investment in innovation. The common rationale behind fiscal incentives for R&D is to increase industrial R&D by lowering the cost of such investments.  

To stimulate and support corporate research, governments have a range of options. These include: 

Tax incentives seems to be a natural policy tool for a government wanting to increase R&D expenditures in market oriented economies. OECD reports that in 2005, 70% of member countries had tax incentives for R&D investments in place, including the US, Canada, Japan and Australia.  Only 50% of these countries had adopted this measure in 1996. There is a growing popularity of this policy instrument. Many countries have special provisions that allow research companies to benefit from the incentives through tax relief or reduced social costs. 

Tax incentives are market-oriented as it is up to industry to decide where to invest the financial support. It is assumed that industry knows which areas and innovations have the potential to grow. Arguments in favour of supporting business R&D through tax incentives include: need to overcome a market failure in early stage financing; promoting growth, and; creating high-quality jobs  

Grants, on the other hand, involve a critical element of “picking winners”. While grants have an important role in directing support to strategic areas, fiscal incentives are arguably a better way of creating an overall increase in R&D spending. Predictability is a second virtue of tax incentives. As long as the company fulfils certain defined requirements, it can rely on the tax incentives to materialize year by year. Tax incentives thus create certainty—which is a key issue for businesses when investing in long-term R&D projects. In contrast, a grant must be applied for and competed with other companies. The exact amount of background work required to obtain grant support varies with the design of programmes. Countries such as the UK and Canada have invested a great deal of effort in making their programmes as accessible as possible to industry, and to reduce the time and money they have to spend on administration.  

Different categories of tax incentives for R&D include: 

Tax Allowances: Tax allowances allow firms investing in R&D to deduct from the income more than what is actually spent on R&D. This reduces the taxable income and the tax bill. The benefit of tax allowances depends on the tax rate that the company faces. Australia, Austria, Belgium, Denmark and the UK are examples of countries that provide tax allowances. A number of countries (e.g. Spain, Denmark, Canada and Ireland) allow immediate or accelerated write-off of capital expenditure on machinery etc. Other countries. The UK, for example, provide accelerated write-off for buildings associated with the R&D work. Many countries also provide tax allowances for R&D outlay or revenue expenditure on R&D. 

Tax Credits: Tax credit is specified as a percentage of the R&D expenditure and this credit reduces the tax payable. Canada, France, Spain, Ireland and Norway are countries that offer tax credits for R&D. Among the OECD countries, credits are generally used more often than tax allowances. 

Extended Incentives: These include Cash Payment and relief of Social Costs. Companies that are involved in R&D could often be many years away from profitability. This is particularly the case for newly established firms in the life science industry. Without profit, these firms do not gain from tax allowances and tax credits. Thus, although this group of companies is financially the most vulnerable, they do not benefit from the standard tools available. Constructing incentives for unprofitable firms thus requires special solutions. One option is to allow companies to carry tax credits and allowances ahead in time, to set against profits in better years. However, carrying a tax credit forward makes it less valuable since time erodes its value. To support these companies, some countries provide tax incentives through an immediate cash payment. This is currently in practice in Canada, France, the UK and Norway, for example, with variations in implementation. Another option is to relieve the companies of social costs related to the R&D expenditure. Because unprofitable businesses also pay social costs for their employees, this measure provides general support to companies performing R&D. The main benefit of the Young Innovative Companies -  YIC - system, in place in France and Belgium, is relief from social costs.  

Fiscal incentives based on volume: This scheme defines the support as a percentage of the total amount of R&D that the company is undertaking. This can lead to a situation whereby governments support R&D that would have been carried out even without the incentives. To encourage increase in R&D spending, countries like France, the US and Spain, therefore, base at least a part of the support on the increase in R&D volume. The credit is calculated as a percentage of the year-on-year change in R&D expenditure. Governments provide tax relief to increased R&D investments; thus, basing the support on the incremental volume change in R&D. Under this measure a special solution is needed to handle a decrease in R&D costs. The tax relief may also be very volatile from one year to another in an incremental system, which creates uncertainty. Most countries therefore prefer a volume-based incentive programmes. 

Targeted Incentives: The rationale for targeted incentives is to give an extra boost to R&D investments in a specific category of companies. These companies may be particularly dear to policy makers or be more likely to suffer from market failures and information constraints that cause them to under invest in R&D. Targeted incentives to SMEs are motivated by SMEs possessing the highest potential to generate future growth but being restricted by their financial instability and high risk, which makes it difficult to attract investors. 

COUNTRY WISE COMPARISON 

FRANCE:

France is a forerunner when it comes to stimulating business R&D through tax incentives.  The main programme, “Crédit d’impôt recherche” (Research tax credit - CIR) was launched in the 1980s and focuses on companies of any size and in any industry. “Jeune Entreprises Innovantes” (Young Innovative Companies - YIC) is a supplementary programme that was introduced in 2004. The YIC system targets young companies that devote at least 15% of their outlay to R&D. YIC companies are also relieved from corporate income tax for the first three years and pay 50% of normal taxes for the following two years, up to a maximum of 100,000 EUR in support. They can also be relieved from local taxes related to the value of properties and buildings. CIR is a tax credit programme with a broad focus. Any company that is conducting R&D can get support from the CIR system. The basis for calculating the credit is both the volume of R&D conducted by the company and the incremental change in this volume over time. The trend is to increase the volume-based part of the support that means less volatility from year to year, while still offering a clear incentive to increase R&D spending. The maximum level of credit is 10 M EUR per year (from 2006 and onwards).  Unprofitable businesses can carry credit forward to reduce future corporate tax. Three years after the credits have incurred, any remaining unused credits are refunded to the company. Newly created companies with no profit can obtain the refunded credit immediately instead of having to wait for three years. 

NORWAY:

SkatteFUNN is a tax credit programme through which companies can have up to 20% of their R&D expenditure financed. Support is given for a specified R&D project rather than for R&D costs in general. The total R&D budget for the project must be limited to 0.5 M EUR, or, in cases where the project is a joint collaboration with an approved research institution, 1 M EUR. An SME can have a maximum of 20% of the R&D costs in the project covered by the credit, while the level for large companies is 18%. This restricts the support to 0.1 M EUR for SMEs and slightly less for large companies. It is possible for a company to claim support for several R&D projects simultaneously but the total support cannot surpass the maximum limits. 

CANADA:

Canada was one of the pioneering countries in using tax incentives for R&D. The Scientific Research & Experimental Development (SR&ED) tax incentive programme, introduced in the 1980s, is a federal programme to encourage companies in general to increase their R&D outlay. The SR&ED programme is the largest source of federal support for industrial R&D. In addition to the federal programme, most provinces have supplementary programmes. The SR&ED provides tax credit as a percentage of qualifying R&D expenditure. The companies that can claim the credit fall into three groups: Canadian-controlled private companies, Other Canadian corporations and Proprietorships, partnerships and trusts. The first group of companies, Canadian-controlled private companies, are treated most favourably and can claim a credit amounting to 35% of R&D expenditure up to 1.42 M EUR Additional R&D costs entitle the company to a credit of 20% of the investments. Other Canadian corporations can claim a credit of 20% of their R&D expenditure. All credits are taxable. Businesses with no taxable income can get the credit as a payment. The rate of refundability depends on the tax situation of the company. Small businesses are entitled to have the share of the credit that corresponds to current expenditure fully refunded while capital expenditure is partially refunded.. Canada also allows rapid write-off on capital investments related to R&D. Each year, more than 11,000 companies claim support through the SR&ED programme. 

BRAZIL:

Brazil has a scheme whereby gross profits which are utilised for R&D are exempt from profits tax. 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 amortization over a minimum of 5 years. 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 amortized 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. 

USA:

In its initial form it was a 25 per cent tax credit for "incremental" Research and Development. This increase was measured over the average of the previous three years. In practice what that has meant is that across most firms about 65 per cent of overall Research and Development spending as reported to the Internal Revenue Service and as reported in the public statements of the companies is actually eligible for the tax credit on average. That is, it comes from the fact that the effective benefit of the tax credit firm by firm in the United States is highly variable depending on tax positions of firms, and because of this, some firms will find R&D cheaper to perform than others; the evidence is that these firms actually do more of it, other things remaining equal. 

UNITED KINGDOM:

Tax relief for R&D was introduced in the UK in 2000, to stimulate SMEs investing in R&D. In 2002, the scheme was enhanced to include large companies also. A special tax credit was also introduced to promote investment in R&D leading to vaccines for third-world diseases. The main ambition has been to create a system that is simple and market-based. The UK tax incentive programme is based on tax allowances. SMEs can deduct 150% of eligible R&D costs and large companies are allowed to deduct 125%. The rules for deducting capital investments related to R&D are among the most generous in Europe, and permit immediate write-off of investments in buildings and equipment. Unprofitable SMEs are offered their tax incentives as an immediate refund. Many research companies in need of improved cash flow exercise this option. Instead of carrying 150% of the R&D costs forward to reduce future taxes, the SMEs can choose to have a credit worth 24% of the R&D expenditure as a cash injection.  

AUSTRALIA:

The basic objective of the R&D tax concession is to provide an incentive for greater levels of business research and development in Australia. While Australian governments have used a plethora of other industrial R&D support mechanisms, such as grants, soft loans and arrangements to encourage linkages, the general and syndicated R&D concessions have almost completely dominated government expenditure on business R&D in the last decade. From the mid 1980s onwards the basic goals of policy have been to increase BERD/GDP through the 150% Tax Concession and assorted Grant programmes; 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 university-industry links especially through the Cooperative Research Centres programme. 

Country

Nature of Tax Incentive

 

 

FRANCE

The main programmes are Research tax credit – CIR and Young Innovative Companies – YIC. The YIC system targets young companies that devote at least 15% of their outlay to R&D. Any company that is conducting R&D can get support from the CIR system.

 

NORWAY

SkatteFUNN is a tax credit programme through which companies can have up to 20% of their R&D expenditure financed. Support is given for a specified R&D project rather than for R&D costs in general.

 

CANADA

The Scientific Research & Experimental Development (SR&ED) tax incentive programme, introduced in the 1980s, is a federal programme to encourage companies to increase their R&D outlay. The SR&ED provides tax credit as a percentage of qualifying R&D expenditure.

 

BRAZIL

Brazil has a scheme whereby gross profits that are utilized for R&D are exempt from profits tax. Rules permit deferral and amortization over a minimum of 5 years.

UNITED KINGDOM

The UK tax incentive programme is based on tax allowances. It was introduced in 2000 to stimulate SMEs investing in R&D.

AUSTRALIA

The basic goals of policy is to increase BERD/GDP through the 150% Tax Concession and assorted Grant programmes.

 A fundamental concern of innovation policy around the world has been the design of programmes that induce substantial and worthwhile R&D with the maximum potential for commercialization. An endemic feature of tax based innovation programmes is a low inducement to new R&D and substantial dissipation of concessions as transfer payments to firms. 

Technological spillovers occur when the research activities of one firm induce higher productivity in other firms. To the extent that knowledge cannot be fully appropriated, there will generally be an underinvestment in R&D. Even with patent protection, imitators can often copy without having to fully compensate the original innovator for the costs of research and first commercialization of new ideas.  In a closed economy the classic solution to the spillover problem is for government to subsidize R&D to bring the marginal private rate of return up to the marginal social rate of return.  In an integrated and open economy, where multinationals conduct R&D and business abroad, and foreign firms conduct R&D and business domestically, it is questionable as to which activities a government would want to subsidise. The general presumption is that domestically performed R&D is important, as spillovers are geographically clustered around where the research takes place.