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Developing R&D through tax regimes
March, 07th 2009

India does have a beneficial R&D (research and development) regime from a tax perspective, says Mr K. R. Sekar, Partner, Deloitte Haskins & Sells, Bangalore. He feels, however, that the R&D incentive regime can be made more robust and attractive by providing a higher super deduction, Government grant for R&D, and extending the benefits to all industries.

Specific provisions allowing for carryover of unabsorbed R&D losses over extended period of time could be provided for, Mr Sekar adds, during the course of a recent email interaction with Business Line.

While there are no restrictions in IP (intellectual property) holdings, we could have beneficial cost sharing/ cost contribution arrangements. The benefits for R&D should be provided on an ongoing basis, as well. These would surely contribute in making India a favourable destination for R&D in the coming years, he notes, citing Towards better prospects, a topical global survey conducted by his firm.

The survey covered 19 countries where significant tax incentives for R&D activities are available and potential R&D structures and products from India to these countries may be high. It spoke of the nature of incentives, eligible industries and qualifying costs, approval formalities, IP restrictions, and jurisdictional restrictions.

The participant countries were Australia, Austria, Belgium, China, France, Germany, Hungary, Ireland, Israel, Japan, Mexico, Malaysia, the Netherlands, Russia, Singapore, South Africa, South Korea, the UK and the US.

Excerpts from the interview.

How relevant is an R&D survey in the current economic scenario?

Cost reduction and optimisation of process are of prime importance to cope with in todays scenario, and this can be achieved by innovation, driven by high quality R&D. With most jurisdictions offering tax incentives for R&D, which are an added advantage, understanding the R&D tax regimes of various countries is high on the agenda of Indian corporates.

This is especially of high relevance to the knowledge-based industries such as software and pharma. This would help them in strategising their investments.

The differences in the tax regimes of the various countries offer ample opportunities to the Indian entities to structure their outbound investments in the area of R&D, and to maximise the tax benefits and bring a tax advantage.

Can you tell us about the tax benefits given by governments the world over to the R&D-intensive units?

Various countries have devised mechanisms to provide tax incentives to units carrying out R&D activities in the form of reduction of tax rates, super deduction of expenses (varying from 100 per cent to 200 per cent) incremental or volume-based incentive, R&D subsidies, grants and so on.

Here is a sample of a few generous tax incentives:

* Austria gives volume-based deductions at 125 per cent and incremental deductions at 175 per cent based on the increase over a three-year rolling average along with cash rebate for companies with turnover less than $5 million.

* The UK provides that SMEs (small and medium enterprises) could claim up to 175 per cent of their R&D expenditure as a super deduction. The scheme also provides cash credit of up to 24.5 per cent of the qualifying costs for SMEs in a situation where the company has losses. The other large companies are entitled to a super deduction of 130 per cent.

* There have been recent amendments to the R&D incentives regime in Singapore, which provides for various tax deductions and incentives depending on whether the enterprise is an existing enterprise or a start-up enterprise, whether the R&D activities are undertaken by the enterprise in-house or outsourced, whether the R&D activities are conducted in Singapore or outside Singapore etc. The additional deduction ranges from 100 per cent of expenses incurred to 200 per cent (maximum).

* Hungary provides a generous 200 per cent super tax-base. China provides 150 per cent deduction on qualifying R&D expenses.

* India provides super deduction ranging from 125 per cent to 150 per cent depending on whether the expenditure is on contributions to R&D institutions or for carrying out in-house R&D activities. At present, India does not have a system of tax credits or subsidies.

Do all countries define R&D uniformly?

Although the basic definition of R&D is similar in most countries, there are variations in country-specific taxation legislation and incentive regimes.

For instance, the Austrian R&D incentives promote inventive activities, which are conducted with the purpose to increase knowledge and develop new applications for this knowledge. This definition covers basic and applied research as well as experimental development within the meaning of the OECD Frascati Manual. Belgium also follows international definitions such as in the Frascati Manual. Japan has a broad definition specifying that the research must be technological/ scientific in nature.

What are the typical stipulations governing the incentives?

Generally the countries specify criteria relating to location of the research activities, residence of IP, whether the costs are borne by the entity, and so on. A few countries have requirements of prior approval.

With respect to the location of the research activities, while in certain countries, the activities have to be physically performed within the jurisdiction, a few others relax the condition by allowing a certain percentage of the activities to be carried outside the jurisdiction. We also have generous and R&D-encouraging jurisdictions, where there are no restrictions on the location of the activities to be carried out.

In Austria, for instance, R&D activities can be carried on outside Austria in a branch or a plant resident within EU/EEA (European Union /European Economic Area), though the costs need to be funded by an Austrian entity.

Australia on the other hand, restricts the benefit to entities where R&D activities are physically performed within Australia. However, a maximum of up to 10 per cent of the R&D activities can be carried on outside Australia.

While R&D activities can be carried on outside Belgium, the activities have to be funded by a Belgian entity to be eligible for the R&D benefits. In the case of China, up to 40 per cent of the R&D activities can be carried on outside the jurisdiction to be eligible for the R&D incentives. France also provides for R&D benefits to companies where the research is carried out in another EEA country as long as the total expenditure is part of the companys tax base. In Singapore the tax deduction of cost is limited to 100 per cent where the expenditure is incurred outside Singapore. India provides super deduction of 150 per cent for carrying out R&D activities in-house.

The other major criterion is the ownership of IPs. Countries such as Hungary, Austria, and Singapore allow the IPs to reside outside the state. Some countries like China, Australia and Japan require the IP to reside in the country itself. There are no specific provisions in the Indian Income-Tax Act on IP restrictions; however, the costs have to be incurred within India.

Approval formalities are specified by countries such as Malaysia, the Netherlands, China, and Australia. Countries such as the US, the UK, France, Hungary, and Japan do not provide for any specific approvals.

In the initial phases of the R&D activities, the units tend to make losses. Are these losses eligible to be carried forward or are there any tax credits given?

Most countries provide for losses to be carried forward and set off against future profits, but the number of years the same can be carried forward are restricted.

For example, in Hungary the depreciation loss can be carried forward infinitely, and other business loss for a period of 4 years. In Ireland the tax credit can be set off against corporate tax payable, and any utilised credits can be carried over for indefinite or credit availed against tax paid by the company or related group companies.

Austria provides a cash subsidy in a situation where the super deduction results in a loss. UK provides for refund of taxes for SME. For large enterprises loss can be carried forward indefinitely/ can be carried back for one year.

In India, there are no specific provisions relating to the carry forward of R&D benefits, the normal provisions provide for carry forward of losses for 8 years.

On the R&D regime in China and Singapore vis--vis the Indian sops.

The R&D regime in China is similar to that in India, to the extent that the benefits are provided to specific industries carrying out research. China provides super deduction of 150 per cent (similar to India). China has restriction on IP holdings, unlike India; and China allows for 40 per cent of R&D activities that can be performed outside China, whereas India encourages in-house R&D to be performed within India.

Singapore on the other hand has specific provisions where R&D incentives are available even in situations where research is carried out outside the country. Contributions to entities carrying out R&D are considered; also, new and start-up enterprises have benefits as well.

Are there what can be considered the most favourable jurisdictions?

Examples of the favourable tax regimes for R&D are Hungary, UK, Malaysia, Singapore and Austria. Hungary, Malaysia and Singapore provide the highest super deduction of up to 200 per cent, and the UK up to 175 per cent, Austria provides super deduction up to 135 per cent and a cash subsidy. There are no restrictions on residence of IP in these countries.

There is no locational restriction in Austria, Hungary and the UK, however in Singapore R&D tax deduction is limited to 100 per cent of the expenditure incurred where the R&D activities are carried on outside Singapore. Also these countries are favourable when it comes to carry-forward of losses.

However, the restrictions these countries have with respect to the eligible industries, and the basic corporate tax rate would need to be considered as well. For instance, Malaysia does not provide benefits to software industries. Singapore not only provides a high rate of super deduction, the basic corporate tax rate is also attractive at 18 per cent. Hence these factors would need to be looked into before concluding on the destination.

With the basic tax rates varying, how would you assess which jurisdiction is favourable? Also, how can R&D considerations come into tax planning?

An analysis of the marginal effective tax rate could be one of the indicators in deciding favourable jurisdiction. For instance, where the corporate tax rate is 34 per cent (say, as in India), the super deduction would help to reduce the tax outgo by 34 per cent on the benefit actually received.

On the tax planning front, the interplay of different incentive regimes can benefit multinationals. One country may require R&D to take place within its geographical boundaries while another have a restriction on costs being borne by the local entity. Companies could structure their investments to take advantage of these tax regimes by suitably structuring the cost sharing across various regimes.

On interesting observations as to the kind of industries targeted by the R&D regimes for tax incentives.

In Hungary special attention is given to agriculture; and in the UK, consumer business and aerospace defence are also recognised. Interestingly, France, Israel, and Malaysia do not recognise software service industries as eligible industries. Certain countries such as South Korea have a very broad-based regime, which entitles all manufacturing industries to this benefit.

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