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R&D tax incentives: Making it work

Monday, 05 October 2015   (0 Comments)
Posted by: Author: Tamar Kahn
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Author: Tamar Kahn (Financial Mail)

Faced with growing discontent from the business sector, the science & technology department is taking steps to make it easier for companies doing research and development (R&D) to claim the tax incentives to which they are entitled.

Specialist advisers have been appointed to help process applications and a task team is to be established to tackle industry concerns.

Government offers companies a 150% tax deduction on their operational expenses for qualifying R&D activities. But the take-up of the incentive since its launch in 2006 has been modest, to say the least. Companies have struggled with bureaucratic delays and unexpected rejections.

The idea behind the incentive is simple. It aims to reduce the after-tax cost of R&D and thus encourage companies to invest more in these kinds of activities, with a positive spin-off for the businesses concerned and the economy as a whole. Not only does investment in R&D result in innovative products and services, but also serves to attract and retain highly skilled individuals and create jobs.

R&D tax incentives are used in all the Brics nations, as well as in emerging economies like Singapore’s. More than R5bn in tax revenue has been forgone by the fiscus since the scheme was implemented, according to treasury’s chief director of economic tax analysis, Cecil Morden.

Whether the R&D tax incentive is having the desired effect is anyone’s guess, as government has yet to evaluate its impact. But what is clear is that companies wanting to claim the tax break are not finding it easy.

A total of 810 companies participated in the scheme between 2006 and the end of March 2014, but because companies submit a separate application for each project, the figure masks the fact that only about 260 companies participate each year.

"None of our members has ever benefited from the tax benefits and some have had disputes since 2007, mainly due to the interpretation of the law and the administrative burden," says Konji Sebati, CEO of the Innovative Pharmaceutical Manufacturers Association of SA, which represents multinational pharmaceutical companies, many of which conduct clinical trials in SA.

When the scheme was first implemented, companies made a retrospective application for the incentive when they submitted their tax returns to the SA Revenue Service (Sars). The system was changed in October 2012, and companies now have to obtain pre-approval from the department of science & technology to claim the tax deduction from Sars. The change was intended to make it harder for companies to make illegitimate claims for R&D expenditure and give oversight to the line department best versed in scientific research, but the failure to invest in capacity to process applications resulted in an inevitable, frustrating backlog.

A presentation to parliament on August 4 showed that the department of science & technology had managed to process only 589 of the 905 applications it had received between October 2012 and June this year, of which just 177 were approved.

In other words, barely one out of five applications received had been given the green light.

Cova Advisory & Associates’ clients wait on average 18 months for an answer, says its MD, Duane Newman. Not only is this a far cry from the department’s 90-day target, but companies battle with the uncertainty this creates around their tax liabilities, he says. "Many companies underclaim because they are wary of an audit by Sars," he notes.

"The incentive isn’t generous enough to change businesses’ behaviour. It would work better if it were generous and quick. As it is, most entrepreneurs won’t touch it," he says.

Clients are also frustrated by the way the department is interpreting the legal definition of R&D, and the apparent inconsistencies in what it approves and rejects, says KPMG tax partner Mohammed Jada. "The wording of the legislation is also problematic because the only appeal mechanism is to go to court. For most companies it’s not worth a legal challenge," he says.

Deloitte SA tax director Newton Cockcroft says the rate at which applications are rejected varies widely across industry sectors, suggesting players in the rejected industries and the department of science & technology have a different interpretation of what constitutes R&D. Just under 35% of the rejections were in the manufacturing sector, and 55% are in the finance and business services sector, according to the department’s figures.

The department’s chief director for science & technology investment, Godfrey Mashamba, concedes it did not invest in sufficient capacity to handle the volume of applications when it took responsibility for adjudicating applications for the incentive in 2012, and was overwhelmed by the administrative burden.

But after a frank meeting with industry on August 21, external experts were appointed and minister Naledi Pandor ordered a task team to be set up to look into the concerns raised by industry, which appear to be particularly acute in the software development industry. The backlog is diminishing, and at the end of August there were 273 outstanding applications, says Mashamba.

"We are trying to find solutions," he adds.

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