How To Rank Countries For Performing Research And Development

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Gregory Stephens
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1 May 2004 A Euromoney publication Europe s tax minefield: Philip Gillett urges cooperation What media owners want from the tax man Beneficial ownership explained Germany publishes LLC guidance Plan early for offshoring How R&D tax credits compare

2 Tax advantages prove their worth to R&D location Before deciding where to locate R&D, companies need to consider which countries are the most attractive. Ken Murray and David Cobb of Deloitte provide an overview of the places with the best tax incentives for performing R&D Global competition to attract R&D facilities, R&D personnel and technological innovation is ever increasing. Often, the best way to influence corporations to locate in a jurisdiction is through tax incentives. Research has shown that government intervention can influence either where firms locate their R&D facilities or, at a minimum, reduce the loss of existing jobs to other jurisdictions as well as increase the amount of technological innovation occurring in the country. To rank the various incentives, a number of factors must be considered: Is the system volume based or incremental? Incrementally based incentives such as the US credit are less attractive. What is the rate of the credit on an after-tax basis? This will be impacted by the size of the additional deduction or tax credit and where additional deductions are offered, the effective tax rate of the country. Most of the countries considered below have effective tax rates of between 30% and 36% with two exceptions, Japan with a 41% rate and Singapore with a 22% rate. Is all or a portion of the credit refundable? For example, in France, unused credits, to a maximum of 8 million ($9.56 million) a year, are refundable from the government after three years or can even be sold to a bank on a discounted value basis. What types of activities qualify? Is it just the R portion of research and development or is it both R&D? The original definition of R&D in the UK was heavily biased towards just research by using words such as novelty and innovation. The current definition recognizes that both R&D does qualify. What types of expenditures qualify? For example, in the UK, the base only includes salaries, materials consumed and transformed and limited subcontract expenditures. Although, the recent budget expanded the range of costs to include utility costs and software tools. However, in Canada, not only salaries and materials are included but also 100% of R&D subcontractor costs, R&D capital equipment and overheads. How certain is one of obtaining the credits? There is no point in investing time and effort in preparing claims for the credit only to lose them in the audit process or having to spend an unreasonable amount of time and effort in defending the claim. For the incentives to be considered in the business planning model, companies must have confidence in the stability of the rules as well as in the efficiency of the audit process. Are there opportunities to claim incentives in more than one jurisdiction on the same project? For example, under the Japanese rules, the R&D can be carried out anywhere in the world as long as it is paid for by a Japanese entity and the resultant intellectual property resides in Japan. Therefore, R&D carried out in Canada and paid for by a Japanese entity would enjoy the incentives in both countries. The original definition of R&D in the UK was heavily biased towards just research by using words such as novelty and innovation Any ranking of countries must to some extent be subjective as it is difficult to measure a number of the factors listed above. For example, although most if not all definitions of R&D are based on the Frascati Manual, there can be subtle differences on which activities qualify, especially in the area of shop floor R&D. Any ranking of countries must to some extent be subjective as it is difficult to measure a number of the factors listed above In ranking the countries, in the charts on these pages, on the criteria chosen, clearly, Austria, Canada, Japan and Spain would be in the top tier of those having the best incentives for performing R&D; France, the Netherlands, Singapore and the UK rank in the middle tier and the US has the least effective regime. May

innovation is ever increasing. Often, the best way to influence corporations to locate in a jurisdiction is through tax incentives.

3 Austria France Rate - 25% additional deduction on all eligible R&D costs; increased to 35% to the extent that expenses exceed a three year base Rate - 5% tax credit on all eligible R&D costs. An additional 45% on the increase over the average of the past two years Refundable - taxpayers can choose to forgo the additional deduction for a refundable credit of 8%. Costs that qualify include both revenue and capital spend. Eligible expenditures include staff costs, overheads, buildings and subcontract costs for work incurred in Austria. Incentives may be claimed for work performed outside of Austria within limits. Refundable up to 8 million ($9.56 million) if still in a loss position after three years. Credits can be discounted at a bank. Eligible expenditures include staff costs, overheads, amortization of capital R&D spend and some subcontract costs. Work must be performed in France. No significant issues with the tax authorities Netherlands Canada. Rate - 20% tax credit on all eligible R&D costs. The credit is taxable in the year following the year it is used. Provinces add additional incentives. There is a 10-year carryforward on unused credits Refundable for Canadian-controlled private corporations within limits. Many provincial credits such as the Quebec 17.5% wage tax credit are refundable to all taxpayers. Payroll incentive: 42% of first 100,000 ($119,439) of eligible payroll costs and then 14% on excess Other incentives available, for example, some other R&D costs, materials, overheads and travel costs; 50% if they are research related and 25% if they are of a developmental nature Work must be performed in the Netherlands Costs that qualify include both revenue and capital spend. Eligible expenditures include staff costs, materials, overheads, capital R&D spend (excluding buildings) and subcontract costs. Japan Work must be performed in Canada. No significant issues with the tax authorities Governments are increasingly using tax relief for R&D activities as a policy instrument to attract R&D facilities and employment. For many companies, reducing their tax cost by way of these incentives can give them a substantial competitive advantage. Planning for either new R&D facilities or where to locate the development of new or improved products or processes should take into account the available incentives. Ken Murray is the leader and co-leader of Deloitte s Canadian and UK R&D practices respectively (kenjmurray@deloitte.ca). David Cobb is the co-leader of Deloitte s UK R&D tax practice (dcobb@deloitte.co.uk). Rate the incremental rate is 15% of the greater of the average of the three largest amounts in the last five years or the largest amount in the last two years; the alternative credit is 8% of R&D expenditures (10% in 2003 to 2005), which can offset up to 20% of total corporate tax liability. Other additional credits are available in certain situations Refundable no Eligible expenditures include revenue and as well as depreciation on R&D capital spend. Work can be performed anywhere in the world provided that it is paid for by a Japanese entity and the intellectual property is retained in Japan 28 May

Costs that qualify include both revenue and capital spend. Eligible expenditures include staff costs, overheads, buildings and subcontract costs for work incurred in Austria.

4 Singapore UK Rate - 200% deduction for qualifying costs. Companies can set aside an R&D reserve of up to 30% of taxable income. The double deduction is offset against this reserve as spent within three years of setting up the reserve. In addition, other incentives are available. Work can be outsourced outside of Singapore with approval of the authorities. Spain Rate - effectively 7.5% Refundable for small and medium sized enterprises Eligible expenditures include staff costs and materials. 100% deduction for R&D capital purchased. Limited subcontract costs. Costs that are capitalized can t be claimed until expensed. However, the recent budget proposes to allow the incentive on costs capitalized as an intangible on as incurred basis. Work can be performed anywhere in the world provided that it is undertaken by employees of a UK claimant company. The incentive was only introduced in April There is little audit experience as yet for large taxpayers. However, the authorities are viewing this as an incentive programme. Rate - the base rate is 30% of qualifying costs with an additional 20% credit above the average of the previous two years. The credit is capped at 50% of tax payable. There is a 15-year carryforward of unused credits. Additional incentives are available. US Incrementally based. The base years are 1984 to 1988 inclusive. The base year calculation is a difficult exercise. Special rules exist for start-ups, which have no base. Eligible expenditures include most R&D costs except buildings. Rate - effectively 6.5% on incremental spending for most corporations. A percentage of the costs for work performed outside Spain can be claimed. The Spanish government has acknowledged that there have been problems in the past with the administration of the programme. They have introduced the option for taxpayers to obtain a binding ruling on the qualification of activities. Eligible expenditures include wages, materials and 65% of subcontracts. Work must be performed in the US. There are significant audit issues. May

Work can be outsourced outside of Singapore with approval of the authorities. Spain Rate - effectively 7.

5 For more information or to subscribe to International Tax Review please contact: UK Hotline: +44 (0) or US Hotline:

Review of R&D Tax Credit. Invitation for Submissions

Review of R&D Tax Credit. Invitation for Submissions Review of R&D Credit invitation for submissions Review of R&D Credit Invitation for Submissions February 2013 Economic and Fiscal Divisions Department of Finance Government Buildings, Upper Merrion Street,