April 19th, 2021
R&D Tax Incentives, like we have in Australia, are intended to drive innovation, and thus productivity and value in the global economy. By reducing the tax costs of those investments, policymakers believe that companies have an added reason to take risks to perform innovation that they may not typically take. However, not every country has tax tools used to incentivize spending on R&D and develop patented innovations, and of those that do, not all are the same. A recent Tax Foundation report looked into the countries within the Organisation for Economic Co-operation and Development (OECD), evaluating their policies on R&D. It found that, especially from an international perspective, broadly neutral tax policies are better for providing a general environment that is supportive of innovation than R&D tax incentives and subsidies or patent box incentives.
The Tax Foundation paper noted that:
- Of the 37 countries within the OECD, 20 have special deduction rules for R&D costs, 18 have a tax credit for R&D, and 19 countries have a patent box. Two OECD countries (Sweden and Estonia) have none.
- Special deductions for R&D expenses allow companies to deduct more than the value of their R&D costs when calculating taxable profits.
- A tax credit for R&D involves receiving a tax credit, such as in Australia where business can qualify for an up to 43.5% refundable tax credit for eligible expenses (the most generous credit rate of the countries).
- Patent boxes allow income from certain types of intellectual property to be taxed at a rate lower than the main corporate tax rate.
- These systems can be complex with regards to credit amounts, eligibility, calculation methods, auditing, and definitions of eligible expenses and uses for tax credits.
- Germany’s 25 percent tax credit only applies to salaries and wages associated with R&D, whereas in Ireland, companies can choose to pay out R&D tax credits to certain employees involved in R&D rather than offsetting their corporate tax bill.
- In some countries, expenses are only eligible for special tax treatment if a business is located in a special geographic tax zone or investing in certain technologies.
- Other countries only apply R&D tax benefits to incremental R&D expenses. If a company spent $1,000 on R&D in 2020 and will spend $1,200 in 2021, only the additional $200 would qualify for an incremental credit. This design is meant to incentivize companies to continually increase their focus on R&D rather than gain tax benefits without increasing R&D spending.
- Reports suggest that, because of these compliance complexities:
- It is not uncommon for companies to leave a portion of their credits unclaimed;
- Only companies that have the resources to monitor and claim R&D expenses will be the main beneficiaries.
- It is impossible to measure how much R&D spending or patenting activity there should be, but studies show that these tax preferences lead to more R&D spending and patenting. However, they also show that this spending and patenting is not necessarily new innovation.
- R&D credits lead to more R&D spending, but also that firms will reclassify other costs to benefit from R&D tax preferences.
- Patent boxes lead to an increase in patenting activity, but the increase in patent activity is not necessarily driven by new innovations, but rather by ensuring profits from existing innovations can benefit from the reduced tax rate.
- Companies that increase R&D activities in response to a new R&D tax credit in one country offset that activity with reductions in other countries, so companies are not necessarily increasing their R&D, but shifting its location.
- In Sweden, they have taken a different approach on tax policy than other OECD countries; the government provides significant funds for business R&D spending.
- In 2017, the Swedish government financed 0.113 percent of GDP of business R&D spending, nearly double the OECD average of 0.06 percent of GDP.
- According to 2017 data, Sweden was second among countries in Europe in R&D spending per capita (with €1,615).
- Sweden also allows business losses to be carried forward indefinitely with no limits, which means profits from research projects with huge upfront costs (and often uncertain outcomes) will not get taxed until profits exceed those losses.
The report recommended:
- Rather than directing resources strictly toward certain eligible R&D activities and patented innovations, policymakers should adopt broadly neutral tax systems which allow investment costs to be fully deducted and losses to be carried forward without limits.
- The incentives for businesses to take on risks with the potential for significant profits will remain, regardless of special preferences for innovative activities.
- Governments should create an environment that is favourable to innovation that reaches beyond tax, with support for academic institutions, basic research, and protections of rights associated with intellectual property rather than relying on preferential tax treatment.