Over a year on, key reforms for SA’s R&D tax incentive still not implemented

More than a year on the Department of Science and Technology has yet to decide on whether to offer a refundable tax credit for the research and development (R&D) tax incentive.

The introduction of a refundable tax credit was one of several recommendations made by a task team in a report in June last year to make a R&D tax incentive, which has been in existence since 2006, more attractive to small businesses and startups.

Unlike a non-refundable tax credit, a refundable tax credit is able to reduce a company’s tax balance beyond zero, making it significantly favourable for small firms.

The task team, set up by Minister of Science and Technology Naledi Pandor (pictured above), said at the time that a refundable tax credit for small businesses – which is in use in Australia, France, Canada, Singapore and the UK – will make the R&D tax incentive more attractive for small and medium-sized enterprises (SMEs).

Only a small percentage of SMEs currently benefit from the incentive.

In June, Imraan Patel, the department’s deputy director general of socio-economic innovation partnership told Parliament that of the 1 013 pre-approval applications received between 2012 and May this year only 39% were from firms with an annual turnover of R40-million and below, while the department said larger companies had higher rates of approval than SMEs.

Since its introduction in 2006 up until May this year 962 firms have taken part in the tax incentive.

‘Departments intends to conduct impact evaluation to assess where refundable tax credit in R&D tax incentive should be implemented’

The department’s spokesman Lunga Ngqengelele said consultations between the department and the National Treasury resolved that a refundable tax credit could not be implemented immediately as it would require amendments to the Income Tax Act.

“A business case for this needs to be developed. To address this, the department intends to initiate an impact evaluation of the incentive in 2017/18 that will, among other things, provide an assessment of the gaps of R&D and innovation support instruments,” he said.

He said while the department has implemented 14 of the task team’s 17 recommendations (which relate to simplifying administrative processes and on policy-related issues) it has yet to make a decision on whether to implement a refundable tax credit as well as two further recommendations.

Review of pre-approval process

The two other recommendations include the need for more aggressive tax breaks and the review of the current pre-approval process which the task team indicated has been largely to blame for the backlog in approvals.

Between November 2006 to September 2012 applicants could simply lodge a claim to have 150% of R&D expenses written off their taxable income. Any decision on whether not to grant the incentive was then made retrospectively by the department. The department in October 2012 changed the system to a pre-approval one.

While the department has made some progress to cut the backlog (in June the department told Parliament that 88% of applications made between 2012 and May 18 this year had been processed), the task team noted that in 2015, 28 of the 34 OECD members had preferential tax treatment to R&D spending businesses. Most of these use the retrospective system.

Ngqengelele said with respect to the review of the pre-approval procedure, no finality has been reached to date as work is still underway.

“Various alternatives are being evaluated to understand their policy implications as well as the risks and resource requirements associated with their implementation,” he said.

He added that the department has had useful exchanges with the experts and practitioners within the OECD network on this matter, and learnt that the set-up of any administrative architecture has specific institutional and resource requirements.

Measures to simplify incentive

He however said specific measures have been implemented to simplify information and procedures for applying for the incentive to make it easier for small businesses and first-time applicants to access the incentives.

These include the publication of new guidelines, new website information and a new simplified online application form. In addition, officials from the department have made themselves readily available to meet firms and provide guidance where required.

“All these were implemented within the existing provisions of Section 11D of the Income Tax Act,” he added.

He said in providing guidance to small firms and startups, information is provided about the existing innovation support incentives, such as those provide by the Department of Trade and Industry, the Technology Innovation Agency (TIA) and others.

‘Startups can tap incentive’

Ngqengelele stressed that startups not yet generating a revenue can also benefit from the tax incentive. Section 11D of the Income Tax Act allows firms that are not yet in taxable position to carry forward the incentive benefit until they are in a position to deduct it.

“Some firms that are approved find this to be useful in building the case for raising external funding. It, however, still presents a challenge for startup firms that will take longer to be in a taxable position,” he said.

He added that for a range of innovative industrial projects, this limitation is partly addressed through grant incentives and financing through TIA and IDC. A funding gaps exists for R&D projects.

The task team also pointed out that when it comes to the total direct and indirect government funding of businesses to carry out R&D as a percentage of GDP, South Africa, with a contribution 0.05%, is among the bottom countries. South Korea and Russia, with figures above 0.4% top the list.

One of the Task Team recommendation was to increase the 150% quantum of the incentive.

However, Ngqengelele said the department and the National Treasury have consulted on this quite extensively, adding that this would form part of  the impact evaluation of the incentive in 2017/18.

He said in addition to an R&D tax incentive, government offers a range of other funding mechanisms to promote more spending on R&D in firms. This includes programmes such as Technology and Human Resource for Industry Programme (Thrip) and the Department of Science and Technology’s Sector Innovation Funds.

Featured image: Science and Technology Minister Naledi Pandor via CTBTO via Flickr (CC 2.0, resized)