Research and development (R&D) activities are performed in different models:
- directly by the entity itself, where qualified engineers, scientists, etc. are appointed to carry out specific development of a new product or enhance the quality of existing products;
- outsourcing some or the entire research work to a third-party service provider; or
- through grants and donations to universities or government institutions.
This series will look at R&D incentives and credits in a several countries, and at the opportunities they present for businesses.
The taxpayer may deduct 100% of all qualifying expenses incurred in connection with R&D, subject to the condition that taxpayers keep a separate record of R&D. The qualifying R&D expenses are deductible from the taxable base, i.e. after the deduction of all allowable business expenses. For R&D centers, up to 150% of the qualifying expenses may be deductible, the percentage depending on the status (micro, small, medium or large company) of the R&D center.
The qualifying expenses include remuneration and payroll expenses of employees engaged to pursue R&D activities (including the remuneration and social security contributions), purchase of consumables related to R&D, rental of research equipment, and depreciation expenses on fixed and intangible assets used in R&D.
The R&D expenses are deductible in the tax year in which they were incurred. If the taxpayer incurred tax losses in that tax year, the R&D expenses are deductible in the subsequent six years. Startups that do not generate sufficient income to claim R&D deduction can claim cash refund of the incurred R&D expense.
Deductions are available for both revenue and capital expenditure on scientific research (section 35 of the Income Tax Act). “Scientific research” means any activities for the extension of knowledge in the fields of natural or applied science, including agriculture, animal husbandry and fisheries, but does not include the acquisition of rights in, or arising out of, scientific research.
A deduction is allowed for the following revenue expenditure:
- Any expenditure laid out or expended on scientific research related to the business, including:
- any scientific research which may lead to or facilitate an extension of that business;
- any scientific research of a medical nature incurred by the taxpayer which has a special relation to the welfare of workers employed in that business; and
- the payment of salary to research personnel and expenditure incurred in the purchase of materials used in such scientific research related to the business during the pre-investment period. Such payments are deductible in full from the profits in the year in which the business is commenced, subject to certain conditions and limits.
Taxpayers can also contribute to an approved research association, university, college or other institution to be used for scientific research, and can claim a deduction of 150% of the sum paid to such association, university, college or other institution from assessment year 2018–19. From April 1, 2019, taxpayers can claim a deduction equal to the sum contributed to an approved research association.
A taxpayer can deduct the direct costs of basic research, applied research and experimental development (conducted by the taxpayer as its own activity) that are accounted for as expenses or depreciation costs of the asset capitalized on the basis of such expenses from the pre-tax profit, provided that the costs were not covered by any grant or subsidy. Effective from January 1, 2014, a taxpayer can claim deduction of the direct costs of R&D activities incurred by its related party if:
- the related party did not deduct these costs;
- the taxpayer holds a document demonstrating the R&D costs incurred by the related party and the amount the taxpayer can deduct, i.e. R&D agreement; and
- the underlying activities are related to the business activities of both entities.
The taxpayer can deduct the cost in respect of basic research, applied research and experimental development purchased from a domestic taxpayer. In this case, the tax incentive is shared between the person ordering such services and the person rendering the R&D based on a joint declaration up to the amount, which can be utilized by the service provider on its own.
The taxpayer can claim three times of the cost as deductible, if the taxpayer is in partnership with a research institution (research facility funded from Hungary State Budget) engaged in basic research, applied research or experimental development, up to a maximum of 50 million Hungarian forint ($172,750) per year. The tax effect of this incentive is considered as state aid for the purposes of the EU regulations.
R&D Tax Credits
A taxpayer can claim R&D tax credit of 30% of the expenses related to R&D such as direct salaries, depreciation of equipment used in R&D, consumables, sub-contracted expenses (up to 2 million euros ($2.22 million) in case of related party, or 10 million euros if the principal and the sub-contractor are not related party). The R&D credit, which takes into account the annual volume of expenditure, amounts to 30% of the expenses related to research and development up to 100 million euros, and 5% in excess of 100 million euros.
For example, if direct salaries and consumable expenses 130 million euros in a year, the total R&D tax credit available is 31.5 million euros (30% up to 100 million euros + 5% on excess of 100 million euros, i.e. on 30 million euros). The tax credit is utilized to offset corporate tax liability. Unutilized tax credit is carried forward in the subsequent three years.
The resident company should satisfy following conditions to claim R&D tax credits:
- tax credits are taken into account in determining the tax base of the company;
- it relates to R&D activities carried out within the European Economic Area (EEA);
- it is not attributable to the French company’s permanent establishment outside the EEA.
An R&D credit is available for innovation expenditures (e.g. prototype design) for small and medium-sized enterprises (SMEs). This credit amounts to 20% of the expenditures, up to 400,000 euros (i.e. the maximum credit is 80,000 euros—20% of 400,000).
Special Regime for Innovative New Companies
A special regime for innovative new companies applies to SMEs, where the equity share capital is owned by an individual. The following conditions must be satisfied to qualify for the regime:
- the company must have been in existence for less than eight years;
- the company must not have been formed by restructuring of existing entities;
- the company must carry out R&D activities with a value of at least 15% of its total deductible expenditure.
This regime also applies to new academic enterprises, in which students or graduates of a masters or doctoral program or teacher-researchers hold at least 10% mainly involved in the development of research. It grants full exemption from corporate income tax for the first profitable 12-month period, and a 50% exemption for the next profitable 12 months.
This regime also grants exemptions or concessions from various other taxes such as:
- exemption from property tax and/or the local economic contribution for seven years with prior approval from relevant local authorities;
- exemptions for eight years from employer social security contributions for certain categories of employees involved in R&D operations.
Patent Box Regime
In line with Organization for Economic Co-operation and Development recommendations (BEPS Action 5), the Finance Act modifies the existing French patent box regime. Under this approach, the major part of R&D activities must be carried out in the country offering the preferential regime, and there must be a direct link between the income benefiting from the preferential treatment and the R&D expenditure that contributes to the income.
Taxpayers must evidence expenditure and income to IP assets to justify that their IP income qualifies under the regime. In other words, the favorable tax treatment of IP income must be linked to the underlying R&D activities undertaken by the taxpayer in the country where it obtains preferential tax treatment. Effective from January 1, 2019 the preferential corporate tax rate was reduced to 10%.
Income and gains from patentable inventions (not patented) are still eligible for the preferential regime. The French National Institute of Industrial Property must certify patentable inventions. The new regime is now available only to SMEs. It applies to the income derived from sale of patents, licensing, plant variety rights, industrial manufacturing processes, and copyrighted software.
The preferential tax rate of 10% applies to the net licensing income (or sub-licensing, etc.), which is determined in three steps:
- Tax base (A) is the difference between (should be positive result):
- the income generated from eligible assets during the financial year; and
- R&D expenses related to these assets and incurred, directly or indirectly, by the company during the same financial year.
- Nexus Ratio (B): the law provides a recapture mechanism for the first tax year during which an item of income becomes eligible for the special regime. This mechanism takes into account eligible expenses incurred in past tax years. In order to include the nexus approach, the net income is then calculated annually based on the following ratio:
- numerator: 130% of R&D expenses directly related to the creation or development of the intangible asset, directly incurred by the taxpayer or sub-contracted to unrelated companies in France;
- denominator: all R&D or acquisition expenses directly related to the intangible asset and directly or indirectly incurred by the taxpayer and sub-contracted to related parties.
- Tax base (A) is multiplied by nexus ratio (B) to arrive at a result on which the preferential tax rate of 10% is charged for payment of corporate tax.
The regime is subject to a formal election in the annual tax return for each asset, good, or service, or category of good or service. In addition, the taxpayer must (i) add an appendix to its annual tax return showing how the net income and the nexus ratio is calculated for each asset or category of asset, and (ii) prepare a defense file in case of a tax audit.
The Finance Act also provides that eligible royalties paid to related parties that are not located in an EU/EEA member state and benefit from a privileged tax regime on the royalties must be subject to tax at an effective rate of at least 25% in the same tax year; otherwise, a portion of the royalty is not deductible.
R&D tax credits provide a source of cash that a business can use towards developing new products and processes or enhancing existing ones. Businesses operating in the above countries should consider the impact of the R&D credit that is available to them, which can help in reducing tax costs. Start-ups that do not generate income or insufficient income to make full use of the R&D tax deduction are entitled to receive a cash refund of the incurred R&D expenses.
Businesses should consider:
- whether they satisfy all conditions to claim the incentive. Only direct expenses such as salaries of researchers, consumables, depreciation on assets used in development of research, etc., are eligible to qualify as R&D expenses;
- details of research work carried out;
- maintenance of documentation to provide evidences during tax audits;
- detailed workings of the calculation.
Businesses can also explore the possibility to apply for a tax ruling to avoid any uncertainty on R&D tax credits.
Disclaimer: The content of this article is intended for general information purposes. You should always seek professional advice before acting. No responsibility is taken for any loss because of any action taken or refrained from in consequence of its contents.
Rajeev Agarwal is an international tax expert.
He may be contacted at email@example.com.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.