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Tax incentive for R&D hampered by backlogs and complexities

Despite policy change being made four years ago.

The Department of Science and Technology (DST) has only received 92 applications for its research and development incentive since September this year.

The significant drop from 311 in 2013 has been attributed to the preapproval system that was introduced in 2012. Companies have to obtain approval for their research and development before they can claim the deductions on project related expenses.

This (preapproval) introduced huge backlogs with companies waiting for more than three years to get approval.

In a country like Norway, 6000 applications for a similar tax incentive are being processed in a couple of weeks. The Australian government received around 17000 applications for its incentive in 2014.

Dov Paluch, director of global innovation incentives at Catalyst Solutions, says the preapproval system – South Africa is the only country to have one – has added a huge administrative burden on the taxpayer and government.

At a recent meeting between the DST, National Treasury, the South African Revenue Service and industry players concerns about the effectiveness of the incentive were raised.

The DST (which approves applications) and National Treasury (which pays the incentive) do not see the need to make a policy shift, yet. They did say they will review progress made so far to see if it is sufficient to result in a “suitable level of efficiency”.

Paluch says the response to industry players is that government is getting better at administering the process.

“My fear is that they are getting better at it because there are less applications. We need a process that is robust enough to handle many more applications and not less applications.”

Paluch, who was a member of the task team appointed by the Science and Technology to review the incentive, expressed disappointment that very little progress has been made since the release of the report earlier this year.

Several recommendations have been made, among others that South Africa should consider a “more refined retrospective” system.

Government has ambitious goals. It wants to increase research and development (R&D) spend to 1.5% of GDP. “It is not even close to that. If you want to do that you need an ambitious incentive. You cannot do that with an average incentive.”

The only recent amendment to the incentive is to allow companies to reopen their tax returns in order to claim the deductions relating to the research projects, even if the time to do so has lapsed (prescription).

Duane Newman, joint managing director of Cova Advisory, says the continued disallowance of the deduction because of a tax technical prescription rule would have further undermined the buy-in on the benefit.

“Once there is a disconnect between the tax incentive and the project, in terms of delays and complexities to navigate, it will become a self-fulfilling prophecy. The incentive will not have the impact on R&D government anticipated,” says Newman, who is chair of the South African Institute of Tax Professional’s incentive committee.

The incentive has been in place for a decade, but the policy change in 2012 introduced a pre-approval system which led to the huge backlogs.

Paluch said the best possible process is “some form of retrospective system” which is being applied by all the jurisdictions offering such an incentive, except South Africa.

He says small South African businesses and start-ups are also not benefitting from the incentive, since most are in a tax-loss position and the incentive only increases their tax loss.

Several countries, including the UK, have a refundable tax allowance. If a small company or a start-up is in a tax-loss situation, it can convert the R&D tax deductions into cash.

According to Paluch, the UK has paid out over £1 billion to SMEs. The South African government does not want to go this route, probably because of tight budgets, he adds.

Government does consider the introduction of an appeal process if a company’s application is rejected. At the moment the adjudication committee will look at the application, make a decision and that is the end of it.

There is no recourse if the application is rejected. The ministerial task team has recommended that before the final decision is made, the company must be able to amend its application.

“Hopefully it will be implemented soon if the recommendation is accepted,” says Paluch.

Government will also consider its qualification criteria for software R&D. Currently only 30% of the applications are successful.

Paluch says the criteria that the research must be on a “global scale” or “a world first” is unattainable.

A company should be incentivised if it develops software that is a first for South Africa, which means it does not have to imported. Other jurisdictions provide for “local innovation”, says Paluch.

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