Below is the Speech Given by Dov Paluch at the Minister’s Business Breakfast on R&D Tax Incentives on Friday 21 August 2015. Dov benchmarked the incentive globally highlighting the need for the incentive to change while providing several recommendations.
Honourable Minister for Science and Technology and senior members of the department / Members of the National Treasury / Members from SARS / Ladies and Gentlemen …
We often hear of people criticizing our government, but the R&D Tax Incentive is an example of our government implementing a far-sighted policy in line with many other countries around the world. We need to applaud our government for its policy intentions around this incentive and showing an interest in making it work. The incentive will however succeed or fail based on how it is implemented. And upfront, we must acknowledge that all of us, Government, Practitioners and Taxpayers are united in trying to make this incentive work for the betterment of South Africa.
I thank you for the opportunity to talk to you today and share some of our experiences and thoughts on this incentive from a tax practitioner’s point of view as well as share some of the experiences of our clients. Other practitioners may have other experiences that they can hopefully share during the course of this morning.
As the Minister pointed out, this morning is a great time to think about the purpose of the incentive and whether it is achieving its goals. In this talk, I hope to present to you the strengths and the weaknesses that we have observed during our time working with the incentive. I will also propose some recommendations.
In order to do that, I feel that it is important to take stock of where we have come from with the incentive and where we want to go through studying two elements of the incentive:
- Policy – Type of incentive, rate of the benefit and qualifying criteria; and
- Administration – How is the incentive implemented?
3 years ago, the R&D Incentive Landscape was extremely uncertain. SARS were responsible for administering the incentive and seemed to be conducting technical reviews on R&D claims many years after submission.
Pharmaceutical R&D was being rejected and all software R&D was being classified as relating to Internal Business Processes and therefore excluded from the incentive.
It is important to note that while the policy of the incentive was unclear, the incentive was administratively easy to access for taxpayers.
Let’s now move forward to today where the tax incentive is now 3 years into its revised format.
With the DST taking over the responsibility of the technical elements of the incentive, the policy intent behind the legislation seems to be coming through in a stronger way.
The rate of the benefit has remained the same, but the qualifying criteria seem to have been clarified somewhat. While certain “harsher” innovation criteria have been added, there seems to be an acknowledgement from a policy perspective that the government wants to incentive more genuine R&D taking place in South Africa.
Pharmaceutical R&D is a great example of this. After a 3 year struggle, the legislation has finally clarified the intention of the incentive.
However, the impressive policy intentions of the legislation (as reiterated by the Minister) are in danger of falling flat as a result of the administration of the incentive. While we acknowledge the Department’s efforts to improve, these issues can no longer be seen as teething problems relating to a new type of incentive. These are systemic issues that need to be dealt with.
This is not a laundry list of complaints about the incentive, but it is important to discuss its current shortcomings which I feel can be broadly categorised into two main areas: factual and perceived.
We are all aware of the main factual issues (and the Ministry will acknowledge these):
- Extremely long waits and backlogs – companies unable to plan to receive the incentive.
- Application form and process are cumbersome and repetitive.
- There is no appeal process – taxpayers feel that this is procedurally unfair. This is especially relevant as taxpayers are receiving rejections so long after application.
- There are no Guidelines – we are still waiting on official guidelines since 1 October 2012.
- There is very little benefit to SME’s – many of whom are in a tax loss situation.
- Lastly – taxpayers are complaining about the administrative burden associated with pre-approval – for companies conducting multiple projects throughout the year this process becomes a nightmare taking them away from their real jobs. Not to mention the progress reports that need to be completed as well.
These are the factual issues, but it is also important to look at the general perceptions of taxpayers about the incentive.
There are a lot of ‘horror stories’ in industry about the R&D Tax Incentive. Many companies that we speak with that are undertaking genuine R&D are reluctant to apply for the incentive because they have heard of others who have been badly burnt. There is a perception that the incentive is too hard to get and not worth the effort. Here is why …
It is felt that the interpretation of the legislation is being looked at too narrowly – Or in fact, that the legislation itself is too narrow. A well-known frustration is within the software industry – how is it possible that approximately 70% or more of software applications are being rejected? If Whatsapp, Facebook or Meerkat would be presented to the committee today, would they be seen as routine developments? There are groundbreaking technologies being developed in SA that are being dismissed as minor and routine.
In addition, Taxpayers feel like they are not able to maximise the incentive – they can only claim on larger projects – while smaller, more immediate projects can’t be claimed as there is not enough time to pre-approve them and the administrative burden outweighs the financial gain.
But most importantly … There is a general perception in the industry of not knowing what is taking place behind the closed doors of the adjudication committee … which is problematic for a number of reasons:
Taxpayers are feeling like they are not being heard and are unsure if their entire application is being looked at. This leads to a perception of an inconsistent application of the law where there can be similar projects with different adjudication outcomes.
If the policy discussions and interpretations would be shared with the public, it would enable them to bring applications more in line with the intended policy rather than clogging up Department’s time with applications that should not be there.
The DST has gone some way to fixing the issues and there are companies that have received approvals.
It is encouraging to see that when discussing the incentive with our successful clients, it appears that when they eventually do receive the benefits what they are able to do with them match the goals of the incentive. They can afford to market and advertise more – bringing more money into the country – leading to them to hire new staff in SA. They also reinvest the tax savings into undertaking even more R&D.
On the improvement front, the letters coming from the Minister are now more detailed, the department seems to be doing better with communication and as commented to me by one of my clients, although it took a long time to finally receive approval, the department seemed very approachable and willing to take on feedback – all of this needs to continue.
However, even if the DST were to get through the backlog and have a quicker turnaround time, I fear that this is only as a result of fewer applications coming in. We need to design a system that is robust enough to cater for the fact that many more companies (not less) should be applying for and receiving this incentive.
This leads us to a discussion on where we want the incentive to go.
When thinking strategically, we need to look at why we have the incentive …
Looking specifically at the SA need … We are lagging behind on most global innovation indexes (whether it is the Bloomberg Innovation Index, or the OECD Competitiveness Index, SA is not where it should be). In addition, SA is trying to increase Expenditure as a percentage of the GDP from 0.76 to 1.5%. This metric has not changed for 3 years … This is a very ambitious goal. We can only achieve these goals through an improvement in the incentive from both a policy and an administrative perspective.
When benchmarked globally – the additional 50% deduction sits somewhere in the middle of what other countries are offering. But for a country trying to significantly increase expenditure on R&D, perhaps being an average incentive is not good enough.
We need to provide a significant reason for R&D to be done here in SA rather than overseas, and perhaps a 14% after tax benefit that needs to be pre-approved is not enough of an incentive to achieve the government’s lofty goals.
So here are six points on how to improve it (and these are by no means exhaustive) …
- Increase the rate of the benefit – We need to provide more of a carrot for companies to conduct R&D in SA – We are in a globally competitive market and other countries are offering up to 300% additional deductions.
- Clarify (and perhaps relax) the qualifying criteria – Either from an interpretation of the legislation or the actual legislation itself. It is important for the public to understand what type of R&D the government is trying to incentive. Looking at global incentives, Singapore only requires companies to conduct development on products that are a “first in Singapore” and not globally. We need guidelines and it is important to implement some form of an appeals process.
- Make the incentive more meaningful for smaller companies. These are companies that are hugely important to innovation in our economy – most in tax loss – many countries provide for a refund for smaller companies. We need to follow suit.
- Following on from this … As recommended by the OECD, it is important to balance cash and tax incentives.
At the moment, the cash incentives on offer for innovation (like SPII) are falling flat.
- Make the incentive easier to administer and easier to access – We need to seriously reconsider the Pre-approval system – SA is globally unique in instituting a pre-approval system – most would agree that there is a need for a change to either a retrospective system or a combination of the two. A pre-approval system seems to simply add to the administrative burden of both the government and taxpayers. Why not have companies submit an annual R&D application to the DST (as is done in Australia – as an eg. – for the incomplete 2013/14 period – AusIndustry has received over 13,000 company registrations worth over $18 billion – our numbers pale in comparison). and
- Finally – Open additional lines of communication – Open continual communication channels for interaction with the public. Send out regular updates with statistics and guidance.
To summarise, both the policy and the administration need a revamp.
My most important recommendation however is the following: In order to ensure that this morning is not simply a once-off, we strongly suggest setting up a joint task team (made up of Government and industry) to review the incentive and all suggestions, and to report back to the Minister on how to develop a sustainable solution.
Bill Gates recently posed the question when discussing Energy Innovation … “Why should governments fund research?” … He answered by saying … “For the same reasons that companies tend not to: because it is a public good. The benefits to society are far greater than the amount the inventor can capture.”
So we must once again applaud the government for its efforts thus far in incentivising private sector innovation. But there is still a lot of improvement required to take this country to where we all know it could be. Given that so many other countries are providing incentives for R&D, we need to make sure that we are not only attracting foreign companies to setup their R&D operations here, but that we aren’t also losing local innovators to foreign markets. The incentive is an essential part of the SA R&D Landscape and it is imperative that we get it right.
I commend the Minister and her team on engaging with the public. Many companies here this morning have global experience that could assist the Ministry on its path to achieving its goals of increasing R&D and innovation in South Africa.
Whilst incentivising private sector R&D in SA has come a long way, there is still more that can, and should, be done. Let’s use events like this to create a positive discussion on how we can take this much needed incentive forward in South Africa.