The commercial structuring of R&D projects - Concequences on potential tax incentives
The manner in which R&D projects are structured will affect who is entitled to the potential tax incentives, and at what rate
Twin R&D tax incentives are available to taxpayers in South Africa (Click here for more details on these incentives).
The basic principle in the Income Tax Act is that the taxpayer funding R&D activities is the person entitled to the R&D incentives – but this principle isn't always easy to apply. In some cases, exceptions apply. This article considers the tax consequences that arise when multiple people play some part in your R&D projects. For example, we consider the consequences of:
• receiving a government grant for (partial) funding of R&D;
• receiving an instruction and/or funding from a client to conduct research on its behalf (commissioned R&D);
• a foreign company funding a research project in South Africa;
• conducting an R&D project jointly with one or more other companies –
How do these scenarios affect your ability to claim the R&D incentives on offer? We deal with each scenario in turn.
In a nutshell: if you receive government funding to conduct qualifying R&D activities, the "regular" supercharged deduction will be limited. In addition, the extent of the limitation will depend on whether or not the government grant is tax-free. The ultimate value of the deduction that can be claimed will also depend on how much of the project is self-funded.
The calculations can become tricky, and expert review is always suggested.
This is one of the contentious, "grey areas" of the R&D legislation. As a general rule in cases where R&D is commissioned:
• the person commissioning the R&D, and who is typically the person funding the project, is usually the person entitled to the supercharged deduction of 150% of qualifying expenditure, while
• the person who actually conducts the R&D activities is also entitled to a deduction under Section 11D, but this is limited to 100% of qualifying expenditure.
This is not as straight-forward as it may appear to be: complications often arise, and entitlement to the supercharged deduction might change in appropriate circumstances. Relevant factors here include:
• which of the parties was at risk in conducting (part of) the R&D project;
• the funding arrangement;
• the intention of the parties; and
• the contents of the underlying agreement.
It is just as important for a taxpayer to be able to establish their entitlement to claim the R&D deduction at a particular rate, as it is to be able to establish that the R&D activities qualify at all. Taxpayers who gloss over this issue place themselves at risk of overstating this tax deduction.
In an aggressive, positive introduction to the R&D legislation in 2008, a major incentive was introduced to South African taxpayers. To paraphrase the new incentive:
• if you are funded to conduct R&D in South Africa,
• by someone who does not pay tax in South Africa (typically, a foreigner or a tax-exempt body),
• then SARS will entitle you to claim a supercharged deduction on the funded expenditure, as if you paid that expenditure out of your own pocket!
This incentive is intended to make South Africa an attractive destination in which to conduct R&D. It offers the potential for a gigantic financial opportunity for South African taxpayers, particularly those who are part of multinational corporations.
Joint R&D Projects
The issue of entitlement to the supercharged deduction has already been described above. This issue very often arises in cases where two or more taxpayers collaborate on a project. In principle, there is no specific exclusion against two or more taxpayers claiming the R&D deduction for activities conducted on a single project. However, each taxpayer's deduction must be limited, strictly, to the value of the particular activities attributed to it.
It is always important that full, substantiating records are maintained to support R&D deductions. In the case of R&D projects, this is even more important.
The complications rise exponentially in these cases. Wherever possible, it is always advisable to take expert advice before embarking on a joint collaboration. Ideally, the underlying agreements should form a basis for entitlement to the supercharged deduction, and this issue ought to be dealt with thoroughly by all parties in the negotiations leading up to the launch of the project.
If this has been of interest to you, and if we can be of assistance, you're very welcome to contact us.