By Barry Visser, Associate Director Grant Thornton Johannesburg
Recent Research and Development (R&D) legislative amendments substantially changed the nature of the R&D allowance contained in section 11D of the Income Tax Act. However, despite the significant changes, this allowance still seems to fail to encourage many companies to undertake R&D. We highlight the most significant barriers and provide suggestions to benefit from the allowance.
It was generally welcomed that the initially proposed requirement that the R&D in South Africa should be “world-beating” in order to qualify for the tax allowance, did not find its way into the final legislation. However, there are various other amendments where clarity is still required or amendments are proposed.
R&D Definition
The word “innovative” has been inserted, but without its own definition. This leaves the word open to subjective interpretation. This interpretation was previously left to the discretion of the Minister of Science and Technology; however, a clear definition is required.
The insertion of the term “functional design” is considered to be limiting. Effectively, only designs with a functional purpose will now qualify, thereby excluding designs where it may be difficult to distinguish between aesthetic or functional purposes.
The replacement of the words “developing or significantly improving” with “making a significant and innovative improvement to” implies that only a successful research project will qualify. It disregards that R&D by its very nature involves trial and error, and where there is error a research project may not necessarily result in an innovative or significant improvement. We suggest that the reintroduction of the word “developing” should be considered.
However, what was made clear under the excluded activities section – which was previously separately listed but is now included as part of the R&D definition – is that internal business processes for sale or granting of right of use to connected parties, is not permissible.
Qualifying expenditure
One amendment that came through as a surprise is that previously 100% of qualifying expenditure could have been claimed with no approval and only the 50% uplift allowance required pre-approval by the Department of Science and Technology (DST). Now, the full 150% requires approval and it should be noted that only R&D expenditure incurred after receipt of the approval by the DST may be claimed. This means much more administration, especially where a company was previously satisfied with not claiming the 50% uplift allowance. It will require careful planning not to miss the potential deduction on expenditure incurred prior to application to the DST.
3rd party carrying on R&D on behalf of taxpayer
In the absence of addressing practical problems encountered in this area, we welcomed the announcement in the recent Budget Speech, that the unintended consequences for entities funding research and development activities carried out by another party will be removed retrospectively from 1 January 2014.
Minister to designate deemed R&D activities
The Minister of Finance, in consultation with the Minister of Science and Technology, may prescribe special R&D criteria by regulation.
In this regard there is a special dispensation, for example for the pharmaceutical (generic medicine and clinical trial) industry and in the recent Budget Speech it was further proposed that the barrier to the first three phases of clinical trials being eligible for the R&D allowance will be removed retrospectively from 1 January 2014.
Proposed solution
The aim of the R&D allowance must be to encourage investment in R&D across all industry sectors and not only to promote some. However, further clarity is required regarding the intention of the activities that should be included as well as the industries that are targeted for the R&D incentive. We propose that broad-based consultation, to include all industries, needs to take place.
In the meantime, we recommend that companies investing in R&D activities submit applications to receive the deduction on qualifying expenditure. Contact Grant Thornton for help to complete the application.