Whilst the Department of Science & Technology (DST) is the gatekeeper of pre-approving R&D projects in terms of current legislation (in place since Jan 2012), the proposed changes by National Treasury appear to simultaneously limit qualifying criteria while at the same time offer special dispensation for selective sectors (an example is companies undertaking clinical trials and development of generic medication, as well as IT companies).
On the face of it, we caution against introducing legislation that has one set of rules for a particular industry sector and another set for other sectors. The very aim of the R&D incentive is to encourage investment in R&D across ALL sectors of the South African economy. A broad based R&D system would certainly assist with the main purposes of the R&D Incentive, i.e. to promote private sector investment in R&D and to encourage employment in South Africa.
Refined definition – one step forward and two steps back?
Changes include refinement of the expenditure exclusions to now be related to the exclusions to the definition itself. The net effect is not expected to be significant, if at all, in the application of the legislation and therefore we question the rationale for the change.
The proposed amendments also removes the long standing qualifying section that allowed companies to qualify for the incentive if it undertook activities aimed at obtaining “knowledge essential to the use of such invention, design or computer program”. Furthermore, it proposes to deny a taxpayer if it fails to make a “significant and innovative” improvement.
This appears to totally disregard the very nature of R&D that involves trial and error, and that there are absolutely no guarantees that a research project will indeed result in a significant improvement. We recommend that the respective draft sections be amended to remove this presumably inadvertent error in drafting.
One needs to be able to walk first, before one starts running!
Applying restrictive innovative criteria as part of the pre-approval process, so as to limit R&D to projects that are only “world-beating” (as opposed to R&D undertaken to maintain a degree of competitiveness) is in our view, likely to deter companies from participating in the incentive as it does not reward South African companies to invest in projects that will allow them to at least compete on an even footing with technologies of foreign companies operating in far more developed economies than ours.
In other words, the implication is that government is not interested in helping South African companies that invest in local R&D in an effort to catch up with the rest of the world. We are confident that this may not have been intended and hope that proposed legislation is modified to reflect this. South Africa is after all, still a developing economy.
The proposed evaluation criteria of R&D needing to be 'world-beating' before an incentive will be provided, is as if to say that one will reward a South African company to invest in R&D if it plans to land a space-craft on planet Mars, but not if it invests in developing South African ‘home-grown’ technology to land a craft on the moon – simply because it has already been done before.
R&D is very much an iterative process, with varying incremental successes as well as failures. Local companies more often than not, do not have access to state of the art technology (which is mainly the case due to its inherent proprietary nature), we should be encouraging our local companies to invest in home grown technology that at least helps it to be competitive with companies that have a history of operating in much more developed economies where often their respective governments have already assisted them with incentives to advance their technology.
Retrospective application - being referee as well as rule maker after the match has begun!
Another major concern is that the proposed changes are to be applied retrospectively from 1 October 2012. Many companies, who have participated in the pre-approval process based on settled legislation promulgated at the beginning of last year, are now going to be judged by the DST & National Treasury on a different set of rules.
Retrospective changes should not be enforced because taxpayers who have applied for pre-approval would have relied on, and importantly undertaken investment in projects, on the basis of the current legislation. Often, the proposed projects are also planned for more than one year.
Many taxpayers also have taken tax positions in returns that have already been submitted based on current legislation, and will be discriminated against by the application of retrospective new amendments. It does indeed indicate a shifting of the goal-posts and is disconcerting for the many companies that were encouraged by the DST & National Treasury to participate in the R&D regime more than a year ago, and who did so in good faith.
Meaningful consultation with stakeholders and applicants needs to occur before legislation is promulgated. We also strongly recommend that any proposed changes that may prejudice taxpayers based on the adoption of the new proposed rules, should only be applied on a prospective basis to pre-approval applications that are submitted after the legislation is promulgated.
We applaud Treasury and the DTI in its effort to stimulate the economy by inter-alia offering tax relief via a reduced 15% corporate tax rate, accelerated depreciation allowances on capital structures (over 10 years) together with relief on VAT and customs as well as an employment incentive.
This is proposed to apply to companies (with effect for a 10 year period from years of assessment commencing on or after 1 January 2014) that operate within SEZs that are approved by the Minister of Finance after consultation with the Minister of Trade and Industry. Importantly, 90% of the companies income needs to be generated from services or the sale of goods related to the business in the SEZ.
We hope that due consideration will be made in ensuring that the commercial linkages to and from the SEZ is also in place. Too often, it is the high transport and related energy costs that hamper companies plans to relocate to an IDZ or an SEZ.
Lastly, the devil is in the detail and we will certainly be reviewing the proposed legislation and providing further comments to both clients and to National Treasury to resolve the inadvertent errors in drafting as well as challenge unfair discriminatory practices relating to retrospective application and conceptual design of the incentives.