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Tax incentives to promote R&D – Frequently Asked Questions

European Commission - MEMO/06/440   22/11/2006

Other available languages: none


Brussels, 22 November 2006

Tax incentives to promote R&D – Frequently Asked Questions

(see IP/06/1598)

What are the most common R&D tax incentives?

R&D tax incentives usually provide for a reduction of the cost of research by reducing the amount of corporate tax paid.

The three basic types of corporate tax relief are: tax deferral; tax allowance; and, tax credit (in the form of tax refunds).

  • A tax deferral is a delay in the payment of taxes, which typically takes the form of accelerated depreciation (eg the full deduction of current R&D expenses). In principle, certain forms of tax deferral exist in the tax treatment of R&D in nearly every country.
  • A tax credit can either reduce a company’s tax bill or, for some small or medium sized companies, provide a cash sum.
  • Finally tax allowances are the amount of R&D expenditure which can be deducted from the actual amount of expenditure incurred, for the purpose of ascertaining the total taxable.

Several Member States have also introduced tax incentives which aim at reducing the cost of employing research personnel. These incentives are used where a policy objective includes the need to increase the number of researchers. The specific benefit of such an approach is that targeted firms use upfront tax relief to carry out R&D activities. These incentives typically take the form of a reduced level of wage tax or social contribution charge for personnel directly involved in R&D activities. These incentives are directly beneficial to the enterprise engaged in the research. Other incentives can offer tax advantages at the level of individuals or firms – for example, individual or corporate donations to foundations which fund or undertake R&D are tax-deductible.

Which R&D tax incentive could be considered incompatible with EU law?

When analyzing a R&D tax incentive, the Commission considers explicit territorial restrictions as incompatible with EU Treaty freedoms. Examples of such explicit restrictions include legal provisions which limit the R&D tax incentive to R&D activities performed domestically. Such territorial restrictions are considered to infringe the freedom of establishment by excluding companies from conducting or sub-contracting their R&D elsewhere in the EU.

An example of an implicit form of territorial restriction would be an R&D tax incentive which is formally open to R&D costs incurred anywhere in the EU but only after approval by an authority in the Member State providing the tax incentive. When such approval is only needed for R&D costs incurred abroad, or if the administrative burden is much heavier for non-resident companies wishing to provide R&D services, the result is that domestic R&D performers are clearly favoured over non-resident, leading to possible infringement of the freedom to provide services.

On the contrary, territorial restrictions which simply reflect the territoriality of the tax competence of Member States could be deemed as compatible with the EC Treaty. For example, a wage tax or social security incentive for R&D personnel might by its nature be limited de facto to persons performing R&D activities in the Member State in which they are taxed or pay social security contributions.

In which case could the R&D tax incentives infringe the community state aid rules?

R&D tax incentives could constitute State aid if they distort competition by favouring certain undertakings or the production of certain goods and affect trade between Member States.

One of the main criteria is the selectivity of the R&D tax incentive. An R&D tax incentive is considered selective if its potential beneficiaries are restricted notably in terms of size (e.g. to SMEs), location or sector and as such is likely to constitute State Aid.

Furthermore, direct tax measures that pursue general economic policy objectives by reducing the tax burden related to certain production costs (including R&D costs) normally do not constitute State aid if they apply without distinction to all firms and to the production of all goods and services.

In certain cases, R&D tax incentives that constitute State aid may be compatible with the Treaty on the basis of Article 87(3). The Commission has also adopted today a new revised Community Framework for State aid for research, development and innovation (the Framework)[1]. It gives more detailed response to the question. (see MEMO/06/441)

What are the good practices observed?

In principle, the utility, scope and level of tax incentives will vary according to the Member State's specific conditions on the existing industrial structure and level of business R&D, macroeconomic situation and overall tax environment.

Notwithstanding that, research on design features of R&D tax incentives shows that Member States and the business community favour such a design of R&D tax incentives that includes elements of simplicity, low administrative and compliance costs, reliability and stability:

  • incentives should be transparent and easily accessible to a broad range of firms to maximise the uptake and hence the increase in R&D and innovation activity,
  • in order to provide reliable and stable framework conditions for firms, the incentives should be established for relatively long time periods and there should be effective and simple application and auditing rules for firms and administrations,
  • certainty should be maintained regarding the amount of tax relief in cases where the level of profit of a firm may vary in time which allows firms to plan investments ahead in time,
  • the nature and basis of incentives should not change too frequently in order to enhance the predictability of eligible R&D activities and costs,
  • when designing R&D tax incentives, policy makers should already clearly identify which data will be needed for their evaluation, and how to collect these data.

How could an EU initiative for Large R&D European projects improve the effect of the project?

The past experiences have indicated the importance of having a coordinated financing mechanism to facilitate large scale EU R&D projects. Parties involved will increasingly require the pooling of financial support from different Member States. Once this is the case, success will partly rely on effective financial engineering, i.e. the capacity to ensure timely and coordinated national support to each industrial participant.

Unfortunately, several Eureka[2] activities only started after every participant had received all of the National financial support, resulting in long delays before the project could start and this even resulted in the cancellation of certain projects.

To resolve these issues, Member States may wish to consider using specific R&D tax incentives for their timeliness and predictability over the duration of a research project instead of solely funding such projects through grants.

How could we improve the cross-border mobility of researchers using tax incentives?

In the context of the European Research Area we argue that we want our researchers to be more mobile and to work with more colleagues in other Member States– building on each others' expertise.

However, researchers currently face a number of administrative difficulties when they want to do this – be it for short or long stays. Therefore, there is a real need to address these issues for example through:

  • the provision of tax free allowances for the actual expenses made for mobility (e.g. travel expenses);
  • improved transparency regarding specific tax incentives which might also be available for researchers (e.g. expatriate tax incentives);
  • avoiding double taxation by improving transparency on provisions from bilateral tax treaties and domestic legislation which are relevant for cross-border researchers and by allowing researchers to maintain fiscal residence in their country of origin for a limited period of time (eg 3 years or more).

How could we improve the functioning of Foundations?

Research foundations are private entities with the objective to enhance scientific knowledge by funding R&D activity, typically in public universities and research centres. However, since certain formal and informal obstacles and disincentives inhibit both donations by individuals and corporations on the one hand and the flow of funds to research on the other, this source of funding is under-exploited.

Therefore, there is a need to improve the tax conditions for cross-border donations and foundation activities to create a level playing field in the EU. Member States are invited to reflect on a common approach regarding i) the tax treatment of the foundations themselves, irrespective of where foundations are established in the EU, and ii) the definition of public-benefit organisations receiving R&D subsidies from the foundations.

How could cross-border outsourcing of R&D be facilitated?

In the case that R&D tax incentives could benefit companies irrespective of where R&D is performed within the EU, it could facilitate any claim on a tax incentive if it is ensured that administrative procedures applied do not discriminate companies on the basis of their origin within the EU.

An example of such a procedure of facilitation used in some Member States, e.g. France and Spain, consists in offering companies the possibility to request an agreement or certificate whereby they are recognised as firms capable of performing R&D. Such certificates, which are valid for several years, are later used to facilitate processing of tax relief claims by tax authorities.

Member States are invited to reflect on a solution where a company established in a Member State should be able to request, where appropriate, such a certificate from another Member State. As an alternative, Member States could also agree on the content of such certificates and agree to mutually recognise them as equivalent, resulting in a lower administrative burden for the companies involved. In some Member States, public entities performing R&D are automatically granted such certificates. In that case, equivalent public entities established in other Member States should be granted the same advantage.

What are the VAT problems relating to R&D incentives?

VAT on R&D costs incurred by taxable persons is deductible where the goods and services in question are used for VAT-taxable transactions. The current rules of the 6th VAT Directive concerning exemptions, public authorities and subsidies may affect this deductibility and hence place an unnecessary burden on certain research activities.

The Commission intends to make a proposal in 2008 in order to modernise the current rules.

When reviewing the legislation, the Commission will critically examine the restrictions on the recovery of VAT on R&D expenditure. It will also consider to what extent the current rules on public authorities and subsidies hamper the creation of public-private partnerships and cost-sharing arrangements, including in the research field where such structures are increasingly being used to conduct R&D efforts requiring the pooling of resources from public and private entities or the outsourcing of research by private entities to public ones (contract research).

The application of current VAT rules to public entities is complex and leads to inconsistent results across the Community. Furthermore, the difference in VAT treatment between public and private entities causes distortions of competition, produces economic inefficiencies and encourages tax avoidance schemes. The Commission will examine ways of simplifying these rules and facilitating their more uniform application throughout the Community in order to secure a level playing field in those sectors of activity where both public and private entities intervene, e.g. the provision of contract research.

Is the Commission prepared to introduce a R&D tax incentive in the Common Consolidated Corporate Tax Base?

In the longer term, it is desirable to seek an EU-wide tax definition of R&D and innovation and to give such expenditure favourable tax treatment in the common consolidated corporate tax base (CCCTB). The Commission will include this in the relevant working group discussions with Member States, with a view to defining a coherent and well-balanced solution in line with other possible incentives within the CCCTB.

Which EU Member States currently have implemented R&D tax incentives?

Currently 15 of the 25 EU Member States have tax incentives for business research and development in place: Austria, Belgium, Denmark, France, Hungary, Ireland, Italy, Malta, the Netherlands, Poland (2006), Czech Republic (2006), Portugal, Slovenia, Spain and the United Kingdom.

What is the EU Member States' progress with regard to the 3%-objective? Do we have figures on the current R&D expenditure in proportion to GDP?

After a period of slow but continued growth between 1997 and 2001, the EU-25 R&D intensity has been stagnating in 2002-2003 at 1.90% and slightly decreasing after that (in 2004, the EU-25 R&D intensity amounted to 1.86%). This is strongly linked to the poor growth performance of some big R&D spenders such Italy, the UK and France. As in the US the downward trend of the 2000-2002 period seems to have come to an end, the deficit in R&D intensity of the EU versus the US is increasing again since 2002.

[ Figures and graphics available in PDF and WORD PROCESSED ]

[1] RDI Framework

[2] EUREKA is a pan-European network for market-oriented, industrial R&D which aims to enhance European competitiveness through its support to businesses, research centres and universities who carry out pan-European projects to develop innovative products, processes and services.

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