Author: Joon Chong, Partner, Webber Wentzel
The Budget has the task of funding a projected revenue shortfall of ZAR 48.2 billion in 2017/2018 and also of promoting economic growth in an economy which has shown signs of lethargy in recent times. One of the measures the Budget proposes to boost the economy is through better use of tax incentives, including the research and development (R&D) incentive in section 11D of the Income Tax Act (ITA).
The R&D incentive in section 11D of the ITA currently allows taxpayers to deduct 150% of expenditure incurred on qualifying projects. Currently, section 11D requires taxpayers to apply for pre-approval of their R&D projects from the Department of Science and Technology (DST) before the taxpayer may qualify for the 150% deduction. The committee tasked with approving these applications consists of three individuals from the DST, one from National Treasury and three from the South African Revenue Service (SARS). Over the last two years, the DST has worked to reduce the backlog of applications through measures such as moving to an online system to process applications.
The Budget proposes that aspects of section 11D which have created complexity in accessing the incentive and the backlog of applications would be considered for revision. These simplifications are to be welcomed in order to ensure that the R&D incentive achieves maximum impact to encourage innovation, skills development and employment.
A joint government-industry task team was established to review the R&D incentive and the task team issued its final report to the DST on 15 April 2016 (R&D Report). Among the recommendations made in the R&D Report were that the procedures to access the incentive be improved, including using a simplified application form, providing new guidelines, ensuring coherence of information provided on the DST website and updating SARS Interpretation Note 50 on the documentary requirements to claim the incentive. There should also be increased internal administrative staff as well as additional external experts to assess the applications. The DST plans to increase the number of experts to 20 who will assist with clearing the backlog. The DST also has a target to provide the pre-approval decision within 90 days of receiving an application. The R&D Report also recommended that the pre-approval system be examined to determine whether it would be possible to change to a retrospective system. The retrospective system would allow companies to register to indicate their intention to undertake R&D in the year ahead and to submit details of the R&D undertaken at year-end. The claim stage would thus be at the year-end when companies would have most of the information required on the R&D expenditure undertaken. The current pre-approval system requires companies to submit R&D information, plans and budgets before actual R&D activities, spending and progress reports are undertaken. The current pre-approval system is uncommon when compared to international best practice as the detailed R&D information and costs required for the committee to make a decision on an application may not be readily available to an applicant before or at early stages of the R&D project. The complexity of information, the application requirements and processes increase the need for consultancy services and reduce the benefits of the incentive.
On measures in place for taxpayers to claim the tax deduction from SARS, the R&D Report observed that delays in obtaining the approval has prejudiced applicants as they would only receive a deduction after two or three years of incurring R&D expenditure. Taxpayers generally avoid re-opening their submitted tax returns as this could trigger a larger-scale audit. Further, if it is not possible to submit revised tax returns, taxpayers would need to lodge objections to existing assessments which may take months or years to finalise and for refunds to be paid. The R&D Report recommends that DST consults with SARS on the issuing of guidelines on information requirements that taxpayers should prepare when claiming the deduction. Furthermore, the R&D Report recommends that SARS publish summary tables annually in aggregated form and per industry, of amounts claimed, amounts allowed and amounts disallowed under this incentive.
To address the challenge of the lengthy delays in receiving feedback on applications and prejudice suffered by applicants, the R&D Report recommends a once-off amendment to section 11D to allow taxpayers a once-off cumulative tax deduction in the year of assessment in which the pre-approval is received from the DST.
The R&D Report also recommends that aspects of the eligibility requirements in section 11D be clarified. The requirement of "innovativeness" should be relaxed to allow a certain level of adaptation of technologies that are new to the country (and not necessarily new to the world). To encourage a critical mass of innovative activities, the R&D Report proposed the criteria of "new to the firm" be considered, provided the knowledge will not generally be available in the public domain.
The R&D Report made a key observation that the requirement for uncertainty in software development was counter-intuitive as the existence of uncertainty could result in the cancellation of the project. The R&D Report observed that the high rate of rejections of applications with information and communication technology (ICT) related activities indicate that the policy intent in section 11D and the ICT activities taking place are not aligned. The DST intends to initiate a separate process to review available support for R&D activities in ICT. This is to be welcomed.
The R&D Report recommends that section 11D(1) be amended to remove the requirement of "uncertainty" from the eligibility requirements for software development. Further, the R&D Report also recommends that the DST issues regulations or guidelines to provide much needed clarification on how the eligibility criteria for software development would apply in practice.
Annexure B of the Budget provides estimates of tax revenue that is foregone as a result of deductions, exemptions and rebates. R&D expenditure in this annexure has seen a steady decrease over the years from 361 million in 2011/2012 year, 340 million in 2012/13, 163 million in 2013/14 and 34 million in 2014/15. We hope that any proposed amendments to section 11D in the 2018 draft bills take effect sooner rather than later, and that they could be implemented and have an impact on R&D as soon as possible. As can be seen from the "revenue foregone" from the R&D deduction/incentive claimed, there has been a significant decrease of amounts claimed over the period.