The phrase “Research and Development” (R&D) tends to evoke images of white lab coats and laboratories. The provisions in Section 11(D) of the Income Tax Act in South Africa makes provision for the R&D Tax Incentive. It has the potential to turn everyday innovation activities in most businesses into an activity that can qualify for additional tax deductions.

Investing time and resources for the development of ideas into new products and services may help reduce the company tax burden. There is one significant hurdle though. The product or service that you develop will need to be new to you, and new to the world. One would guess that the assumption being made here is that South Africa has an abundance of resources and capacity in leading the world for high tech innovations on a daily basis. Leading from this is a set of onerous requirements that stringent and complex. The governing legislation around Section 11(D) of the Income Tax Act includes more complexity – it requires companies to apply and get approval for your project before the project starts.

Determining What Qualifies for the R&D Tax Incentive
An application to obtain approval for your project must meet the following criteria to qualify for the ‘super’ deduction of research and development expenses:

1. the research is scientific or technological in nature and integrates one of the hard sciences, such biology, chemistry, computer science or engineering
2. it creates a new or improved level of functionality, reliability, quality or durability, like designing for better performance
3. it hopes to eliminate uncertainty that was present at the start of the process
4. it involves systematic investigative or systematic experimentation

Guidelines to help determine whether you meet the criteria to be eligible for Section 11(d) corporate tax deductions:

• the purpose of the R&D – it must be for new knowledge or a new or improved process, product or service.
• a systematic approach is an organised and planned approach to formulate and test possible solutions to the uncertainty
• scientific or technological uncertainty exists if the knowledge
  • is not publicly available, and
  • cannot be worked out by a competent professional in that field
• scientific or technological uncertainty can arise when
  • it may be uncertain whether a goal can be achieved
  • you may be confident that the goal can be achieved but don’t know how to achieve it.
• there is scientific or technological uncertainty if a competent professional would need to undertake an investigative process to test, analyse or prototype possible approaches to achieving your goal, or
• there may be uncertainty (from a scientific or technological perspective) in relation to whether the output will meet desired specifications such as response time, reliability, reproducibility or cost.
• what matters for eligibility in South Africa is that your activities have a material purpose of resolving scientific or technological uncertainty.

How to qualify for the R&D Tax Deductions for business in South Africa

• as indicated above, the R&D activities must meet the defined criteria
• you should own the outcome of the Research and Development
• the R&D activities must take place within South Africa
• you should put in place a system to capture direct and indirect expenditure. You should be able to verify that such work was undertaken
• the R&D Tax Incentive does not apply to adaptation or duplication of an existing business component, or market surveys and studies conducted to improve a firm’s operations

You might be wondering-:

When do I Apply for the R&D Tax Incentive?

• firms would need to apply at the idea or hypothesis stage of a new project. It is important the the application is submitted before the development work commences
• the applicant would need to show they will be doing eligible R&D that qualifies as Research and Development expenses that are SARS tax deductible
• the pre-application may suit certain firms [contractors] that submit proposals to a client for a project. In this scenario, it would put the firm in stronger position as their systems may be geared to collect data on time and resource allocation. At the end of the day, it is irrelevant wether the project achieves the outcome, or the solution implemented.

Now:

What expenses would be eligible for deduction as Research and Development?

• salary and wages paid to employees when working on eligible R&D activities.
• cost of Sub-contractors working directly on the project

Note: You will need to ensure that expenses directly related to the approved project is recorded.

• other inputs such as ingredients, materials, prototypes, testing, data analysis, etc
• apportionment of Overheads to the extent they were incurred for the eligible R&D activity

Are Production or Commercialisation Trials Eligible?

• the initial trials that are conducted with a systematic approach will be an eligible R&D activity. As long as these attempt to understand and eliminate any uncertainty in the process or equipment.
• further trials, whether post commercialisation, or start-up of a new manufacturing site will not be eligible [as the technological uncertainty had been resolved with the first trials]. If, for some unexpected phenomena, the new equipment or processes or conditions expose unexpected problems requiring the resolution of scientific or technological uncertainty, there these may be considered as eligible R&D activities.

Every company conducting R&D in South Africa must seriously consider the R&D Tax Incentive as an opportunity to reduce their tax liability and boost their cash flows. During tough economic times, as we have now, this is of considerable value to any business that conducts Research and Development. The incentive is open to companies of all sizes in virtually any sector of the SA economy.  There is no minimum threshold or cap to the tax allowance.

The R&D Tax Incentive is provided for in Section 11[D] of the Income tax Act. It allows your company to deduct an additional 50% on Operational R&D Expenses from taxable income. This reduces your taxable income. The R&D Tax Incentive translates to an effective 14% reduction in SARS income taxes.

In order to qualify for the R&D Tax Incentive, you need to apply to the Department of Science and Innovation, before you start the R&D project. The R&D Tax Allowance is open to businesses of any size, in any sector of the economy. You have to be a registered taxpayer with SARS. The R&D activities must be conducted here in South Africa. Once approved you receive an application number.

So, what is the R&D Tax Incentive [also known as the Scientific and technological Research and Development Tax Incentive]?

South Africa’s Research and Development as a percentage of GDP needs to move towards the target of 1.5% – regarded as the minimum required to help us to compete globally. This target was set in the National Development Plan for achievement by 2030. The aim of this incentive is to encourage South African companies to invest in research and development.

The government introduced Section 11D into the Income Tax Act. This tax incentive enables a taxpayer to claim an allowance with respect to Research & Development (R&D) expenses.

All R&D expenses automatically qualify for a 100% deduction. The South African R&D Tax Incentive provides an additional 50 % ‘super’ tax deduction for certain R&D expenses. This translates to a net 14% income tax benefit. This means if a company spends R1 million on eligible R&D, its tax liability to SARS will be reduced by R140 000. For the investor or shareholder, the main effect is to increase the after tax return on investment. At a corporate tax rate of 28%, the incentive benefit translates into a benefit of 14c for every rand spent on R&D, thus reducing the marginal cost of R&D

What other deductions are available for companies conducting R&D in South Africa?

Section 11D provides another incentive that relates to capital equipment acquired specifically for Research and Development. An accelerated depreciation allowance is provided for capital R&D expenditure on building, machinery, plant, implement, utensil or article. In terms of this accelerated depreciation allowance, 50% of the cost of the asset may be claimed in the year during which the asset is first brought into use, 30% in the subsequent year and 20% in the year thereafter.

What are the company requirements to qualify?

To be eligible, a company must be an incorporated entity and recognised as a company under the Income Tax Act. Individuals, non-profit organisation and trusts are not eligible.

In order to qualify, the company [taxpayer] must comply with the following requirements for the expenditure to qualify for the 150% allowance.

1. The R&D expenditure must be conducted as part of your normal business and trading activities.
2. The R&D activities must be conducted in South Africa.
3. The R&D project and activities must need certain criteria as defined in Section 11D

What happens in the case where R&D is funded by third parties or grants from government. Can I still qualify for the R&D Tax Incentive?

A company that funds R&D undertaken by another company can qualify for R&D tax deduction, provided that the funded company does not claim. A company can also claim a deduction for R&D that it outsources to a South Africa university or science council. Companies in joint ventures (JVs) can claim to the extent that they fund the R&D.

Section 11D(7) acknowledges that a firm can receive other funding from government, public entity or municipality towards its R&D activities.  An amount equal to such a funding will be excluded when the R&D tax deduction is calculated. This is to ensure that only the R&D expenditure incurred by the company qualifies. A company cannot claim for the R&D tax deduction of 150% for the amount of a government grant for the R&D expenses.