Module 1: What R&D incentives are

After this module you will be able to explain the three forms an R&D tax incentive can take, follow each one from the eligible costs to the tax bill or the bank account, and recognise the features the seven schemes share, so that any country page on this site makes sense on a first reading. Finance teams who want the calculation detail should continue to Scheme mechanics in the In-House Finance Team Program.

What this module covers

• What an R&D incentive rewards and why it runs through the tax system.
• The three forms of benefit: a credit, an offset or payable credit, and an enhanced deduction.
• How a benefit reaches the company: a smaller tax bill, a cash payment, or a carry to another year or another tax.
• What happens when there is no tax to pay.
• The features every scheme has in common, and the four points on which the seven countries differ.

What the incentive rewards

Every one of the seven schemes does the same basic thing. It takes money a company has already spent on research and development and returns part of it through the tax system. Governments do this to encourage more R&D than companies would fund on their own, and they use the tax system because every company already files a return.

Three consequences follow for a beginner. First, the incentive is a tax claim: it is made in, or alongside, the tax return, and it uses the tax authority's definitions, not the company's. Second, it rewards spending that has already happened, so the claim is prepared after the year end even though the records that support it are made during the year. Third, the tax authority can review the claim afterwards like any other entry in the return, which is why the later modules spend so much time on evidence.

Three forms of benefit

A credit is a percentage of the eligible costs, subtracted directly from the tax the company owes. A credit of 100 reduces tax by 100. Whether it is worth anything to a company with no tax to pay depends on whether the scheme makes it refundable, lets it be carried to another year, or lets it be set against a different tax.

An offset or payable credit works like a credit but is designed to be paid out in cash when it exceeds the tax due. The cash element usually comes with a condition, such as a turnover limit, a cap linked to the payroll taxes the company has paid, or payment spread across instalments.

An enhanced deduction does not touch the tax bill directly. It increases the amount deducted from taxable profit, so its value is the extra deduction multiplied by the company tax rate. As illustrative arithmetic, an extra deduction of 100 at a tax rate of 20% is worth 20 in tax saved. This is why deduction schemes quote large percentages that cannot be compared with credit rates until both are converted into tax saved.

Tax bill or bank account

Follow the money and there are only three destinations. The benefit can reduce the tax due for the year, which helps a profitable company at the point the return is processed. It can be paid out in cash, which is what makes a scheme useful to a loss-making or pre-revenue company, and which is where turnover limits, payroll caps and instalment rules appear. Or it can be carried: forward to a later year, back to an earlier one, or across to a different tax such as payroll tax.

Timing follows the route. A reduction in tax arrives when the return is processed. A cash payment arrives when the tax authority pays it, which may follow the return, follow a registration or approval step, or be spread across more than one year. Module 4 sets these steps in order.

What the seven schemes have in common

Beneath the different names and rates, the seven schemes are built from the same parts, and the rest of this program takes them one at a time.

1. A definition of R&D built around a scientific or technological uncertainty and systematic work to resolve it. Module 2.
2. A list of eligible cost categories, with staff costs the largest in most claims, and rules for contractors, materials and overheads. Module 3.
3. A claim made in or alongside the tax return, in some countries after a registration, notification or approval step. Module 4.
4. An expectation of records that show the uncertainty, the work done to resolve it and the costs, made at the time rather than reconstructed later. Module 5.
5. A review power, under which the tax authority can ask for those records and reduce or recover the benefit if they do not support the claim.
6. A preference for work done in the country, expressed through limits on overseas and contracted costs that vary in strictness.

The schemes differ on four points: the form of the benefit, its rate, whether and how it can be paid in cash, and whether anything must be filed before the claim. The table below covers the first, third and fourth; the comparison page sets the rates side by side.

Illustrative example

Illustrative example. Harbour Robotics Ltd, a hypothetical company, spends 100,000 on eligible costs in a year. Under a credit scheme at the New Zealand rate of 15% of eligible R&D expenditure, the credit is 15,000. If the company owes 10,000 in income tax, the credit removes that bill and leaves 5,000, which is refundable in some cases, with refunds capped including by reference to labour-related taxes, or otherwise carried forward (see refundability in New Zealand). Under a deduction scheme, if the same 100,000 were all staff costs and consumables for R&D carried out in Singapore, the 400% deduction on the first S$400,000 gives a deduction of 400,000. At the Singapore corporate income tax rate of 17 percent that deduction is worth 68,000 in tax, of which 17,000 is the ordinary deduction any business expense would earn, so the incentive itself is worth 51,000, provided the company has enough taxable profit to absorb it (see enhanced deductions in Singapore). Same spend, two mechanisms, and neither figure means anything until the profit position is known.

Across the seven countries

Where to go next

• Compare R&D incentives by country: the seven schemes side by side.
• Scheme mechanics: the finance team version of this module.
• Running a claim: guides on preparing, filing and managing a claim.
• Start here: how the site is organised.
• R&D Tax Fundamentals: the program overview and the other four modules.