RESEARCH AND DEVELOPMENT TAX INCENTIVE PROGRAMME

1. RESEARCH AND DEVELOPMENT TAX INCENTIVE PROGRAMME Godfrey Mashamba Chief Director Briefing to the Portfolio Committee on Science and Technology 27 August 2014

2. Presentation content • Overview of the R&D tax incentive programme • Uptake by companies • Impact areas: • R&D expenditure • Contribution to industry sectors, SMEs and industrial policy focus areas • Results of R&D supported through the incentive (including new products) • Process of tabling the 2013/14 annual report on the R&D tax incentive to Parliament

3. Overview of the R&D tax incentive programme • Companies undertaking R&D in South Africa qualify for a tax deduction in terms of Section 11D of the Income Tax Act (1962), as amended. • The incentive is part of a package of policy instruments to promote economic growth, enhance competitiveness and other broader objectives. • Through this incentive, the government wants to encourage increased R&D in the business sector, by firms of any size or industry. This is important in order to: • Increase the overall investment in R&D. • Promote innovation, i.e. development of new products, processes and services. • Promote technological advancement and competitiveness. • Secure innovation spillovers and retain R&D workforce. • South Africa is amongst the countries in the world that offers generous R&D tax incentives, offering up to 150% in tax deductions.

4. Overview of the R&D tax incentive programme (2) • To be eligible for the incentive, a company’s activities must be approved by the Minister of Science and Technology (applicable from 1 October 2012). • A company must: • Be an incorporated entity and recognised under the Companies Act, (Act 71 of 2008). Individuals, non-profit organisation and trusts are not eligible. • Be engaged in eligible R&D activities within the Republic. • Incur R&D expenditure on or after the date of receipt of the application by DST, and such R&D expenditure must be incurred in the production of income.

5. Overview of the R&D tax incentive programme (3) • Companies can claim the tax deduction on a retrospective basis for R&D expenditure of prior 1 October 2012. • Since 1 October 2012 taxpayers require approval from the Minister of Science and Technology for R&D activities before claiming the deduction . • The adjudication committee brings together crucial capacities from DST, NT and SARS to implement this incentive. • The 2012 amendments have attracted new participants to the R&D tax incentive (refer to slide 8). Application submitted to DST by company DST Evaluates Application and makes recommendation no yes Adjudication committee makes recommendation to Minister no yes Submit recommendation to Minister of Science and Technology yes Minister ‘s Final Decision no yes Letter sent to company

6. Why does the government support private sector R&D? • The 2002 National Research and Development Strategy identified declining and weak business R&D investment as a key constraint to the country’s economic growth and development. • Generally, the rationale is based on a market failure argument, that private sector is likely to under-invest in R&D, because of: • Challenges of inappropriability of the results of R&D. • Long term nature of tangible benefits from R&D. • High risk associated with R&D creates a funding gap within the firms. • Inability to attract external funding due to information asymmetries.

7. Why does the government support private sector R&D? (2) • Positive externalities: • Knowledge developed from R&D, the human capital as well as learning and technology adoption and usage by other companies create greater societal returns. • Long-term returns from R&D far outweigh the tax expenditure that the government foregoes in the short term. • Counterarguments exist, however, that R&D tax incentives create unnecessary distortions to economic efficiency and tax equity, and also create an additional burden with respect to tax administration.

8. Uptake: Yearly number of companies taking part in the incentive (Nov 2006 to Feb 2014) • Between November 2006 and February 2014, a total of 820 companies have taken part in the incentive. • The number of participating companies has increased gradually since 2007, peaking at 414 in 2012/13. Legislative changes in October 2012 meant that companies could access the incentive either as retrospective claims for R&D undertaken prior to 1 October 2012 or apply for pre-approval of R&D planned for after that date.

9. Uptake: Participation per industry sector • The incentive is accessed by companies from all the industry sectors. More than 80% of the participating companies come from the two sectors, namely the manufacturing and the financial intermediation, real estate & business services (i.e. software development). • These patterns have remained the same over the years and resemble the country’s business R&D situation as reported by the national R&D survey.

10. Uptake: Participation by size of company (using latest year turnover declared by company) • Small and Medium Enterprises (SMEs) make up 46.7% (383) of the total number of participating companies., the same proportion as large companies. The remaining 6.6% (54) of companies are undisclosed in terms of turnover size. • The percentage of SMEs applying for the incentive has increased in the past 2 years, following the October 2012 amendments.

11. Amount of R&D investment leveraged by the incentive (Nov 2006 to Feb 2014)

12. Reported R&D expenditure per industry sector • Only the amounts retrospective claims of pre-October 2012 are reported above. • The bulk (68%) of the R&D expenditure supported is in the manufacturing sector, followed by 12% in the financial intermediation, real estate & business services (i.e. software development).

13. Reported R&D expenditure in terms of contribution to industrial policy priorities • The incentive shows a strong orientation in leveraging R&D that supports the priority focus areas of the current National Industrial Policy Action Plan (IPAP), with about 74.5% of participating companies in those areas, accounting for R19.6 billion (or 55.8%) of the reported R&D expenditure. • The top four of the IPAP sectors in terms of supported R&D spending are: • upstream oil and gas, with R4.6 billion. • chemical, cosmetics, pharmaceuticals and plastics, with R3.9 billion. • electrotechnical and ICT, with R3.8 billion. • Automotives, components, medium and heavy commercial vehicles, with R3.3 billion.

14. Reported R&D expenditure in terms of company size • Most (80%) of the R&D expenditure is reported by companies with turnover of R100 million and above. SMEs (turnover of R40 million and below) have reported less than 10% of the R&D expenditure. The DST continues to monitor the uptake by SMEs closely to determine if any changes are needed.

15. Results derived from the R&D supported by the incentive

16. Results derived from the R&D supported by the incentive (2) • The results of R&D indicated in the previous slide are a simplified aggregation administrative data available at the DST, as reported by companies. They are in no way showing a complete picture of the effect or impact of the incentive. This is so because some of the results of R&D take several years to materialise. • Further work is necessary to appropriately quantify the impact of the incentive. To begin this process, the data between the DST and SARS need to be reconciled (to address timing differences and stages of data points), e.g. number of beneficiary companies, R&D expenditure and the actual deduction allowed by SARS.

17. Results derived from the R&D supported by the incentive (2) • Appropriate methodologies can then be applied in estimating the impact at different levels, i.e.: • Additional/incremental R&D induced by the incentive. • The 2nd order effects – in terms of creating new knowledge, patents, propensity to come up with innovative new products, etc. • 3rd order effects – economic performance of beneficiary companies in term of revenues from new products, productivity, profitability, etc. and attracting new R&D performers and international R&D.

18. Process for tabling the 2013/14 annual report on R&D tax incentive to Parliament • Section 11D(17) of the Income Tax Act requires the Minister of Science and Technology to report to Parliament, annually, on the direct benefits of the R&D activities encouraged by the incentive programme in contributing to economic growth, employment and other broader government objectives. • The 2013/14 report is being finalised within the DST and will be submitted for tabling to Parliament upon approval.

19. THANK YOU www.dst.gov.za