LA ACTITUD HACIA EL PRODUCT PLACEMENT

[Applicable provision: Section 11D]

I. Background

Innovation, research and technological development are key factors for improved productivity (leading to new or improved products, processes or services). This enhanced productivity is a necessary condition for increased economic growth and international competitiveness. Research and development can also result in knowledge spillovers and assist in developing skills in the economy. Government recognises the importance of R&D and seeks to encourage higher levels of R&D expenditure and investment. South Africa offers a variety of direct subsidies for R&D through the Department of Science and Technology and in addition the tax regime provides incentives aimed at ensuring that the local R&D environment is sufficiently attractive.

It should be noted that the objective of the R&D tax incentive is to generate additional R&D expenditure, not merely to provide tax relief for R&D expenditure that would have happened in

the normal course of business. The success of the R&D tax incentive will be measured against this metric and the extent to which the success of R&D translates into higher levels of domestic productivity, economic growth, skills development, employment and taxable income in future.

The tax incentive for R&D is two-fold. Firstly, operating expenses incurred directly and solely for purposes of conducting R&D are 100 per cent deductible. In addition, capital expenses also qualify for an immediate 100 per cent expensing (write-off).

This favourable tax treatment is extended to operating expenses that may be characterised as being capital in nature (oftentimes, such expenses lead to the creation of an intangible asset).

Secondly, these qualifying expenses generate a further 50 per cent deduction if the R&D is approved by the Minister of Science and Technology. Thus, some R&D expenses may be eligible for a 150 per cent deduction (i.e. where ministerial approval has been granted).

II. Reasons for change

Information uncovered by the adjudication committee during the approval process for the additional 50 per cent uplift reveals that the incentive can possibly be claimed in respect of some R&D activities that were never intended to fall within the ambit of this regime. An example of such activities is R&D ‘related’ expenditure incurred to upgrade internal businesses that are subsequently sold to connected parties. The language in the provision also gives rise to uncertainties in interpretation and can be a deterrent to certain legitimate applications. Such anomalies need to be addressed in order to accelerate the adjudication and approval processes.

Taxpayers view the current definition of R&D as automatically qualifying for the 50 per cent uplift. The ministerial approval process was meant to require extra effort by taxpayers to be eligible for the uplift. The intent behind this was to ensure that government subsidises R&D expenditure that was unlikely to have occurred in the absence of the incentive, again the need for some additionality.

III. Proposal

The existing R&D tax incentive regime has been revised to achieve the following main objectives:

1. To align the 100 per cent and 50 per cent deductions. The application by taxpayers to the Minister of Science and Technology will be for the 150 per cent deduction.

2. To ensure a more robust definition of R&D, requiring that R&D for the purpose of this incentive will be innovative in nature (including improvements). Government wishes to encourage R&D expenditure that yields positive externalities for the economy, while recognising that much R&D taking place in South Africa is akin to reverse engineering.

3. To simplify and streamline the legislation for ease of use.

In summary, the amendments are as follows:

1. Adjustments to the R&D definition;

2. Clarification of R&D exclusions;

3. Clarification of section 11D deductible R&D expenditures;

4. Clarity of allowable R&D expenditure to be provided in regulations; and 5. Miscellaneous.

A. Adjustments to the R&D definition

To streamline and simplify the regime, R&D expenses will qualify for 150 per cent deduction if the R&D expenditure (i) meets the definition of R&D, (ii) is approved by the Minister of Science and Technology and (iii) the R&D activities are undertaken in South Africa. It is therefore crucial that the definition for R&D is sufficiently robust and attracts genuine R&D that is innovative.

The first part of the definition focuses on the creation and development aspects whilst the second part of the definition focuses on improvements. Both parts will be subject to the innovative requirement and improvements will also have to result from ‘systematic investigative or systematic experimental activities of which the result is uncertain for the purposes of…’ – a requirement that is currently only linked to the creation / discovery of knowledge aspects. In terms of the creation and development aspect of the definition, the creation or development should lead to:

1. An invention capable of registration under the Patents Act; or

2. A design capable of registration under the Design Act, but only functional designs of a scientific and technical nature (as opposed to designs of an aesthetic nature); or 3. Innovative commercial computer programs intended for sale or use to unrelated

customers (as opposed to internal upgrades or improved internal use by the entity and related members); or

4. Knowledge essential to the use of such invention, functional design or computer program.

The revised definition ensures that the R&D is intended for wider use than internal business use (e.g. by the taxpayer or those connected to taxpayer). Moreover, the resulting knowledge essential to the use of intellectual property has to be an integral part of the created intellectual property – not just operating manuals or instruction manuals, or documents to be utilised after the R&D is complete. The overall intent of the definition is also shifted more toward a scientific / technological bias with an added emphasis on innovation.

B. Clarification of R&D exclusions

The current R&D regime contains a number of exclusions that should more rightly be viewed as exclusions to the R&D definition instead of a denial of deductible section 11D expenditures.

These exclusions are accordingly adjusted as a counterpart to the R&D definition itself.

Certain specific forms of knowledge (for example, management, enhancement of internal business processes, social science and humanities, market research, sales or marketing promotion) fall outside the scope of the incentive.

C. Clarification of section 11D deductible R&D expenditures

1. Excluded expenditures

R&D expenditure is fully deductible even if the expense is of a capital nature. Expenses of a capital nature are included for the purposes of the deduction because taxpayers should not lose the deduction if activities lead to the development of an intangible asset. However, this allowance of expenses of a capital nature also arguably allows for the immediate deduction of capital allowance assets (e.g. buildings and machinery) when these items should be depreciable over time as specified elsewhere in the Act (e.g. section 12C). Capital allowance assets (and registration expenses associated with intangibles), other than prototypes and pilot plants created solely for the purposes of research and development, will accordingly be excluded from the immediate write-off.

2. South African activities must be meaningful

Under current law, the R&D tax incentive regime is available solely in respect of R&D undertaken within South Africa. The proposed legislation clarifies that these activities must have some level of significance, meaning that local persons should have some level of control over research methodology. Stated differently, the activities must enhance local skills development.

An exception to this requirement is R&D expenditure incurred for clinical trials. This will be prescribed by the Department of Science and Technology and SARS by way of guidelines and regulations.

D. Clarity for allowable categories of R&D to be provided in regulations

The Minister of Finance, in consultation with the Minister of Science and Technology, may designate certain categories of R&D by way of regulations. The regulations will prescribe the criteria for evaluating eligible and non-eligible R&D in the case of pharmaceutical companies (i.e.

clinical trials). More detail will also be provided for other types of eligible R&D expenditure, including the ICT sector.

E. Miscellaneous

1. Government and quasi-governmental funding

Current law prohibits the additional 50 per cent deduction to the extent that the expenditure is funded by a government grant (i.e. an exempt grant) and this limitation was too narrow. The exclusion has been broadened and the denial will be adopted in such a way that if R&D is funded through government or quasi-governmental agencies, there will be no 150 per cent deduction. No reason exists to provide the 150 per cent deduction when government or quasi-governmental agencies fund the expenditure. The purpose of the incentive is to enhance private funding.

2. Withdrawal of approval for additional allowance

Under current law, the Minister of Science and Technology may withdraw approval for an additional allowance (even though the R&D was previously approved) if any material facts change that would have had the effect that the approval would not have been granted. This provision does not comprehensively deal with other factors which that would necessitate withdrawal of approval, such as fraud or non-disclosure and these will be added.

IV. Effective date

The proposed amendments to will come into effect on 1 January 2014 and will apply in respect of amounts incurred on or after that date.

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