Most countries have a more narrow definition of qualifying expenditures than used by the OECD in the “Frascati Manual”, while others feel that definitions should be adjusted to include innovation. Other targeting can also be observed. Many countries target SMEs and have richer provisions for this group. Collaborate research may also be targeted, as may be specific industries or start-up firms.
A fundamental question is whether a distinction should be made between pure research (R) and development (D). One can argue that spillover effects are more likely in the case of research, and therefore in theory preferential tax relief should be targeted at research, not development. In practice, government may target relief to research as a way to keep program costs down. On the other hand, as noted above, a large part of the social rate of return to R&D is due to imitation and diffusion of new technologies, mainly for countries behind the technological frontier. This consideration would argue in support of development relief.
Furthermore, business often claims that development opportunities are often more profitable, and therefore to boost productivity and profitability, governments should not skew relief towards the research end. It may also be noted that innovation is more directly linked with productivity gains and profitability, and that innovation is a wider concept that R&D.
Notes
1. See the decentralization website of the World Bank (www.worldbank.org/publicsector/decentralization) for an overview of the different arguments surrounding the debate on decentralization.
2. See Oates (1972) for the take-off of the fiscal federalism discussion and Oates (1999) for on comprehensive overview of the discussion in the past two decades.
3. See Joumard and Kongsrud (2003) for more details on the share of government expenditure.
4. The same applies to taxes collected at the sub-central level, and automatically transferred to the central government. This is not very common, but this is the case in Germany. There, the administrative power of tax collection is assigned to the Länder, but the federal parliament still has the legislative power on these taxes.
5. See Section 2.3 in Chapter 2, for more details about the GST in Australia.
6. This include that there is a minimum 5-year period of local residence for inheritance duties, a cooperation agreement is required for any change in the taxation of leased vehicles or vehicles owned by enterprises, and it is not allowed to reduce the progressivity of the personal income tax in order to attract wealthy taxpayers.
7. For an outline of the system before reform see OECD (1998). For a summary and a comprehensive overview of the reform, see Bundesministerium der Finanzen (2003).
8. The federal budget had to bear an annual “settlement” premium of estimated € 1.3 billion from 2005 onwards to reach the approval for the reform by the 16 Länder governments. Otherwise some Länder would have had with net losses as a result of the reform. In other words, the efficiency gains implied by the system for interstate fiscal equalization resulted in a higher burden on the federal budget.
9. The Länder to which the premium accrues deduct 12 per cent of their above-average increase in revenues from their assessment base.
10.€ 10.5 billion per year, including € 3.4 billion in earmarked grants which become part of Step 4 as a result of the reform.
11. To be precise: an origin-based income-type VAT, which is calculated by the subtraction method. In essence, the sum of profits and wages are taxed by the IRAP.
12. For more details see Section 7 in Chapter 2 on Italy.
13. Total tax revenue of state and local governments was approximately 0.51 per cent of GDP from 1996 to 2000.
14. Additionally, sole traders or entrepreneurs deriving income from trade or business and liable to local trade taxes (Gewerbesteuer) are afforded relief with the crediting of the trade tax against income tax liability. As a result, the majority of SMEs are given full relief from trade tax.
Furthermore, the restructuring of unincorporated companies by way of a tax-neutral transfer of reserves is facilitated by reintroducing the so-called “Co-partner tax remission”. This provision makes the transfer of a company easier and helps SMEs cope with inter-generational succession.
15. Under the communist regime, profit tax rates varied widely and were subject to yearly negotiation, and set with reference to firm profitability and national policy objectives. With the fall of the communist regime in November 1989, reforms of the tax system began immediately.
16. Also, in 1992, the final withholding tax rate on dividends and interest was 25 per cent. This withholding tax rate was reduced to 15 per cent in 1994 in the Slovak Republic, and in 2000 in the Czech Republic.
17. The inclusion of a “supplementary contribution” brings the basic rate (33 per cent) to 33.99 per cent.
18. A continued profit exemption applies for profits of Belgian Co-ordination Centres, the only remaining major tax expenditure. Other preferential schemes (e.g. for “redeployment companies”) were frozen in the early 1990s, and the capital investment deduction was limited to investment by SMEs and to investments that generate positive spillovers (e.g. R&D, environmental benefits).
19. A separate capital tax is levied on financial institutions.
20. Nor is the Swiss tax regime neutral if a business is sold: while a sole proprietor must report all profits as income, shareholders can pocket all of their capital gains without paying any tax.
21. A partnership would tend to be more favourable if a business is doing poorly and is running a loss, as the losses may be used to offset other taxable income.
22. Cf. Griffith (2000).
23. Tax rules allowing accounting rules to be used to determine whether R&D expenditure is deductible for tax purposes were introduced in 2001, and may remedy the perceived under-reporting.
24. The problem of unusable tax relief can be addressed in two ways: the provision of cash refunds for unused credits, or permitting a flow-through mechanism under which firms can transfer unused R&D credits to shareholders. Flow-through provisions however tend to be less efficient than direct refunds. The value to a taxable firm of a credit that can be used to fully offset current tax equals the cost of the credit to the government. Similarly, the value of a non-wastable (fully refundable) credit to a non-taxable firm equals the cost to the government. On the other hand, unused credits that are flowed through to investors are usually discounted, often heavily. In particular, the price that can be attached to an instrument that flows through one euro in credits to investors will range between the value of the credit to the investor (usually, one euro) and the value of the credit to the firm earning the credit in the absence of the flow-through (possibly zero). Depending on supply and demand conditions for flow through credits, the amount of relief provided to the R&D performer could be well below one euro.
25. A similar drawback arises where an R&D performer is located in a country with a full or partial imputation system providing individual shareholders with imputation credits based on the actual amount of tax paid.
26. For example, in the case where a firm had spent an average of € 20 million per year over the previous three years, but in the current year intends to spend € 10 million, the current year moving-average base and credit would be € 20 million and € 0. Thus, any additional R&D expenditures above € 10 million (and below € 20 million) would not generate a credit and would disadvantage the taxpayer by increasing the base in each of the following three years.
27. This can be illustrated by the following example. Assume a three-year moving average base, and a taxpayer that has spent € 10 million euro per year on qualifying R&D over the past three years, implying a three-year average of € 10 million. Compare two investment plans: one where a taxpayer continues to spend € 10 million in each year over the following two-year period, and another where investment is delayed in the current year, to make a € 20 million expenditure in the following year. While the taxpayer spends € 20 million euro in total over the two-year period in each case, zero expenditures qualify for the credit in the first case, while € 13.3 million qualifies in the second.
© OECD 2004
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(23 2004 04 1 P) ISBN 92-64-01657-0 – No. 53671 2004