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By Edwin Naidu
Tax practitioners in South Africa have criticized the lengthy research and development tax credits process, calling for an appeals mechanism to improve the current system.
The comments—suggesting the process to obtain tax incentives is more akin to a “disincentive"—follow a Jan. 16 draft interpretation note published on the South African Revenue Service website inviting comment on how to improve and clarify rules for encouraging private sector investment in research and development.
“It takes over three years to file and complete a response, and there is still no provision for an appeal process despite widespread requests for such a mechanism,” leading Johannesburg tax practitioner Darren Margo told Bloomberg BNA in a Jan. 19 interview.
The National Treasury introduced the rules, Section S11D, in 2006 to encourage private-sector investment. The Department of Science replaced SARS in the administration of the R&D Incentive in 2012.
The incentive is part of an extensive package of policy instruments driven by the Department of Science, along with SARS, Department of Trade & Industry, Technology Innovation Agency and National Treasury in an effort to promote innovation and enhance competitiveness, supporting economic growth.
In its 2016 Budget Review, the National Treasury, estimated that over 6 billion rand ($443,162,187) in tax revenue was foregone through the R&D tax deductions for the period 2005 to February 2015.
Margo said the latest note has put up barriers instead of simplifying the process, and “is not an incentive but a disincentive.”
The greatest challenge, he said, is the requirement by the Department of Science for companies to submit R&D incentive applications before completing projects. This means it could take up to three years to finalize an application for incentive.
Margo said the note had been drafted without the input of legal and finance professionals as the Department of Science had excluded patent attorneys whose input he deemed essential, from the process.
“I’m skeptical of the note having a positive impact. It papers over the cracks, without addressing issues such as the time it takes to finalize an application, and more significantly, the absence of an appeals process,” he said. “The public has long been asking for inclusion of an appeals process, and this has not been heard,” he said.
A government task team investigating the R&D tax incentive found that there were lengthy delays in May. 2016 in receiving feedback on applications and consequent prejudice suffered by applicants.
At an Aug. 2016 workshop, the team referred to the method of submitting applications and the long turnaround times in providing the final decision to applying companies. This system needed to be reviewed, taking into account lessons from other jurisdictions that administer R&D incentives.
In an earlier April 2016 report, the task team said that corporate income tax rates are expected to resume their long-term fall, warning that tax competition could reduce the generosity of the 150 percent tax deduction for multinational enterprises.
This, it stressed, could make the South African incentive less competitive in the international context.
The relative after-tax cost of R&D is a major consideration for multinational firms with R&D activities. They tend to carry out their R&D activities where it is cheaper and where it promises the most benefits, said the task team’s report.
Tax incentives are part of the equation for comparing the net private cost of R&D. Firms also look for tax implications of intellectual property and transfer pricing, availability of inputs and markets, as well as the potential for tapping into existing knowledge networks, it added.
Duane Newman, joint managing director of Johannesburg-based incentives experts, Cova Advisory & Associates, told Bloomberg BNA that the biggest criticism is over the lack of certainty for companies since the incentives took effect in 2012.
“The main challenge was capacity of the Department of Science to handle the wave of applications from industry which occurred at once,” said Newman.
He added that to their credit, the department held workshops and remained transparent throughout the process, “for which they should be commended. But it has not solved the problems.”
Newman admitted that administration under the department has improved. Companies were supportive of its handling of incentives but the challenge of applying for the incentive before the R&D project is completed remains a hurdle.
“There has been debate about the timing of the application. Should it be before or after the R&D is complete?” he asked.
Newman said South Africa should follow global best practice and submit an application after the R&D is done but before a tax return needs to be submitted. This would reduce the uncertainty of whether R&D does qualify or not.
“While an interpretation note from SARS is welcome, the DST also put out a guide on S11D and it is important that one document is prepared for taxpayers to use,” he said.
Godfrey Mashamba, chief director for Science and Technology Investment in the Department of Science and Technology, told Bloomberg BNA the department is mindful of concerns around the incentive and the need for an appeal process.
Mashamba referred inquiries about the appeal process to the National Treasury. He did however reveal that the department has already begun addressing concerns around this through complaints made via the Promotion of Administrative Justice Act when administering the incentive. In this way, he said before an applicant for incentive is turned down, the applicant would be given an opportunity to present mitigating facts.
“The objective of the incentive is to stimulate higher levels of private sector R&D in the country,” he said.
Mashamba said that it was a concern that some applications had taken longer to be processed but the Department of Science has put in place measures to deal with bottlenecks.
“We hope that the negative impression created by administrative backlogs in the past years has not discouraged firms from investing in R&D locally. Things have improved, for instance, by 31 December 2016, about 88% of the 1,125 applications received had been adjudicated—compared to 75% of the 1,032 applications in March 2016.
“The applications received in 2016 have been easier to process quicker due to the improved quality of applications submitted by companies,” he said.
Academic John Butler-Adam, a consultant to the University of Pretoria, told Bloomberg BNA the note is incredibly wordy and, in some instances, repetitious.
“In trying to provide clarity, many issues are over-worked and there are also inconsistencies. Much is made, for example, of the importance of work/materials/objects to be ‘not commonplace; new; and innovative.’ But it is very difficult to understand how something can be both new and not commonplace, without being (most likely) innovative,” he said.
Regarding the absence of an appeal process, Butler-Adam said administrators must provide reasons for a decision, therefore, it makes no sense, not to have an appeals process.
Keith Engel, chief executive of the South African Institute of Tax Professionals, told Bloomberg BNA there was no major change to the legislation in the note.
“The procedures are slow, and people are finding it hard to get through the system, the debate now is about whether proposed changes could make it easier or even more difficult,” he said.
Comment on the note must be submitted by Feb.10.
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