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When is research & development tax deductible?

When is research & development tax deductible?

The South African government introduced Section 11D of the Income Tax Act number 58 of 1962 to encourage and incentivise private sector investment towards the research and development of scientific or technological activities. The Act assists in ensuring that research and development activities are conducted within South Africa, and this will ultimately resulting in a positive economic growth.

Section 11D of the Act provides for two types of incentives – a 150 percent deduction of operating expenses and accelerated depreciation of any building or part thereof, machinery, plant, implements, utensil or article.

However, a taxpayer has to meet various requirements relating to the taxpayer, the particular expenditure and the research and development activities. The particular activity must also advance scientific or technological knowledge general.

Furthermore, the requirements state that the taxpayer must operate a trade and must intend to apply the research and development outcomes to generate income. Moreover, the taxpayer must have incurred the expenditure directly for research and development activities. For example, accommodation costs incurred by a researcher while attending a conference – even though the conference related to the research and development of a qualifying activity – are not tax deductible. However, expenditure incurred prior to the commencement of trade is deductible under another section.

The research and development activities must constitute a qualifying activity.

A qualifying activity comprises the discovery of novel and non-obvious information, the creation of an invention, design, computer program of scientific or technological nature or knowledge essential to the use thereof. Examples of such activities include discovering the characteristics of a compound which already exists in nature but which has been unidentified.

The invention must be novel and have an inventive step and be usable in trade, industry or agriculture. The developed invention need not form part of a patent application, but must be protectable by way of a patent. It is worth noting that certain inventions are not patentable under the South African Patent Law.

Furthermore, a design must be functional and not aesthetic and qualify for registration under the Designs Act.

Another qualifying activity is that the research and development result in the development or creation of a computer program. In terms of the Copyright Act a computer program is a set of instructions fixed or stored in any manner and which, when used directly or indirectly in a computer, directs its operation to bring about a result.

If this definition is followed, the costs for the research and development will be deductible, on condition that the developed computer program is original and of a scientific and technological nature.

The South African Revenue Service (SARS) states that software packages developed for administration, human resources or accounting purposes are excluded from the tax incentive as they constitute management or internal business processes. Moreover, SARS’s view is that all computer programs that automate internal business processes or create management efficiencies, do not qualify. This is despite the fact that even if the developed program is to be sold to third parties and not for the company’s internal use. However, this has a negative effect as it may exclude most software development companies from claiming the research and development deduction. This is a litigious issue and relevant stakeholders can only hope that SARS will in due course alter its view. Despite this, it is crucial to note that the onus is on the taxpayer to explain to SARS how the claimed activities fall within the qualifying activities.

Section 11D(5) of the Act further provides that no deduction is allowed for the costs of exploration or prospecting, trade marks, market research, legal and financial activities, sales or marketing promotion. Registration expenses to obtain and/ or renew a patent or design are deductible in terms of section 11gB.

Research funded by a third party, like commissioned work, is limited to a 100 percent, not a 150 percent deduction. If research is funded through a taxable government grant, expenditure equal to twice the grant amount is deductible at 100 percent. Costs incurred in excess of twice the grant are deductible at 150 percent. If the grant is tax exempt, expenditure equal to twice the grant amount is not allowed. However, excess of twice the grant amount will be deductible at 150 percent.

The interpretation and implementation of section 11D requires knowledge on the principles of tax law as well as intellectual property law. Taxpayers should consult with patent attorneys to assist in documenting the relevant technical information required by SARS to support the research and development claim. Furthermore, patent attorneys should inform and encourage their clients to make use of this incentive.

Tumelo Mashabela

Partner TumeloTs@adamsadams.co.za