More trouble than it’s worth?

A fairly generous deduction is allowed under the Income Tax Act in respect of research and development, but it’s not that easy to claim.

Peter O’Halloran - Tax advice

The deduction allowed for research and development (R&D) is available under current legislation only until 2022. As is to be expected, not everything related to R&D is deductible. In fact, the deduction is subject to stringent and narrow interpretation and requirements.

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Section 11D of the Income Tax Act mentions five categories: non-obvious scientific or technology discoveries; inventions, designs, innovative computer programs and associated essential knowledge; making significant and innovative improvements with respect to the foregoing; creating a multi-source pharmaceutical product; and conducting clinical trials.

The collation of data in the normal course of business does not qualify, neither does development of internal business processes, unless the development is done for resale on an arm’s-length basis. Also excluded are market research, oil/gas/mineral exploration and so forth.

Broadly, the rules provide that a company making the expenditure within South Africa for purposes of trade can deduct
150%. The minister of science and technology must, however, approve the expenditure according to a list of criteria. Only expenditure gone into on or after the date of approval qualifies.

The acquisition of immovable property, equipment and associated accoutrements is not allowable expenditure, save for expenditure in respect of assembly of a prototype. The latter should not be assembled for manufacture or resale, but be built for R&D only. Costs relating to administration or compliance are excluded as well.

The funding by a taxpayer of another taxpayer’s R&D is allowable as a deduction in the amount of 150% of the expenditure, subject to strict provisions. These include approval of the minister and the fact that the funded entity is an associated company.

A further limitation is that the exemption applies only to the actual amount spent, not the amount originally made available.
The minister’s approval can be withdrawn if reporting commitments are not adhered to, or if a material change of facts occurs, or in the case of misrepresentation.

As attractive as the 150% deduction is, better terms are available in special purpose vehicles in countries close by, with no sunset clauses and less red tape. Alternative jurisdictions would certainly be more welcoming and accommodating and offer better incentives.