Status update on processing of application for the R&D tax incentive Godfrey Mashamba Chief Director: Department of Science and Technology Presentation to the Standing Committee on Finance (SCOF), 04 August 2015

Contents Part 1: Introduction and overview of the R&D tax incentive Part 2: Uptake by companies since 2006 Part 3: Status update in processing applications Part 4: Measures in place to improve efficiency

Part 1: Introduction and overview of the R&D tax incentive

Overview of the R&D tax incentive programme Companies undertaking R&D in South Africa qualify for a tax deduction in terms of Section 11D of the Income Tax Act (1962), as amended. The incentive is part of a package of policy instruments to promote economic growth, enhance competitiveness and other broader objectives. Through this incentive, the government wants to encourage increased R&D in the business sector, by firms of any size or industry. This is important in order to: Increase the overall investment in R&D. Promote innovation, i.e. development of new products, processes and services. Promote technological advancement and competitiveness. Secure innovation spillovers and retain R&D workforce. The incentive comprises a deduction of 150% on qualifying R&D expenditure. This puts South Africa amongst the countries in the world that offers generous R&D tax incentives.

Overview of the R&D tax incentive programme (2) To be eligible for the incentive, a company’s activities must be approved by the Minister of Science and Technology (applicable from 1 October 2012). A company must: Be an incorporated entity and recognised under the Companies Act (Act 71 of 2008). Individuals, non-profit organisation and trusts are not eligible. Be engaged in eligible R&D activities within the Republic. Incur R&D expenditure on or after the date of receipt of the application by DST, and such R&D expenditure must be incurred in the production of income.

Overview of the R&D tax incentive programme (3) Companies can claim the tax deduction on a retrospective basis from SARS for R&D expenditure incurred prior 1 October 2012. Since 1 October 2012 taxpayers require approval from the Minister of Science and Technology for R&D activities before claiming the deduction. The adjudication committee brings together crucial capacities from DST, NT and SARS to implement this incentive. The 2012 amendments have attracted new participants to the R&D tax incentive. Application submitted to DST by company DST Evaluates Application and makes recommendation yes If not completed, return to previous step Adjudication committee makes recommendation to Minister yes Minister makes Final Decision yes Letter sent to company

Why does the government support private sector R&D? The 2002 National Research and Development Strategy (NRDS) identified declining and weak business R&D investment as a key constraint to the country’s economic growth and development. Generally, the rationale for incentivising R&D is based on a market failure argument, that private sector is likely to under-invest in R&D, because of: Challenges of inappropriability of the results of R&D. Long term nature of tangible benefits from R&D. High risk associated with R&D creates a funding gap within the firms (especially SMEs and start-ups). Inability to attract external funding due to information asymmetries (especially SMEs and start-ups).

Why does the government support private sector R&D? (2) Positive externalities: Knowledge developed from R&D, the human capital as well as learning and technology adoption and usage by other companies create greater societal returns. Long-term returns from R&D far outweigh the tax expenditure that the government foregoes in the short term. Counterarguments exist, however, that R&D tax incentives create unnecessary distortions to economic efficiency and tax equity, and also create an additional burden with respect to tax administration.

Part 2: Uptake by companies since 2006

Uptake: Yearly number of companies taking part in the incentive (Nov 2006 to Feb 2015) On average, about 260 companies took part in the programme per year between 2007/08 and 2014/15. A company can apply on a yearly basis. Legislative changes in October 2012 meant that companies could access the incentive either as retrospective claims for R&D undertaken prior to 1 October 2012 or apply for pre-approval of R&D planned for after that date.

Part 3: Status update in processing applications as at 30 June 2015

Processing of pre-approval applications per year (as at 30 June 2015) Reporting period* Number of applications Applications withdrawn Applications adjudicated Remaining stock still to be adjudicated October 2012 to December 2012 244 6 218 20 January 2013 to December 2013 311 3 266 42 January 2014 to December 2014 238 2 97 139 January 2015 to date (June 2015) 112 8 104 Totals 905 11 589 305 * Reporting periods are defined to reflect the periods covered by successive legislative amendments A total of 905 applications have been received since Oct 2012 to date. 27% (244) of these were received in the three months October to December 2012. The initial slow momentum in the adjudication process, largely due to internal DST capacity constraints and the learning in the whole process, resulted in the build-up of backlog which has since been carried over to the subsequent years.

Number of applications Progress in adjudicating applications per quarter (as at 30 June 2015) Number of applications

By number of projects contained in the applications Progress in adjudicating applications per quarter (projects) (as at 30 June 2015) By number of projects contained in the applications

Tracking the backlog – Remaining stock of applications per quarterly periods (as at 30 June 2015) Red – more than 12 months Amber – 6 to 12 months Green – less than 6 months The 62 applications with dates of 2012 and 2013 are prioritised for finalisation by 2nd week of August. Companies have been given a deadline {week ending 24 July} to submit information, failing which adjudication will proceed on the basis of what is available already. This approach will be repeated every other month to address the oldest 3-monthly batches of applications. The Jan-Mar 2014 stock (38) will be prioritised next.

Finalised applications: Approvals/Non approvals per industry  Description Approvals Part-approvals Non-approvals Totals 10000 – Agric, hunting, Forestry and Fishing 15 3 18 20000 – Mining and Quarrying 8 7 30000 to 39000 – Manufacturing 115 60 112 287 40000 – Electricity, Gas & Water Supply 4 10 50000 – Construction 60000 – Wholesale & Retail Trade 1 70000 – Transport, Storage & Communication 13 21 80000 – Finance & Business Services 39 20 174 233 90000 – Community, Social and Personal Services 177 96 316 589 The highest number per sector of finalised applications is manufacturing with 287 (or 43% of all adjudicated), followed by finance and business services with 233 (40%). This adds to 88% of total adjudicated to by 30 June 2015. A very large proportion of finance and business services are ICT activities (including software development). Such applications have a high rate of non-approvals at 75%. In terms of R&D expenditure, manufacturing constitutes 44%, followed by finance and business services (35%) and then mining (25%). This add up to 90% of all the adjudicated applications to date.

Common reasons for non approval of ICT related activities Lack of relevant information in an application. Internal business process, which are excluded in terms of the Act. Not innovative, i.e. Activities commonly available in the market – wherein no indication is given about what new knowledge would be discovered and/or any scientific or technological activities being undertaken or how the intended work compare to existing technology. Activities proposed lacking technological uncertainties. Routine upgrades and/ or maintenance.

Part 4: Measures to improve efficiency

Measures put in place to improve efficiency Adjudication on Pharmaceuticals and Clinical Trials applications has commenced, following gazetting of Regulations by Minister of Finance on 23 April 2015. “R&D Incentive Online” – A new IT system is being developed to enable online submission of applications. Testing is currently underway. External experts have been appointed and they are making the required impact in terms of volumes and quality of advise informing decisions. Guidelines are being finalised to incorporate aspects of the online submission system. The DST has schedule events to interact with companies in order to improve understanding of the information requirements for making an application.

Presentation www.dst.gov.za THANK YOU Godfrey Mashamba Chief Director: Science and Technology Investment Department of Science and Technology Cell: +2782 804 3758 Tel : +2712 843 6425 E-mail : Godfrey.Mashamba@dst.gov.za Presentation www.dst.gov.za