Theme heading insert RESEARCH AND DEVELOPMENT TAX INCENTIVE PROGRAMME Briefing to the Portfolio Committee on Science and Technology 27 August 2014 Godfrey Mashamba Chief Director

1.Overview of the R&D tax incentive programme 2.Uptake by companies 3.Impact areas: –R&D expenditure –Contribution to industry sectors, SMEs and industrial policy focus areas –Results of R&D supported through the incentive (including new products) 4.Process of tabling the 2013/14 annual report on the R&D tax incentive to Parliament Presentation content 2

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. South Africa is amongst the countries in the world that offers generous R&D tax incentives, offering up to 150% in tax deductions. Overview of the R&D tax incentive programme 3

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 (2) 4

Theme heading insert 5 Companies can claim the tax deduction on a retrospective basis for R&D expenditure of prior 1 October 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 (refer to slide 8). Application submitted to DST by company DST Evaluates Application and makes recommendation Adjudication committee makes recommendation to Minister Minister ‘s Final Decision Submit recommendation to Minister of Science and Technology Letter sent to company yes no yes Overview of the R&D tax incentive programme (3) yes

Why does the government support private sector R&D? 6 The 2002 National Research and Development Strategy identified declining and weak business R&D investment as a key constraint to the country’s economic growth and development. Generally, the rationale 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. Inability to attract external funding due to information asymmetries.

Why does the government support private sector R&D? (2) 7 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.

Theme heading insert 8 Between November 2006 and February 2014, a total of 820 companies have taken part in the incentive. The number of participating companies has increased gradually since 2007, peaking at 414 in 2012/13. 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. Uptake: Yearly number of companies taking part in the incentive (Nov 2006 to Feb 2014)

Theme heading insert The incentive is accessed by companies from all the industry sectors. More than 80% of the participating companies come from the two sectors, namely the manufacturing and the financial intermediation, real estate & business services (i.e. software development). These patterns have remained the same over the years and resemble the country’s business R&D situation as reported by the national R&D survey. 9 Uptake: Participation per industry sector Industry sector Number of companies % to total Agriculture, hunting, forestry and fishing Mining and quarrying Manufacturing Electricity, gas & water supply Construction7 0.8 Wholesale & retail trade Transport, storage & communication Financial intermediation, real estate & business services Community, Social and Personal Services6 0.8 TOTALS820100

Theme heading insert 10 Small and Medium Enterprises (SMEs) make up 46.7% (383) of the total number of participating companies., the same proportion as large companies. The remaining 6.6% (54) of companies are undisclosed in terms of turnover size. The percentage of SMEs applying for the incentive has increased in the past 2 years, following the October 2012 amendments. Uptake: Participation by size of company (using latest year turnover declared by company) Annual turnover range (in R million)Number of companies% to total UndisclosedTurnover not indicated546.6% SMEs10 and below % 10 > % 15 > % 20 > % 30 > % Large firms40 > % 50 > % 100 and above % Total820100%

Theme heading insert 11 Amount of R&D investment leveraged by the incentive (Nov 2006 to Feb 2014) Government contribution: R3.2 billion This is the tax revenue foregone due to R&D tax deductions as per National Treasury estimates for the period 2005/06 to 2012/13 This amount indicates how much the R&D tax incentive costs the government. The amounts are updated on a retrospective basis, annually, to include new claims. Private sector R&D investment leveraged: R35.1 billion R&D expenditure amounts indicated by companies when claiming the deductions (Nov 2006 to 1 Oct 2012): R25.4 billion R&D expenditure amounts indicated by companies when applying for pre-approval of new R&D (1 Oct 2012 – Feb 2014): R9.7 billion

Theme heading insert Only the amounts retrospective claims of pre-October 2012 are reported above. The bulk (68%) of the R&D expenditure supported is in the manufacturing sector, followed by 12% in the financial intermediation, real estate & business services (i.e. software development). 12 Reported R&D expenditure per industry sector Industry sectorR&D expenditure amounts reported by companies (Nov 2006 to Oct 2012) (in R’000) % to total Agriculture, hunting, forestry and fishing Mining and quarrying Manufacturing Electricity, gas & water supply Construction Wholesale & retail trade Transport, storage & communication Financial intermediation, real estate & business services Community, social and personal services TOTALS

Theme heading insert 13 The incentive shows a strong orientation in leveraging R&D that supports the priority focus areas of the current National Industrial Policy Action Plan (IPAP), with about 74.5% of participating companies in those areas, accounting for R19.6 billion (or 55.8%) of the reported R&D expenditure. The top four of the IPAP sectors in terms of supported R&D spending are: -upstream oil and gas, with R4.6 billion. -chemical, cosmetics, pharmaceuticals and plastics, with R3.9 billion. -electrotechnical and ICT, with R3.8 billion. -Automotives, components, medium and heavy commercial vehicles, with R3.3 billion. Reported R&D expenditure in terms of contribution to industrial policy priorities

Theme heading insert Most (80%) of the R&D expenditure is reported by companies with turnover of R100 million and above. SMEs (turnover of R40 million and below) have reported less than 10% of the R&D expenditure. The DST continues to monitor the uptake by SMEs closely to determine if any changes are needed. 14 Reported R&D expenditure in terms of company size Annual turnover range (in R million) R&D expenditure amounts reported by companies (Nov 2006 to Oct 2012) (in R’000) % to total UndisclosedTurnover not indicated SMEs10 and below > > > > Large firms40 > > and above Total

Theme heading insert 15 Results derived from the R&D supported by the incentive Aggregation of data reported by individual companies (Nov 2006 to Oct 2012) 649 conference proceedings reported by 53 companies 765 scientific publications reported by 55 companies 81 companies reporting local patents 33 companies reporting international patents 1062 new products launched reported by 416 companies 111 other IP outputs reported by 50 companies

The results of R&D indicated in the previous slide are a simplified aggregation administrative data available at the DST, as reported by companies. They are in no way showing a complete picture of the effect or impact of the incentive. This is so because some of the results of R&D take several years to materialise. Further work is necessary to appropriately quantify the impact of the incentive. To begin this process, the data between the DST and SARS need to be reconciled (to address timing differences and stages of data points), e.g. number of beneficiary companies, R&D expenditure and the actual deduction allowed by SARS. 16 Results derived from the R&D supported by the incentive (2)

Appropriate methodologies can then be applied in estimating the impact at different levels, i.e.: –Additional/incremental R&D induced by the incentive. –The 2 nd order effects – in terms of creating new knowledge, patents, propensity to come up with innovative new products, etc. –3 rd order effects – economic performance of beneficiary companies in term of revenues from new products, productivity, profitability, etc. and attracting new R&D performers and international R&D. 17 Results derived from the R&D supported by the incentive (2)

Section 11D(17) of the Income Tax Act requires the Minister of Science and Technology to report to Parliament, annually, on the direct benefits of the R&D activities encouraged by the incentive programme in contributing to economic growth, employment and other broader government objectives. The 2013/14 report is being finalised within the DST and will be submitted for tabling to Parliament upon approval. Process for tabling the 2013/14 annual report on R&D tax incentive to Parliament 18

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