RESEARCH AND DEVELOPMENT: INCOME TAX TREATMENT

The need to become more technology proficient and being actively engaged in the scientific and technological innovation space, has become a top priority for a lot of companies because of the fast-paced changes in the world today (VUCA). It has become an “innovate or fall away” market place and the need has increased for companies to actively engage in activities that consist of Research and Development not only for the tax benefits that these expenses could possibly provide, but because it is a way to ensure that companies continually motivate and their businesses are sustainable for the future if executed properly.

Section 11D of the Income Tax Act was introduced in 2006 to provide businesses with an incentive to invest in research and development of scientific or Technological activities with the full support of the Department of Science and Technology. Ever since the introduction of this section there have been changes made to the section and it was redrafted in its entirety in 2012 in terms of the Draft Taxation Laws Amendment Bill. The new section that was redrafted in 2012 was made applicable to ‘Research and Development” expenditure that was incurred on or after 1 April 2012 but before 1 April 2022, effectively making it applicable for that 10-year period. Since companies usually plan for these types of expenses for the long run it seems as if a rug is ready to be pulled under the feet of the taxpayers for this deduction, but however it is worth analysing the benefits or any disadvantages that this section presents, while there is still time.

Section 11D: Research and development

In its entirety Section 11D has the main substantive provisions which are contained in section 11D (1) -(10) and the more stringent administrative provisions which are contained in section 11D (11) -(18). The first few sections of the section deal with the meaning of the phrase, “Research and Development”, as well as a few other technical factors that need to be considered. The intention is made clear of what kind of scientific research and development can qualify for the 150% deduction, and the Tax Legislation tries not to leave a lot of room for ambiguity for what is applicable. However, the focus will be on software that is developed by companies because of the comprehensive and detailed nature of Section 11D.

In terms of the Income Tax Act of 1962 and after all the amendments, Research and Development is “the systematic investigative or systematic experimental activities for:

(a) Creating or developing –

(i) An invention as defined in section 2 of the Patents Act

(ii) A functional design

(iii) A computer program as defined in section 1 of the Copyright act which is of an innovative nature

(b) Making a significant and innovative improvement to any invention, functional design, computer program or knowledge, to new or improved function, “

The new Section 11D goes on further to also include the expenditure that is incurred in improving these kind of programmes and designs. This must be some kind of silver lining included in the new Section 11D as the previous incarnation never included expenditure incurred on improving such designs. However, this expenditure must be incurred by the companies “directly and solely in respect of Research and Development undertaken in the Republic”.

Therefore, if a company decides to take on Research and Development in the form of any software programmes and patents, and incurs expenses on any initial and any improvement on such designs given that it is in the republic and these expenses are incurred for the purposes of trade and in the production of income, then the 150% deduction is not far from reach.

Section 11D also excludes certain research and development that includes activities where expenses are incurred for:

“development of internal business processes unless those business processes are mainly intended for sale or for granting right of use…”.

This is often the struggle for companies as to what kind of software development is similar to the wording in the provisions, that provides for what is excluded as Research and development. Recently there was a court case and an interesting judgement that was handed down by the Cape Town Tax court in 2015 between ABC (Pty) Ltd v The Commissioner for the South African Revenue Service (IT13541) and a detailed explanation and an opinion on the thoughts of SARS can be found in that judgement on exactly what he deems to be part of “internal business processes”. This is one of the more objective matters that need to be considered and critically analysed by any companies in pursuant of these types of Research and development.

The latter part of Section 11D includes the administrative requirements which are the biggest hurdle of this whole section, because the section now provides for the establishment of a statutory committee which will look at applications of taxpayers in respect of this expenditure. Applications must be made to this Statutory committee to try get approval for the 150% deduction.

Therefore, the requirements of Section 11D are quite stringent and strategic considerations need to be made by those in charge of governance on whether the benefit will outweigh the costs on implementation of these projects.

CONCLUSION

Valuable tax allowances are therefore on the table, but the process that has been introduced by Section 11D for claiming the extra deduction involves a lot of technical knowledge, and the process can be lengthy and tedious. Expert knowledge on the principles of tax law will be useful in these circumstances and companies are advised to seek the proper advice to assist in the documentation required and the information needed by SARS.

This article is a general information sheet and should not be used or relied upon as professional advice. No liability can be accepted for any errors or omissions nor for any loss or damage arising from reliance upon any information herein. Always contact your financial adviser for specific and detailed advice. Errors and omissions excepted (E&OE)

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